I have previously gone on record as a sceptic when it comes to the theory that taxing the rich more has a negative effect on the economy. Now an article in the July 2012 issue of Economia, the Chartered Accountants’ Magazine (stay awake at the back there!) does much to justify my scepticism.

The article is broadly supportive of my conclusions that it is possible to extract more tax from a country’s wealthiest citizens without making them flee the country or damaging economic growth.

Some interesting statistics:

  1. In the US the top 1% of income earners (those earning more than $344,000 per year) pay about a third of all income taxes (some $318 billion), handing over around 25% of their income to the taxman
  2. In the UKthe top 1% of income earners pay quarter of the total income tax burden.
  3. However, in the USin 1970 the wealthiest 1% took home just 9% of total USincome, whereas now that is close to 24%.
  4. In the US 22,000 households making more than $1 million per year paid less than 15% of their income in tax, and 1,470 managed to pay no federal income tax at all.
  5. In the UKabout 550 people earning more than £1 million paid a lower average tax rate than those with an Annual income of £20,000, and some 330 of these were paying a tax rate of less than 10%.

There is a long-standing theory, based on the work of economist Arthur Laffer in the 1970s, that higher taxes can reduce tax revenues, encapsulated in the so-called ‘Laffer curve’. However, there is plenty of empirical evidence to the contrary, for instance:

  1. Because many tax avoidance strategies rely on deferral of income, leaving higher tax rates in place for a significant period of time makes them harder to avoid.
  2. A key feature of making higher tax rates work is to effectively counter tax avoidance.
  3. Countries such as Sweden, Germanyand Denmark, which levy high tax rates on the wealthy, have outperformed the USand UKeconomically in the past decade.
  4. In the 1950s and 1960s the UShad very high top tax rates and its economy grew very swiftly.

Thus theUKgovernment is doing precisely the right thing by introducing a General Anti-Abuse Rule, and thus cracking down hard on those tax avoidance schemes that have the highest cost in lost tax to the Exchequer. But at the same time they are being inconsistent by reducing the top rate of income tax from 50% to 45%, when arguably they should be increasing it, but certainly holding it steady.

However. I think there is a deeper philosophical point behind all this economic analysis. If we are going to rely on investment from the wealthiest in society to stimulate sustainable economic growth in theUK, we need a long-term commitment from those people to invest and continue to invest in theUK, and thus we need people who are committed to living, working and investing in this country.

To entrust the future economic well being of this country to people who would abandon theUKat the drop of a hat is surely a massively risky economic strategy to adopt. Because even if it is not tax that causes them to abandon these shores, who is to say what other factor it might be?

Highly skilled as the British are at knocking this country, if you look around the world it is actually a really great place to live. Democracy, freedom of speech, a temperate climate, a widely spoken language, a huge variety of landscapes, small travelling distances between major cities, a multi-cultural society – shall I go on? No wonder theUKis such an attractive destination for those from other countries, and such a difficult place to leave for the indigenous population. So how hard do we need to work in cutting taxes to encourage wealthy entrepreneurs to stay or come here? I would suggest not as hard as we might think.

Finally, I recommend a perusal of the Emmanuel Saez / Peter Diamond November 2011 paper on topUStax rates as thought-provoking reading for those interested in developing a sustainable long-term tax system to theUK’s best advantage.