By Alex Estorick, Intern, Reform.
As Tim Montgomerie noted earlier today, Britain needs an agenda for keeping talented people in Britain and moving to a low tax economy should be a key part of this.
In October this year Kinetic Partners estimated that around 1,000 hedge fund managers (with an average income at £1.5 million to £2 million per year) have left the UK. They estimated that the loss to the exchequer has already reached a minimum of £500 million. City AM also recently highlighted that if bankers’ bonuses were reduced from £7 billion to £4 billion, as has been mooted, HMRC would lose £1.8 billion in revenue. One factor in these changes has been a desire to make the taxation of higher earners fairer. But should we be concerned if rich people are leaving the UK?
It is not surprising that people debate the taxation of high income earners. In an environment when many families are facing increasing costs of food, lower benefit payments and the prospect of a post-Christmas increase in VAT, attention naturally turns to ensuring that people who have incomes many, many times the pay of the average family pay their “fair share.”
Yet to have an honest debate on whether the tax system is actually fair it is necessary to first debunk certain misconceptions about taxes on higher earners. High income earners make a large contribution to tax revenue in the UK. The richest 1 per cent of taxpayers provide nearly a quarter of total income tax revenues and the richest 10 per cent provide over half. The UK relies on this group to fund a large proportion of public services.
There is concern that recent changes such as the 50p tax rate, claw-back of personal allowances and reduction in relief for pension contributions have led to the perception of the UK being a hostile (and uncompetitive) tax environment. The 50p tax rate on incomes over £150,000, for example, means the UK has the joint fourth highest top rate in the EU.
The loss of tax revenue when high earners leave the country (or decide not to come here in the first place) means that spending cuts have to be higher than otherwise, or additional tax rises are needed. So the question then becomes how do we balance fairness (such as a desire to alleviate poverty) with a desire to ensure that the tax system does not encourage the most mobile and productive workers to leave the country. One idea that has been considered in countries like New Zealand is that of a tax cap.
In 2001 a Ministerial Inquiry into the Tax System (the McLeod Review) established by a Labour Government considered the idea of a tax cap. This tax cap would limit the amount of tax that any individual would pay. The aim of the cap was to both attract high-income non-residents who may be tempted to locate to New Zealand and retain wealthy (internationally mobile) residents.
The key limitation to the tax cap (aside from the foregone revenue, which may be moderate if the gains from retaining higher earners in the tax base are considered) is the perception of fairness. How fair is it to cap the taxes of the highest income earners when so many other families are facing difficult times? The answer is, as optimal tax theory has shown, lower tax rates at the very top of the income distribution can potentially lead to higher income earners paying more, not less, tax. Given this, perhaps this is exactly the sort of approach that a fair tax system should take?
