Are the super-rich paying enough tax?

Probably not.

Robin Hood wouldn’t have approved of the trend in tax policy over recent decades. Taking from the rich to give to everyone else has fallen out of favour, especially in Britain and the US. Since the early 1950s the top rate of income tax has tumbled in the US from above 90 per cent to 35 per cent. And a mix of different types of income means many of the super-rich pay an overall rate less than that. In Britain, too, the levy on the rich has halved since peaking in the 1970s at 83 per cent. And while HMRC reports that the share of total tax paid by the top 1 per cent in the UK has increased since 1999, tough fiscal times mean politicians on both sides of the Atlantic have been casting a covetous eye over the bulging wallets of the wealthy.

While the UK’s Conservative-Liberal coalition recently edged the top rate of income tax down, there have been other proposals to force the rich to contribute more – notably the idea of a higher charge on £1m homes, the so-called mansion tax.

In the US, Barack Obama is seeking re-election on a platform of raising top-rate income tax and imposing a minimum 30 per cent tax on those earning more than $1m a year, a policy originally suggested by billionaire investor Warren Buffett. "This debate is partly about fairness," says Len Burman, professor of practice in public administration and international affairs at Syracuse University and former Treasury official under Bill Clinton. "But there is no right or wrong answer to the question of how much of their money the rich deserve to keep." There are also myths about the dangers of taxing the rich that are often repeated with little evidence to back them up, he argues.

In reality, many economists believe governments can extract more money from their wealthiest citizens without chasing them out of the country or hobbling economic growth. Most clashes on high-end taxes begin with the tricky question of justice. The starting point for this debate is one of necessity. Most governments would like more cash. Government debt held by the public in the US is on track to climb from about two thirds of national income to as high as 100 per cent over the coming decade.

"Levels this high would make America vulnerable to a debt crisis that would make the fallout from the Greek debt crisis look like a picnic," says Bob Williams, an economist at the Tax Policy Center in Washington.

Meanwhile, despite far more active effort to control spending, Britain’s fiscal position still looks precarious. Thrift by the government has been hurting growth, further undermining tax revenues.

"The depressing fact is that cuts in spending won’t be enough to fix public finances," says Joel Slemrod, a tax specialist at the University of Michigan. "Painful as it is, we will need both spending cuts and tax increases."

Many right-leaning experts acknowledge that taxes will need to rise. But they also point out that high earners already pay more than their fair share. To back this up, friends of the rich observe that in recent years the top 1 per cent have paid about a third of all income taxes in the US – an impressive $318bn. (To make it into the 1 per cent club, you need to earn more than $344,000 per year.) On average they handed over roughly 25 per cent of their income to the taxman. By contrast the bottom half of American earners chipped in just 2.3 per cent of income taxes and were taxed at an average rate of just 1.8 per cent. Close to half of Americans pay no income tax at all.

Rich Brits aren’t far behind. The top 1 per cent shoulder a full quarter of Britain’s total income tax burden. Still, these figures tell only half of the story. As Occupy protestors never tire of saying, the rich have secured a bigger share of the national pie. As a result higher tax rates would merely be clawing back part of the outsized gains in income the wealthy have claimed over the past few decades. In 1970 the wealthiest 1 per cent of Americans took home just 9 per cent of the nation’s total income. Now that is closer to 24 per cent – the highest level since 1928.

Even if America doubled the effective tax rate on the top 1 per cent this golden group would still have an after-tax income twice as high as in 1970 in real terms, according to Professor Emmanuel Saez, an economist at the University of Berkeley. Income gaps have widened in the UK too.

Public anger is also roused by the fact that some of the super-rich pay an extremely low tax rate indeed. This may be a small minority but they attract a lot of attention. In an announcement to accompany his Buffett tax plan, President Obama disclosed that 22,000 households that made more than $1m per year paid less than 15 per cent of their income in tax – and 1,470 managed to pay no federal income tax at all, according to figures for 2009 from the Internal Revenue Service.

Mitt Romney, the Republican presidential nominee, paid 15 per cent tax on his $21m income partly because his money comes from investment dividends, in a form of payment known as "carried interest", which attracts a lower tax to reward risk taking. He also donates money to charity, which would further reduce his tax liability. America also offers a 15 per cent tax rate to hedge fund managers on fees they get for investing other people’s money. 

Squeeze the rich?

A similar case can be made in the UK. Research by the Treasury showed that about 550 people earning more than £1m a year were paying a lower average tax rate than those with an annual income of £20,000. Some 330 of these super-high-income Brits were managing to get away with a tax rate of less than 10 per cent.

So there is an argument in favour of both sides of the fairness debate. But assuming politicians will have to levy higher taxes on the rich, it is worth asking how this can best be done.

For decades, right-wing economic theorists have offered dire warnings about the consequence of trying to squeeze the rich. The first line of defence is that the rich will simply manage to avoid the tax. Second, in grabbing more from the rich, governments actively retard economic growth. That leaves everyone worse off. "These theories are intuitively appealing," says Williams at the Tax Policy Center. "But the evidence that this happens in practice is not terribly compelling." 

Take the idea that government revenues actually decline as tax rates rise. In 1974, economist Arthur Laffer impressed US President Gerald Ford and advisers Donald Rumsfeld and Dick Cheney by demonstrating how higher taxes could actually reduce tax revenue. The theory behind the famous Laffer curve – first drawn on a cocktail napkin for the president – is that tax hikes encourage the rich to work less, find more creative ways to evade taxes and postpone or scrap investments. As marginal tax rates move close to 100 per cent, government revenues would actually fall to zero.

Fans of Laffer claim that the celebrated curve was recently put to the test in the UK – and passed with flying colours. Eager for revenue, the Labour government raised the top rate of tax from 40 per cent to 50 per cent in 2010. While revenue didn’t actually fall, it didn’t rise much either. Affluent Brits found various ways to avoid the hike. Bankers asked for bonuses to be paid before the tax came into effect. After the tax came into force, others asked for income to be delayed in the hope that Labour would be replaced by the Conservative Party. Some even moved overseas.

Some would argue Britain was not an entirely fair test. Many tax avoidance strategies relied on delaying tactics. Had the tax remained in place for longer it would have been harder to avoid. There is also plenty of heavy-hitting economic research that shows higher tax rates can deliver more government revenue, especially if the tax code is simplified to reduce avoidance.

Professor Saez and Peter Diamond, the Nobel Prize-winning economist, published a paper in November 2011 concluding that even without closing tax loopholes, top tax rates in the US could be pushed as high as 48 per cent without falling foul of the Laffer curve of declining revenues. If the tax loopholes were removed, the rates could go up to 76 per cent.

Saez helpfully estimates that a tax of 67 per cent on the top 1 per cent would actually raise $4trn over the coming decade – far from enough to close the deficit but a very big step along the way. The common assumption that higher taxation – especially on the rich – slows the economy has even less foundation. Start with a geographical comparison. Many countries around the world tax at far higher levels than Britain or the US and achieve similar rates of growth. The Swedish government, for example, claims 53 per cent of GDP in tax – far higher than the 32 per cent collected by the government in the US, even including state and local authorities. And while it’s true other factors may have played a part, the nation’s economy has outpaced that of the US over the past decade. In fact Anglo-Saxon nations have not grown faster than countries that ignored Laffer’s advice, including Germany and Denmark. 

A time-based comparison goes against defenders of the rich too. There has been no noticeable acceleration of growth in the US or UK as their governments have gone about pruning the top rates of tax.

"In fact the US economy grew very swiftly in the 1950s and 1960s, when top rates of tax were draconian by current standards," observes Mark Weisbrot, the co-director of the Center for Economic and Policy Research in Washington. Professors Diamond and Saez contend that this is because a lot of what the rich do does little to promote economic growth – a claim that many on the right will dispute. So this leaves the question of how best to tax the rich. Buffett’s tax, which sets a 30 per cent floor under the tax rate of those earning more than $1m, makes for gratifying politics.

Sadly, this type of approach can cause policymakers real headaches (witness the charity tax in the UK) and would raise pocket change in budgetary terms, about $47bn over 10 years, compared with expected federal revenues of $41trn. 

Leak tragedy

There is a way of taxing the rich that will yield far more revenue and be much harder to avoid: plugging leaks in the tax code. "The US tax code is riddled with loopholes that the rich can exploit," says Professor Burman. "And many of these deductions are skewed to benefit the rich."

One example is the mortgage interest tax deduction, which allowed Americans to exclude from their income payments on home loans of up to $1m. This disproportionately benefits the rich. Those in a 35 per cent tax bracket will save $35 for every $100 of mortgage interest. Those in the humbler 15 per cent tax bracket save just $15 per $100 on what is likely a lower interest payment. Scrapping this deduction could raise $80bn a year – 20 times more than the Buffett tax over 10 years. Even capping deductions at a lower rate could garner impressive sums. And other policies benefit the wealthy, including a deduction on state income tax. A bolder move in the US would be to tax investment income at the same rate as income.

"Among the main reasons the rich pay less is the privileged treatment of investment over sweat and toil," says Dr Weisbrot. Equalising the two could yield enough to scrap corporate income tax, which is really a form of double taxation on profits. "The best way to ensure the rich pay more is to simplify the tax code," says Professor Burman. "You can even have lower rates and yet raise more money." 

Of course, soaking the rich won’t solve the fiscal problems of Britain or the US. One study by the Tax Policy Center showed that if policymakers tried to rely on top taxpayers alone to bring down the deficit to 3 per cent of GDP, the highest rate would need to rise over 90 per cent.

Few believe this is practical or desirable. Instead the pain will have to be more evenly spread throughout society. But on both sides of the Atlantic there is a compelling case for demanding a bigger contribution from the super rich.

This article originally appeared in Economia.

Photograph: Getty Images

Christopher Alkan

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Andy Burnham and Sadiq Khan are both slippery self-mythologisers – so why do we rate one more than the other?

Their obsessions with their childhoods have both become punchlines; but one of these jokes, it feels to me, is told with a lot more affection than the other.

Andy Burnham is a man whose policies and opinions seem to owe more to political expediency than they do to belief. He bangs on to the point of tedium about his own class, background and interests. As a result he’s widely seen as an unprincipled flip-flopper.

Sadiq Khan is a man whose policies and opinions seem to owe more to political expediency than they do to belief. He bangs on to the point of tedium about his own class, background and interests. As a result he’s the hugely popular mayor of London, the voice of those who’d be proud to think of themselves as the metropolitan liberal elite, and is even talked of as a possible future leader of the Labour party.

Oh, and also they were both born in 1970. So that’s a thing they have in common, too.

Why it is this approach to politics should have worked so much better for the mayor of London than the would-be mayor of Manchester is something I’ve been trying to work out for a while. There are definite parallels between Burnham’s attempts to present himself as a normal northern bloke who likes normal things like football, and Sadiq’s endless reminders that he’s a sarf London geezer whose dad drove a bus. They’ve both become punchlines; but one of these jokes, it feels to me, is told with a lot more affection than the other.

And yes, Burnham apparent tendency to switch sides, on everything from NHS privatisation to the 2015 welfare vote to the leadership of Jeremy Corbyn, has given him a reputation for slipperiness. But Sadiq’s core campaign pledge was to freeze London transport fares; everyone said it was nonsense, and true to form it was, and you’d be hard pressed to find an observer who thought this an atypical lapse on the mayor’s part. (Khan, too, has switched sides on the matter of Jeremy Corbyn.)

 And yet, he seems to get away with this, in a way that Burnham doesn’t. His low-level duplicity is factored in, and it’s hard to judge him for it because, well, it’s just what he’s like, isn’t it? For a long time, the Tory leadership’s line on London’s last mayor was “Boris is Boris”, meaning, look, we don’t trust him either, but what you gonna do? Well: Sadiq is Sadiq.

Even the names we refer to them by suggest that one of these two guys is viewed very differently from the other. I’ve instinctively slipped into referring to the mayor of London by his first name: he’s always Sadiq, not Khan, just as his predecessors were Boris and Ken. But, despite Eoin Clarke’s brief attempt to promote his 2015 leadership campaign with a twitter feed called “Labour Andy”, Burnham is still Burnham: formal, not familiar. 

I’ve a few theories to explain all this, though I’ve no idea which is correct. For a while I’ve assumed it’s about sincerity. When Sadiq Khan mentions his dad’s bus for the 257th time in a day, he does it with a wink to the audience, making a crack about the fact he won’t stop going on about it. That way, the message gets through to the punters at home who are only half listening, but the bored lobby hacks who’ve heard this routine two dozen times before feel they’re in the joke.

Burnham, it seems to me, lacks this lightness of touch: when he won’t stop banging on about the fact he grew up in the north, it feels uncomfortably like he means it. And to take yourself seriously in politics is sometimes to invite others to make jokes at your expense.

Then again, perhaps the problem is that Burnham isn’t quite sincere enough. Sadiq Khan genuinely is the son of a bus-driving immigrant: he may keep going on about it, but it is at least true. Burnham’s “just a northern lad” narrative is true, too, but excludes some crucial facts: that he went to Cambridge, and was working in Parliament aged 24. Perhaps that shouldn’t change how we interpret his story; but I fear, nonetheless, it does.

Maybe that’s not it, though: maybe I’m just another London media snob. Because Burnham did grow up at the disadvantaged end of the country, a region where, for too many people, chasing opportunities means leaving. The idea London is a city where the son of a bus driver can become mayor flatters our metropolitan self-image; the idea that a northerner who wants to build a career in politics has to head south at the earliest opportunity does the opposite. 

So if we roll our eyes when Burnham talks about the north, perhaps that reflects badly on us, not him: the opposite of northern chippiness is southern snobbery.

There’s one last possibility for why we may rate Sadiq Khan more highly than Andy Burnham: Sadiq Khan won. We can titter a little at the jokes and the fibs but he is, nonetheless, mayor of London. Andy Burnham is just the bloke who lost two Labour leadership campaigns.

At least – for now. In six weeks time, he’s highly likely to the first mayor of Greater Manchester. Slipperiness is not the worst quality in a mayor; and so much of the job will be about banging the drum for the city, and the region, that Burnham’s tendency to wear his northernness on his sleeve will be a positive boon.

Sadiq Khan’s stature has grown because the fact he became London’s mayor seems to say something, about the kind of city London is and the kind we want it to be. Perhaps, after May, Andy Burnham can do the same for the north – and the north can do the same for Andy Burnham.

Jonn Elledge edits the New Statesman's sister site CityMetric, and writes for the NS about subjects including politics, history and Daniel Hannan. You can find him on Twitter or Facebook.