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

Getty
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Air pollution: 5 steps to vanquishing an invisible killer

A new report looks at the economics of air pollution. 

110, 150, 520... These chilling statistics are the number of deaths attributable to particulate air pollution for the cities of Southampton, Nottingham and Birmingham in 2010 respectively. Or how about 40,000 - that is the total number of UK deaths per year that are attributable the combined effects of particulate matter (PM2.5) and Nitrogen Oxides (NOx).

This situation sucks, to say the very least. But while there are no dramatic images to stir up action, these deaths are preventable and we know their cause. Road traffic is the worst culprit. Traffic is responsible for 80 per cent of NOx on high pollution roads, with diesel engines contributing the bulk of the problem.

Now a new report by ResPublica has compiled a list of ways that city councils around the UK can help. The report argues that: “The onus is on cities to create plans that can meet the health and economic challenge within a short time-frame, and identify what they need from national government to do so.”

This is a diplomatic way of saying that current government action on the subject does not go far enough – and that cities must help prod them into gear. That includes poking holes in the government’s proposed plans for new “Clean Air Zones”.

Here are just five of the ways the report suggests letting the light in and the pollution out:

1. Clean up the draft Clean Air Zones framework

Last October, the government set out its draft plans for new Clean Air Zones in the UK’s five most polluted cities, Birmingham, Derby, Leeds, Nottingham and Southampton (excluding London - where other plans are afoot). These zones will charge “polluting” vehicles to enter and can be implemented with varying levels of intensity, with three options that include cars and one that does not.

But the report argues that there is still too much potential for polluters to play dirty with the rules. Car-charging zones must be mandatory for all cities that breach the current EU standards, the report argues (not just the suggested five). Otherwise national operators who own fleets of vehicles could simply relocate outdated buses or taxis to places where they don’t have to pay.  

Different vehicles should fall under the same rules, the report added. Otherwise, taking your car rather than the bus could suddenly seem like the cost-saving option.

2. Vouchers to vouch-safe the project’s success

The government is exploring a scrappage scheme for diesel cars, to help get the worst and oldest polluting vehicles off the road. But as the report points out, blanket scrappage could simply put a whole load of new fossil-fuel cars on the road.

Instead, ResPublica suggests using the revenue from the Clean Air Zone charges, plus hiked vehicle registration fees, to create “Pollution Reduction Vouchers”.

Low-income households with older cars, that would be liable to charging, could then use the vouchers to help secure alternative transport, buy a new and compliant car, or retrofit their existing vehicle with new technology.

3. Extend Vehicle Excise Duty

Vehicle Excise Duty is currently only tiered by how much CO2 pollution a car creates for the first year. After that it becomes a flat rate for all cars under £40,000. The report suggests changing this so that the most polluting vehicles for CO2, NOx and PM2.5 continue to pay higher rates throughout their life span.

For ClientEarth CEO James Thornton, changes to vehicle excise duty are key to moving people onto cleaner modes of transport: “We need a network of clean air zones to keep the most polluting diesel vehicles from the most polluted parts of our towns and cities and incentives such as a targeted scrappage scheme and changes to vehicle excise duty to move people onto cleaner modes of transport.”

4. Repurposed car parks

You would think city bosses would want less cars in the centre of town. But while less cars is good news for oxygen-breathers, it is bad news for city budgets reliant on parking charges. But using car parks to tap into new revenue from property development and joint ventures could help cities reverse this thinking.

5. Prioritise public awareness

Charge zones can be understandably unpopular. In 2008, a referendum in Manchester defeated the idea of congestion charging. So a big effort is needed to raise public awareness of the health crisis our roads have caused. Metro mayors should outline pollution plans in their manifestos, the report suggests. And cities can take advantage of their existing assets. For example in London there are plans to use electronics in the Underground to update travellers on the air pollution levels.

***

Change is already in the air. Southampton has used money from the Local Sustainable Travel Fund to run a successful messaging campaign. And in 2011 Nottingham City Council became the first city to implement a Workplace Parking levy – a scheme which has raised £35.3m to help extend its tram system, upgrade the station and purchase electric buses.

But many more “air necessities” are needed before we can forget about pollution’s worry and its strife.  

 

India Bourke is an environment writer and editorial assistant at the New Statesman.