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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Theresa May could live to regret not putting Article 50 to a vote sooner

Today's Morning Call.

Theresa May will reveal her plan to Parliament, Downing Street has confirmed. They will seek to amend Labour's motion on Article 50 adding a note of support for the principle of triggering Article 50 by March 2017, in a bid to flush out the diehard Remainers.

Has the PM retreated under heavy fire or pulled off a clever gambit to take the wind out of Labour's sails while keeping her Brexit deal close to her chest? 

Well, as ever, you pays your money and you makes your choice. "May forced to reveal Brexit plan to head off Tory revolt" is the Guardian's splash. "PM caves in on plans for Brexit" is the i's take. "May goes into battle for Brexit" is the Telegraph's, while Ukip's Pravda aka the Express goes for "MPs to vote on EU exit today".

Who's right? Well, it's a bit of both. That the government has only conceded to reveal "a plan" might mean further banalities on a par with the PM's one-liner yesterday that she was seeking a "red white and blue Brexit" ie a special British deal. And they've been aided by a rare error by Labour's new star signing Keir Starmer. Hindsight is 20:20, but if he'd demanded a full-blown white paper the government would be in a trickier spot now. 

But make no mistake: the PM didn't want to be here. It's worth noting that if she had submitted Article 50 to a parliamentary vote at the start of the parliamentary year, when Labour's frontbench was still cobbled together from scotch-tape and Paul Flynn and the only opposition MP seemed to be Nicky Morgan, she'd have passed it by now - or, better still for the Tory party, she'd be in possession of a perfect excuse to reestablish the Conservative majority in the House of Lords. May's caution made her PM while her more reckless colleagues detonated - but she may have cause to regret her caution over the coming months and years.

PANNICK! AT THE SUPREME COURT

David Pannick, Gina Miller's barrister, has told the Supreme Court that it would be "quite extraordinary" if the government's case were upheld, as it would mean ministers could use prerogative powers to reduce a swathe of rights without parliamentary appeal. The case hinges on the question of whether or not triggering Article 50 represents a loss of rights, something only the legislature can do.  Jane Croft has the details in the FT 

SOMETHING OF A GAMBLE

Ministers are contemplating doing a deal with Nicola Sturgeon that would allow her to hold a second independence referendum, but only after Brexit is completed, Lindsay McIntosh reports in the Times. The right to hold a referendum is a reserved power. 

A BURKISH MOVE

Angela Merkel told a cheering crowd at the CDU conference that, where possible, the full-face veil should be banned in Germany. Although the remarks are being widely reported in the British press as a "U-Turn", Merkel has previously said the face veil is incompatible with integration and has called from them to be banned "where possible". In a boost for the Chancellor, Merkel was re-elected as party chairman with 89.5 per cent of the vote. Stefan Wagstyl has the story in the FT.

SOMEWHERE A CLOCK IS TICKING

Michael Barnier, the EU's chief Brexit negotiator, has reminded the United Kingdom that they will have just 15 to 18 months to negotiate the terms of exit when Article 50 is triggered, as the remaining time will be needed for the deal to secure legislative appeal.

LEN'S LAST STAND?

Len McCluskey has quit as general secretary of Unite in order to run for a third term, triggering a power struggle with big consequences for the Labour party. Though he starts as the frontrunner, he is more vulnerable now than he was in 2013. I write on his chances and possible opposition here.

AND NOW FOR SOMETHING COMPLETELY DIFFERENT

Emad asks if One Night Stand provides the most compelling account of sex and relationships in video games yet.

MUST READS

Theresa May is becoming adept at avoiding defeats says George

Liv Constable-Maxwell on what the Supreme Court protesters want

Theresa May risks becoming an accidental Europe wrecker, says Rafael Behr

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Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to British politics.