Optimal tax rate for top one per cent may be as high as 83%

Paper suggests cutting taxes may divert attention to wasteful bargaining

Via Daniel Elton, a new(ish) paper (pdf) by economists Thomas Piketty, Emmanuel Saez and Stefanie Stantcheva makes the case for the optimal tax rate of the richest one per cent could be as high as 83 per cent.

The authors look at three possible ways in which top incomes respond to marginal tax rates.

The first is the "supply side" channel cited by Arthur Laffer when he developed his concept of the Laffer curve. Under this channel, marginal tax rates that are too high result in people doing less work than they otherwise would. Lower tax rates thus respond to more economic activity, and greater growth and higher tax revenue. Laffer's work was used by the Reagan administration to justify cutting the top rate in the US, from 70 per cent down to 28 per cent.

The second is the "tax avoidance" channel. This is the model cited by the Chancellor when he made the decision to cut the tax rate for top earners in Britain from 50 per cent to 45 per cent. The argument is that high tax rates increase tax avoidance, but the authors argue – in common with many of the Chancellors critics – that tax avoidance can be dealt with directly, writing that:

A better policy would be to first close loopholes so as to eliminate most tax avoidance opportunities and only then increase top tax rates.

The third is the "compensation bargaining" channel. The authors argue that:

While standard economic models assume that pay reflects productivity, there are strong reasons to be sceptical, especially at the top of the income distribution where the actual economic contribution of managers working in complex organisations is particularly difficult to measure.

As a result, top workers have ample opportunity to set their own pay, through bargaining harder or influencing compensation committees. The incentives for this economically wasteful activity are higher the lower tax rates are. Just as with the supply side model, tax cuts increase the wealth of the richest in society, but unlike that model they do not also increase growth; rather, the extra money for the rich comes from those poorer than them.

The authors, using their estimates of the elasticity of the various channels (that is, the magnitude of the effect), then calculate what the optimum rates would be. Under the first model, they find it to be roughly 57 per cent – 5 per cent higher than the top British tax rate is until the cut takes effect (National Insurance for top earners is 2per cent). Assessing the second model (Osborne's preferred argument), they find that the optimal tax rate would be 62 per cent, but argue that if the correct anti-avoidance and simplification measures were put in place, it would be 71 per cent.

The third model, however, outputs an optimal rate of 83 per cent. The authors still assume a minor supply-side effect, making up 40 per cent of the total elasticity, which is why it isn't higher. That is, they still assume that high tax rates will encourage the rich to work less, but they also assume that they will encourage the rich to put more of their effort into actual work, and less of it into "compensation bargaining".

How to decide between models one and three (the authors assume that once anti-avoidance measures are put in place, model two is the same as model one)? The former predicts that lower tax leads to more work, the latter that it merely leads to higher pay. As a result, tax cuts should be correlated with higher growth. Are they? Well, no:

As a result, the bargaining model can at least be said to be as realistic as the supply-side model; and if that's the case, the optimal top tax rate for most nations is likely to be far in excess of where it is set now.

For more, see the authors in the Boston Review, VoxEU, or their original paper (pdf).

Pictured: Laffer. No, wait, laughers. Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

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The strange death of boozy Britain: why are young people drinking less?

Ditching alcohol for work.

Whenever horrific tales of the drunken escapades of the youth are reported, one photo reliably gets wheeled out: "bench girl", a young woman lying passed out on a public bench above bottles of booze in Bristol. The image is in urgent need of updating: it is now a decade old. Britain has spent that time moving away from booze.

Individual alcohol consumption in Britain has declined sharply. In 2013, the average person over 15 consumed 9.4 litres of alcohol, 19 per cent less than 2004. As with drugs, the decline in use among the young is particularly notable: the proportion of young adults who are teetotal increased by 40 per cent between 2005 and 2013. But decreased drinking is not only apparent among the young fogeys: 80 per cent of adults are making some effort to drink less, according to a new study by consumer trends agency Future Foundation. No wonder that half of all nightclubs have closed in the last decade. Pubs are also closing down: there are 13 per cent fewer pubs in the UK than in 2002. 

People are too busy vying to get ahead at work to indulge in drinking. A combination of the recession, globalisation and technology has combined to make the work of work more competitive than ever: bad news for alcohol companies. “The cost-benefit analysis for people of going out and getting hammered starts to go out of favour,” says Will Seymour of Future Foundation.

Vincent Dignan is the founder of Magnific, a company that helps tech start-ups. He identifies ditching regular boozing as a turning point in his career. “I noticed a trend of other entrepreneurs drinking three, four or five times a week at different events, while their companies went nowhere,” he says. “I realised I couldn't be just another British guy getting pissed and being mildly hungover while trying to scale a website to a million visitors a month. I feel I have a very slight edge on everyone else. While they're sleeping in, I'm working.” Dignan now only drinks occasionally; he went three months without having a drop of alcohol earlier in the year.

But the decline in booze consumption isn’t only about people becoming more work-driven. There have never been more alternate ways to be entertained than resorting to the bottle. The rise of digital TV, BBC iPlayer and Netflix means most people means that most people have almost limitless about what to watch.

Some social lives have also partly migrated online. In many ways this is an unfortunate development, but one upshot has been to reduce alcohol intake. “You don’t need to drink to hang out online,” says Dr James Nicholls, the author of The Politics of Alcohol who now works for Alcohol Concern. 

The sheer cost of boozing also puts people off. Although minimum pricing on booze has not been introduced, a series of taxes have made alcohol more expensive, while a ban on below-cost selling was introduced last year. Across the 28 countries of the EU, only Ireland has higher alcohol and tobacco prices than the UK today; in 1998 prices in the UK were only the fourth most expensive in the EU.

Immigration has also contributed to weaning Britain off booze. The decrease in alcohol consumption “is linked partly to demographic trends: the fall is largest in areas with greater ethnic diversity,” Nicholls says. A third of adults in London, where 37 per cent of the population is foreign born, do not drink alcohol at all, easily the highest of any region in Britain.

The alcohol industry is nothing if not resilient. “By lobbying for lower duty rates, ramping up their marketing and developing new products the big producers are doing their best to make sure the last ten years turn out to be a blip rather than a long term change in culture,” Nicholls says.

But whatever alcohol companies do to fight back against the declining popularity of booze, deep changes in British culture have made booze less attractive. Forget the horrific tales of drunken escapades from Magaluf to the Bullingdon Club. The real story is of the strange death of boozy Britain. 

Tim Wigmore is a contributing writer to the New Statesman and the author of Second XI: Cricket In Its Outposts.