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23 June 2014updated 09 Sep 2021 6:36am

How the Labour party should make the case for a return to the 50p top rate of tax

The 50p commitment may in fact be consistent with a move away from simple redistributive policies. Labour should argue this.

By Madeleine Power and Tim Stacey Tim Stacey

Last week the IPPR launched its Condition of Britain: Strategies for social renewal report. A hugely ambitious and important project, the report outlines a programme of work focused on moving political parties away from transactional relationships and from simple redistributive policies.

The Labour party has already enthusiastically signed up to the report’s proposals for Jobseeker’s Allowance, and in time may make further commitments to the IPPR’s policy suggestions. However, this commitment to move away from the easy characterisation of the party as simply ‘taxing the rich to pay the poor’ may have one small problem, the commitment to a 50p top rate of income tax. This has, perhaps predictably, already been portrayed as a classic ‘politics of envy’ policy. So how does the 50p policy fit within a programme of work that looks to move away from this?

New research by The Equality Trust provides one explanation, by looking at the pre-distributive case for a return to the 50p top rate of income tax.

The proportion of UK income that is going to the richest one per cent has been increasing since the late 1970s and in 2009 made up 15.4 per cent of gross income in the UK. This increase is usually justified by the claim that the top one per cent are growing the pie for all of us, and that their increasing wage is simply the market paying them what they deserve. To tax them more would therefore harm economic growth, punishing us all. This in turn is often used to defend a lower or reduced rate of income tax on the richest.

Our report, Course Correction, shows that these arguments just don’t stand up to scrutiny. We found that increases in the pre-tax income of the richest one per cent across the developed world were strongly related to top tax rates. As countries cut their top rate of tax, their top 1 one per cent grew rich, while countries that cut their top rate of tax by less now have a less rich top one per cent.

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At the same time we found that, according to a wealth of research literature, there is no relationship between these top tax rate cuts and economic growth. To put it simply, it looks like cutting the top tax rate increased the top one per cent’s slice of the pie without actually growing the size of the pie itself.

To understand why this might be the case we looked at the literature on how people with large incomes respond to tax increases. A standard economic assumption is that the number of hours these individuals work decreases as taxes increase, but in reality this isn’t the case for those on high incomes.

According to the evidence, even when taxes on them were very high, people with top incomes were working most of the hours they could. This meant that when taxes were cut there wasn’t any possibility for them to work more hours. A second argument is that high taxes cause the richest to up sticks and move elsewhere. But research shows that only when taxes were very high relative to other countries did people on top incomes respond by migrating.

Realistically, this means that a top tax rate in the UK shouldn’t be significantly higher than other OECD countries if we want to prevent migration of high earners. But the average top tax rate in OECD countries is 47 per cent and more than a quarter of OECD countries have top tax rates of 50 per cent or higher. Many of the countries with a higher top tax rate actually have stronger economies than the UK, opening up the possibility that the top tax rate could be raised without harming the economy.

Others might object to raising the top tax rate on the grounds that deliberately attempting to decrease high-pay is anti-business. However research suggests that it might in fact be a positive for business.

Evidence shows that businesses have difficulty in determining the value brought in by their senior managers. Executive pay is just as likely to increase as a result of measures which a CEO has no control over (like oil company executives getting a pay rise because the price of oil rose) as they from something which they do control. Pay has increased at the same rate as company size, but there’s no evidence that companies are seeing the value from their executives increase at the same rate.  Meanwhile there is growing evidence that increased executive pay is actively harmful for companies by incentivising short-term thinking.

One of the most prominent explanations used to explain the increase in pay for top execs is their bargaining ability. This suggests that senior managers are in a position to argue that they are bringing in value (even if there isn’t evidence to support this). In the absence of objective measures of value, companies assume that their execs are above average and set their pay to be above the average for similar companies, thereby constantly pushing pay higher and higher. Tax can provide a helpful counter pressure, as companies are reluctant to increase incomes if they believe that half of that increase is going in tax rather than going to the employee. Additionally, high earners are less likely to bargain for higher and higher pay if they know the extra they bargain to receive will be paid in tax.

For Ed Miliband and the Labour party, this shows how the 50p commitment may in fact be consistent with a move away from simple redistributive policies.

For all other politicians it shows that a 50p top tax rate can tackle top pay, providing benefits for businesses and society as a whole.

Madeleine Power and Tim Stacey, The Equality Trust