UK – The 50P Rate: A Bad Tax That’s Hard to Scrap

On February 21, the Office for National Statistics will publish figures for public finances in January.

These figures, which the chancellor of the exchequer will get a day early, are important in their own right. January is one of the big months for tax receipts, so they will tell us whether the government’s deficit reduction programme is on track, overshooting or undershooting.

The January numbers will also give us the first solid indication of the impact of the 50p top rate on incomes above £150,000. If they are strong, in what is the key self-assessment month, it will at least suggest that the tax is in some decent revenue. If they are weak, it will add to the sense of anticipation over the second piece of information heading Osborne’s way.

This is the exercise he commissioned from Her Majesty’s Revenue & Customs (HMRC) in order to provide a definitive answer to the question of whether the 50p rate is a net revenue raiser. Officials are currently going through the self-assessment forms and other evidence.

They will present a report to the Treasury in time for the March 21 budget, when the intention is to publish it. It will inform Osborne’s decision on whether to stick with the top rate he inherited from Labour.

I shall come on to the tricky politics of that in a moment. What do we know about the numbers? So far this fiscal year tax revenues have been rising reasonably strongly: from April to December last year central government receipts were 5% higher than in the corresponding period a year earlier.

When it comes to income tax and capital gains tax, however, a breakdown by the Office for Budget Responsibility suggests these were lagging well behind other receipts, up by only a cumulative 1.7%, though December on its own, up 4.6%, was a little better.

How much does the Treasury expect to raise from the 50p rate? Projections done by officials at the time Alistair Darling introduced the new top rate two years ago were for the net addition to revenue to settle at around £3 billion a year. This is not a sum to be sneezed at though it is only 0.5% of this year’s expected government receipts and under 2% of income tax revenues.

Even that sum is called into question by some independent experts. The Institute for Fiscal Studies, in its recent green budget, looked at the effects of the new rate on indirect taxes (such as Vat and excise duties) as well as direct taxes such as income tax and National Insurance.

It concluded that if spending by the high-paid is cut as a result of the tax, then the government may be robbing Peter to pay Paul. The fall in indirect tax revenues almost offsets the rise in direct taxes.

In this case, the IFS found, the net revenue raised by the tax reduces to less than £1 billion a year. Under other assumptions about the way incomes and spending have responded to the new tax, so-called elasticities, the net tax take turns negative. In other words the government’s coffers would be poorer as a result of the 50p rate.

There are things even the IFS cannot model but the Treasury is keenly aware of. If the 50p rate has resulted in enough high earners moving to Switzerland and elsewhere, then all the taxes paid by these people are lost to the economy.

The behavioural changes assumed by the Treasury in estimating the direct revenue gains mainly assumed people would engage in tax avoidance, not that they would choose to become tax exiles.

The fact that many high-earners can do so means that one way of preserving any revenues from the tax – clamping down even harder on tax avoidance schemes – could easily be counter-productive. The effect might be to put people on the next plane to Switzerland.

So what will happen? The chancellor will, as I say, publish the HMRC report in the budget and will respond to it. Given that officials are looking at direct taxes only, it will be surprising if it does not conclude that the 50p rate is bringing in at least some additional revenue, though probably not as much as the Treasury’s original £3 billion long-run estimate.

What will be Osborne’s response? When he was in Davos last month, the chancellor was clear. “I have always said this is a temporary tax,” he said. “The long-term damage of this tax is potentially quite considerable, and that’s why it is temporary.” He urged British business leaders attending the speech to furnish him with the evidence on that damage to help him get rid of it.

Since he was in Davos, quite a few things have happened. We have had the affairs of both Stephen Hester’s on-off bonus and the now de-knighted Fred Goodwin.

The Liberal Democrats have increased the pressure for accelerating the move towards a £10,000 personal tax allowance, paid for by increasing taxes on the wealthy. At one time the proposed mansion tax was seen as the price the Tories might have to pay for getting rid of the 50p rate. Now it is being pushed as the way to pay for tax cuts for low earners. Danny Alexander, the Liberal Democrat Treasury chief secretary, wants to scrap higher rate pension tax relief in order to lift the personal allowance to £12,500.

There was a lot of emphasis on unfairness, fat cats and bonuses even before recent events. There is even more now. I may be reading too much into it but I did not see a mention of the 50p rate in Osborne’s speech last week to the Federation of Small Businesses. Some say it could be a deal-breaker for the coalition.

The danger, however, is that the 50p rate takes on an air of permanence. Margaret Thatcher cut the high top rate of income tax she inherited from Labour at the first opportunity in 1979. Nearly two years into the parliament, the “temporary” top 50p rate is intact and, given the politics, unlikely to go any time soon.

So Osborne is a bind. Does he keep a tax that raises little or any revenue and may be doing “considerable” damage to the economy, or does he abolish it and risk upsetting his coalition partners and being seen as the friend of fat cats and bankers.

A compromise might be a firm pledge to abolish it by the end of the parliament. At one time this was the minimum business expected from the government. Now it would be seen as a sign of boldness.

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

This post originally appeared at David Smith’s EconomicsUK and is posted with permission.