Friday, 9 December 2011

More on marginal tax rates

In my post on optimum tax rates I mentioned as an afterthought that the 52% marginal direct tax rate in the UK goes through what seems to me to be a psychologically important level of 50%.  Comments on a blog that's easier to read than this one have led me to expand on the point.

The analysis of optimum marginal tax rates depends on how much taxable income changes when the tax rate changes.  Changes in taxable income can result from two causes: reduction of broad income and tax avoidance which reduces taxable income without the taxpayer actually earning less money.

Tax avoidance, through income timing or taking income in a different way, will involve careful planning, so all avoidable taxes should be considered.  But reduction of broad income by trying less hard to earn money, or by moving overseas to a friendly tax regime, will be caused not so much by considered analysis of what's worth it for the money as by one's gut reaction to the marginal tax rate - "Do I really want to do this piece of work just so that Osborne can get 52% of the reward?"

In that context it seems to me that 50% is an important level to breach.  It may be that the curve relating taxable income to marginal tax rate has a kink in it at about that level, so that either 42% or 62% might raise more revenue than 52%.

This is just speculation; empirical evidence would be hard to come by.  One can't simply experiment with tax rates from year to year: a temporary change will see more elasticity than a permanent change, because some top-rate taxpayers are able to advance or defer their income.

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