Things not to do: Increase the top rate of income tax

Some people claim the rich are not paying their “fair share” of the tax total, and propose that the top rate of income tax should be raised to 50 percent, and some even say 60 percent. They often then proceed to say how the extra billions raised should be spent.

The problem is that there would be no extra billions. Less revenue would be raised at 50 or 60 percent than is currently raised by the top rate of 45 percent. In 1979 when a Conservative government took office, the top rate of income tax was 83 percent on wage income, with an additional 15 percent surcharge on money earned from investments, giving a top rate of 98 percent. Very few people paid 98 percent since it was hardly worth people earning money if they were only allowed to keep 2 pence for every pound earned.

The Conservative government made a series of income tax reductions. It cut the top rate on high earners to 60 percent and abolished the 15 percent investment income surcharge. More money was raised from the lower rates. It later cut the top rate to 40 percent with a standard rate of 25 percent. Again, more money was taken by the Treasury at the lower rates.

The reason is that economic activity became more worthwhile when people were allowed to keep more of what they made. Secondly, it became less worthwhile to make complex use of tax havens and to employ accountants to devise tax-sheltering schemes. At the lower rates it was simpler just to pay the tax. Thus more revenue was raised because the tax base increased and avoidance declined.

There was another significant effect. The proportion of the total paid by top earners increased. Where the top 10 percent had been paying 35 percent of the total, it went up after the tax cuts to 48 percent. The richest went from paying just over a third to just under a half of all income tax. In 1976 the top 1 percent paid 11 percent of the total; now they pay 29 percent of it. The top 10 percent of earners now pay 60 percent of all income tax, whereas the bottom 50 percent pay only 10 percent of the total.

More money would be raised by lowering the top rate to 40 percent, and more still at 35 percent; and the top earners would be paying a larger share of the total. It is politically difficult to be seen to be cutting tax rates for the rich, but the government could declare the target percentage of the total it wants the top 10 percent of earners to pay, and adjust rates accordingly to achieve it.