Thursday, 8 September 2011

That 50% tax rate

As every student of elementary economics will have been taught, there are two ways of analysing the effect of income tax on effort and enterprise.

One assumes that work is disagreeable and leisure is agreeable. All workers have to do some work but at the margin have the choice of whether to do a little bit more or a little bit less. The higher the net wage (ie after tax) the more attractive work becomes compared to leisure. This is the rationale for paying time and a quarter or time and a half for overtime. A high marginal tax rate reduces the net wage and makes work less attractive. Therefore the worker reacts by doing less work and enjoying more leisure.

The other analysis comes to the opposite conclusion. It assumes that the worker has in mind the income necessary to maintain his/her household's standard of living. Most households live up to their incomes. An increase in the marginal tax rate means that net household income falls. Hence the worker will work more in order to maintain the household standard of living (whereas under the first argument he would say something on the lines of "Sod this for a lark," work less and lower the household standard of living even further.)

There are flaws in both analyses. Both are couched in terms of hours worked and most workers don't have much choice: we are given a job with a stated number of hours and that's it (apart from the possibility of overtime, mentioned above.) Only part-time workers tend to have much flexibility on the number of hours worked, although, of course, some "full timers" can get a second, part-time (evening) job.

A more serious flaw, in my view, is that both analyses assume that the monetary reward is the only or most important factor in determining how hard one works. Beyond earning enough for the basic necessities, this is unlikely to be true for most people. Pride, the respect of one's colleagues, desire for promotion, doing a fair day's work for a fair day's wage, all motivate the employees. Entrepreneurs are similarly motivated, along with aims such as to maintain the reputation of a respected business, to increase the size of the business or market share, fame (for actors, singers, artists etc), to wield more power, gain in prestige, or even have enough to contribute to a political party and get a knighthood.

Empirical evidence suggests that marginal tax rates may affect the amount of work offered by part time "second income" earners (in earlier times usually housewives earning "pin money) but not many others. That high marginal tax rates discourage effort and enterprise is a convenient myth promulgated by the rich.

Personally I would keep the 50% tax rate, introduce it at a lower level and consider even higher rates for for higher incomes. Remember at present it is only paid once taxable income has reached £150 000 a year, Depending on allowances, that's around £3,000 a week. Over half the working population would be in the seventh heaven if they received that amount a month. If we really are "all in this together" then the rich have to play their part, not opt out of the society that enables them to be rich.


  1. "That high marginal tax rates discourage effort and enterprise is a convenient myth promulgated by the rich."

    In other words - naked greed

  2. Quite so. The contrast with the "rich" (or at least some of them)in the US and France is enlightening.

  3. Now with the 50% tax rate, let's have a proper land tax to secure a measure of social justice and equity in the tax system and we'll be getting somewhere.

  4. Thanks for your comment, Richard. Like you I'd like to see land taxation move far higher up the agenda. I've just read Hattersley's biography of Lloyd George and he was very keen. Liberals still were when I joined in the early 60s. Vince Cable's "Mansion Tax" would be a step in the right direction, although I think the same effect could be achieved with less controversy by simply adding a few more bands to the house valuations for the community charge.