One of the amusing little asides in the economics of taxation is that we here in Europe have rather higher tax rates than they do over in the United States. Yet the structures of our tax systems – more specifically, the laws surrounding who gets taxed and why – suggest that we should in fact have lower rates than they. The point being about our old friend the Laffer Curve and where the peak of it is.
For those who might have learned their economics at Islington Technical College – yes, the Laffer Curve is real, it exists, we also have a pretty good idea where that peak is. Where higher rates bring in less revenue, where lower rates will also bring in less revenue.
Moody’s providing us with the hook for this rumination:
Britain’s public finances may significantly weaken as pressures including an exodus of high earners, a push to end austerity and an ageing population continue to mount. New analysis from credit ratings agency Moody’s has underlined a host of problems faced by the Government finances. The warning of fiscal risks ahead comes despite a decade of cuts to public services following the 2009 financial crisis, and show that public debt could be close to 90pc of GDP by 2020. Politicians have increasingly concentrated the tax take on “a small number of taxpayers for revenue”, the analysis showed.
Taxing the richer among us to pay for the public goods we gain from good government is just fine. As Adam Smith said, the richer should be paying perhaps more than in proportion. The idea of a progressive taxation system is just fine. The thing is though that does run up against the strictures – restrictions – on how much you can actually tax the rich before they bugger off. Which they can do in two ways.
One, obviously enough, is simply not bother to go to work. Or not work so hard. Not, that is, produce so much of whatever it is that they do. Perhaps Adele wouldn’t make another album if we taxed her at 98%. We would be poorer by the absence of torch songs about Old Etonian ex-husbands. Or richer, obviously.
But we’d also be poorer by the tax revenue we didn’t get if she had made that next album and paid 50% tax on it.
We’d like to know what that peak of that Laffer Curve is. At what point do the rich do less, so much less that we lose revenue? The best bet we’ve got is from Diamond and Saez. 54% in a system with allowances. An allowance here meaning tax privileged forms of income. Say, a lower capital gains tax rate – which is something we should indeed have.
Hmm. So, UK and US tax rates appear to be at about that. Because do note this is all taxes upon income. So, in the UK, it includes employers’ national insurance. In the US social security tops out in a manner that NI doesn’t, but there are state income taxes to add to the Federal rate. The rates in continental Europe are often higher and thus arguably above that peak.
But we need to go further. Because an obvious “allowance” in this sense is the ability to just bugger off. Leave the country and thus pay no tax. Americans can’t do that, taxation is passport based. Europeans can. Move from London to Paris – or vice versa – and you are free of HMRC and into the clutches of Le Fisc – or vice versa. Or, more importantly, from London to Monaco and thus tax free.
So, the European tax systems should, logically, have a lower Laffer Curve peak than the American. And yet that’s not the way the tax systems work, is it? Which is an interesting observation. Well, at least I think it is.