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BRIEFING PAPER

Number 249, 26 September 2018

Income tax: the additional 50p rate

By Antony Seely

Inside: 1. The Labour Government’s

approach 2. The Coalition Government’s

approach 3. Recent developments 4. Appendix: The Mirrlees

Review on the 50p rate

Number 249, 26 September 2018 2

Contents Summary 3

1. The Labour Government’s approach 5 1.1 Pre-Budget Report 2008: the 45p rate 5 1.2 Budget 2009: announcement of the 50p rate 9 1.3 Initial reactions 11 1.4 Debate as to its potential yield 14 1.5 The 2010 Budget 17

2. The Coalition Government’s approach 20 2.1 The June 2010 Budget 20 2.2 The 2011 Budget: HMRC’s assessment 21 2.3 The 2012 Budget: cutting the additional rate to 45p 24 2.4 Finance Bill 2012 32 2.5 Subsequent debate of the 45p rate 34

3. Recent developments 40

4. Appendix: The Mirrlees Review on the 50p rate 48

Cover page image copyright: Attributed to: 50p / 2 by Howard Stanbury. Licensed under CC BY 2.0 /

image cropped.

3 Income tax: the additional 50p rate

Summary In his 2009 Budget, the then Chancellor, Alistair Darling, announced several tax increases to “raise over £6 billion by 2012, to secure our economic future and to provide help for people now when they need it most.” These changes included increases in the rates of indirect taxes – such as duties on road fuel and alcohol – for the current tax year, and changes to income tax from April 2010, including a new 50p rate on incomes above £150,000. The new 50p rate dominated reactions to the Budget, as many saw it as a major change in the Labour Government’s approach to taxing the wealthy. There was also much discussion as to whether the change would raise as much as the Government estimated: £1.3 billion in 2010/11, rising to £3.05 billion in 2011/12.1 HM Revenue & Customs estimate that 236,000 individuals paid the 50p rate in 2010/11, compared to the total taxpayer population of 31.3 million.2

The new Conservative-Liberal Democrat Government did not mention the 50p rate in the agreement underpinning the Coalition, though it announced that the personal allowance would be increased in the forthcoming Budget “to help lower and middle income earners” as the first of a series of “real terms steps each year” toward setting the allowance at £10,000.3 In his first Budget on 22 June 2010, the Chancellor George Osborne confirmed that the personal allowance would rise by £1,000 to £7,475 from April 2011, while the Budget report noted that the 50p rate would “remain in place for the time being.”4 In his second Budget on 23 March 2011 the Chancellor made no changes to the rates of income tax for the coming year but underlined his view that the 50p rate “would do lasting damage to our economy if it were to become permanent” and said he had asked HMRC to review “how much revenue it actually raises.”5

In his Budget on 21 March 2012 Mr Osborne announced the additional rate would be cut to 45p from April 2013. HMRC had found evidence of considerable ‘forestalling’ – taxpayers shifting income into the previous tax year to avoid the 50p rate – “at a cost to the taxpayer of £1 billion”, and, in his words, “no Chancellor can justify a tax rate that damages our economy and raises next to nothing.”6 HMRC’s assessment of the impact of the 50p rate was set out in a detailed report, which estimated that the cost of cutting the rate to 45p would be only £100m by 2014/15, given the anticipated response by taxpayers to the new rate.7 Although the Chancellor’s announcement was quite controversial, the Government implemented this rate change as proposed.

The additional rate remains set at 45p.8 In answer to a PQ in January this year Treasury Minister Mel Stride cited HMRC’s assessment as showing “that the 50p rate was a distortive and economically inefficient way of raising revenue and it did not raise what was

1 HC Deb 22 April 2009 c244; Budget 2010, HC 451, March 2010 p140 (Table A11 : item l) 2 HMRC, National Statistics: Number of individual income taxpayers (Table 2.1), May 2018 3 HM Government, The Coalition: our programme for government, 20 May 2010 p30. See also, Income tax :

increases in the personal allowance (2010-15), Commons Briefing Paper 6569, 17 June 2015. 4 HC Deb 22 June 2010 c179; Budget 2010, HC 61, June 2010 p32 (para 1.97) 5 HC Deb 23 March 2011 c957. See also, HC Deb 14 September 2011 c1191W 6 HC Deb 21 March 2012 cc805-6. The Coalition Government confirmed that the additional rate would be

45% for 2013/14 in the Budget the next year (Budget 2013, HC 1033, March 2013 para 1.202-3). 7 HMRC, The Exchequer effect of the 50 per cent additional rate of income tax, March 2012 pp48-53. The

report estimated that the ‘static cost’ of this tax cut, with no allowance for any behavioural response, would be £3.35 billion in 2014/15. See also, Budget 2013, HC 1033, March 2013 p66 (Table 2.2 – item t)

8 For details of tax rates and allowances for 2018/19 see, HM Treasury, Overview of tax legislation & rates (Annex A), November 2017.

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expected”, adding, “there has been no new evidence to suggest the conclusions of this report were incorrect.”9

HMRC estimate that 393,000 individuals will pay the additional rate in 2018/19. In this year it is estimated that 31 million people will pay income tax.10 HMRC also estimate that total income tax liabilities in this year will total £185 billion; additional rate taxpayers’ liabilities are estimated to be £56.4 billion, about 30% of the total.11

This note discusses the background to the 50p rate, the debate over its political significance and its economic impact, before looking at the Coalition Government’s decision to cut the additional rate to 45p, and recent speculation as to its future.

9 PQ122188, 19 January 2018 10 HMRC, National Statistics: Number of individual income taxpayers (Table 2.1), May 2018 11 HMRC, National Statistics: Income Tax liabilities, by taxpayer's marginal rate (Table 2.6), May 2018

5 Income tax: the additional 50p rate

1. The Labour Government’s approach

1.1 Pre-Budget Report 2008: the 45p rate In his Pre-Budget statement on 24 November 2008, the then Chancellor, Alistair Darling, announced a number of measures to “raise revenue in future years”; among the options to raise funds, Mr Darling suggested that the ones he had chosen were “the fairest and affect those who have done best out of the growth of the past decade”:

Today’s pre-Budget report shows that the tax burden, as a share of gross domestic product, will fall from 36.3 per cent. last year to 35 per cent. in 2011-12. Against that background, I propose from April 2011 to increase by ½ per cent. all rates of national insurance contributions for both employees and employers.

To ensure that the increase does not fall on those on low or modest incomes, I have decided, at the same time, to raise the starting point for national insurance to align it with that for income tax, so that no one on under £20,000 will pay any more national insurance contributions as a result. Secondly, those with the highest incomes have seen their earnings almost double since 1996, so—again from April 2011—I intend, only on income over £150,000, to introduce a new rate of income tax of 45 per cent. This higher rate of tax will affect only the top 1 per cent. of incomes.

I also intend to withdraw the long-standing anomaly of the income tax system under which the personal allowance is worth twice as much to higher-rate than to basic-rate taxpayers. Again, I will protect those on middle incomes; this will affect only those earning over £100,000—that is, the top 2 per cent. So from April 2010, those with incomes between £100,000 and £140,000 will see the value of their personal allowance reduced, so that they get the same benefit as basic-rate taxpayers. For people with incomes above £140,000, I will withdraw the full value of that personal allowance.12

The Pre-Budget Report gave more details on each of these changes:

• The income tax personal allowance will be restricted for those with incomes over £100,000 – the two per cent of people with the highest incomes – from April 2010, when the economy is forecast to be growing. From that level of income, the personal allowance will be reduced at a rate of £1 of allowance lost for every £2 of income over that level until it is halved in value. At this value, the personal allowance will be worth the same as for a basic rate taxpayer. From £140,000 of income, the remaining allowance will be completely withdrawn at the same withdrawal rate, so that people with the very highest incomes do not benefit from the personal allowance;

• A new additional higher rate of income tax of 45 per cent (and 37.5 per cent for dividend income) for those with incomes above £150,000 from April 2011. This will ensure that people with the very highest individual incomes pay a greater share of their income in tax; and

• A 0.5 per cent increase in the employee, employer and self-employed rates of NICs from April 2011, alongside an increase above indexation in the point at which individuals start to pay NICs – known as the primary threshold – so that it is aligned with the personal allowance. This will ensure that the fiscal consolidation is broad based, without affecting those over state pension age, who do not pay NICs. These changes will be introduced from 2011, when the economy is forecast to be growing above trend rates and real incomes are growing strongly.

12 HC Deb 24 November 2008 c496

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The measures above mean that people with incomes below £40,000 will not pay more income tax and NICs in April 2011 than in April 2008. People with incomes between £40,000 and £100,000 a year will pay slightly more income tax and NICs, around £3 a week on average. Those with incomes between £100,000 and £140,000 will pay around £22 a week more on average in income tax and NICs, while those between £140,000 and £200,000 will pay on average £61 a week, and progressively more as income rises.13

The report estimated that introducing the 45% rate – and raising the tax rate on trusts to 45% - would raise £670m in 2011/12. Restricting the personal allowance for individuals with incomes over £100,000 would raise £1.32bn in the same year. By contrast, increasing the rates of NI by ½ a percentage point on employees, employers and the self-employed would raise an estimated £5.4bn in 2011/12; raising the NI primary threshold to align it with the personal allowance would cost £1.6bn.14

Much of the reaction to the PBR focused on the Chancellor’s announcement of a temporary cut in VAT, as the centrepiece of a fiscal stimulus programme for the coming year.15 That said, Robert Peston, then BBC news business editor, suggested that the income tax proposals were “the first seriously redistributive tax changes since the 1970s … in a way, this Labour government has ditched the cornerstone of Thatcherism, which is that those on highest earnings will create wealth for the benefit of all of us if they’re allowed to keep as much as possible of their respective incomes.”16

Robert Chote, who was director of the Institute for Fiscal Studies (IFS), argued that the decision to withdraw the personal allowance for wealthier taxpayers was as important a change as the new 45p rate, especially from the perspective of the incentives created by the tax structure for people to change their behaviour:

The introduction of the new 45p income tax band on incomes above £150,000 understandably caught everyone’s attention, being the first increase in the highest income tax band since 1974. The Treasury estimates that this will raise £1.6 billion in a full year, although this has to be a very tentative guess. If more of these people declare less taxable income, put more into their pensions, increase charitable giving or engage in avoidance than the Treasury expects then it may raise less than it hopes.

Almost as important in revenue terms – and much less obvious to the naked eye – is the impact of taking away the personal income tax allowance for people on high incomes. This in effect creates two new 60% income tax bands for incomes between £100,000 and £106,450 and between £140,000 and £146,450 for no obvious economic rationale. This will create a very powerful incentive for people with incomes within these bands to increase their pension contributions until their taxable incomes fall to the bottom of the bands.17

In an editorial the Financial Times noted the incentives the new higher rate would create, going on to argue that, “there is a broader question of uncertainty too. After Labour won three elections promising not to increase the top rate of income tax, plans for the first such hike since 1974 prompts fears of further rises. Now that the commitment to stop at 40 per cent has gone, why believe 45 per cent will be a sticking point?”18 The Institute of Chartered Accountants were strongly critical of the proposal in their submission to the Treasury Committee on the PBR:

13 Pre-Budget Report, Cm 7484 November 2008 p85 14 op.cit. p194 (Table B5). The yield from both the 45% rate and the withdrawal of the personal allowance

would be lagged due to self-assessment, and the Government estimated that for 2011/12 onwards, each measure would raise £1.6bn (Table B5 – footnote 3).

15 For example, the Treasury Committee’s report on the PBR did not discuss any of these direct tax changes in detail (Second report: Pre-Budget Report 2008, HC 27, 28 January 2009).

16 “End of Thatcher’s tax incentives”, Peston’s Picks blog – BBC news, 24 November 2008 17 Opening remarks for post-PBR briefing – Robert Chote, IFS 25 November 2008 p3 18 “Leader: Fussy and feeble income tax rises”, Financial Times, 27 November 2008

7 Income tax: the additional 50p rate

The withdrawal of personal allowances at one pound for every two pounds of income creates an effective additional tax rate of 20% in addition to the 40% income tax rate— ie an effective tax rate of 60% at income levels just above £100,000 and £140,000.

This effect is demonstrated by the comparison of “Case A” and “Case B” in Table 1. as follows:

This example demonstrates that income of £100 has resulted in a further tax charge of £60, an effective marginal tax rate of 60% … the proposals introduce considerable complexity into the income tax system and associated tax calculations and result in two effective marginal rates of tax of 61%.

This increased complexity contrasts with the announcements in 2007 PBR designed to simplify the tax system, in particular the introduction of a flat-rate of Capital gains Tax (CGT). The difference in rate between the top rate of income tax (45%) and CGT (18%) is now 27%, further increasing the incentive to ensure that returns are received by way of capital gains rather than income.19

By contrast, in their evidence to the Committee, the TUC, while concerned about the rise in NICs, argued that restricting the personal allowance was “a very positive move, which responds to a point made by the TUC for some time now that the progressive nature of our tax system is undermined by excessive use of reliefs and allowances by the very wealthy.”20

In their Green Budget in January 2009, the IFS noted that there were considerable difficulties in making accurate predictions as to the amounts of money these changes could raise, since it “requires accurate information about income growth at the top of the income distribution, the shape of the income distribution and the responsiveness of the very rich to changes in their marginal tax rates. All of these are subject to a high degree of uncertainty.”21 The IFS also raised concerns about the impact of withdrawing the personal allowance on the schedule of marginal tax rates; for taxpayers whose allowance was subject to this taper, the effective marginal rate, expressed as a percentage of employer cost, would be 66%:

This is calculated by adding together the income tax rate, employees’ NI rate and employers’ NI rate and dividing by 1 plus the employers’ NI rate, in this case (0.45 + 0.015 + 0.133)/1.133. This is because increasing gross earnings by £1 leads to additional income tax liability of 45p, additional employees’ NICs of 1.5p and additional employers’ NICs of 13.3p and the total cost to the employer has increased by £1.133. This therefore gives the proportion of an extra pound that an employer spends employing someone that is taken in income … It is possible that an optimal tax schedule does involve a lower marginal rate at the very top of the income distribution than slightly lower down … This might be the case if those at the very top of the income distribution were more responses to changes in their marginal effective

19 Pre-Budget Report 2008, HC 27 2008-09 Ev81-2 20 op.cit. Ev88 21 Green Budget 2009, January 2009 p213

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rate .... However …. it seems unlikely that it would figure the two large spikes in the marginal rate schedule that the government is proposing.22

Just prior to the 2009 Budget, the IFS published a follow-up report on the potential response of taxpayers, drawing on correspondence with the department, and earlier research on the responses of wealthy taxpayers when the highest income tax rates were last changed in the late 1980s. The research was highly technical, but, very briefly, the authors looked at the relationship between marginal tax rates, and the income share of the richest 1% of adults, over the period 1962-2003.23

As they observe, the UK experienced a dramatic drop in the marginal effective tax rates (METRs)24 on the highest incomes during the 1980s, which makes it a particularly valuable period to study: “up to 1978, the top METR on earnings was 83%. Under the Thatcher administrations, the top rate dropped to 60% in 1979, and then dropped further to 40% in 1988.” Assuming an underlying consistency in the way individuals and firms respond to marginal tax rates, the authors go on to suggest that raising tax rates on the highest earners would be unlikely to provide an effective method of raising revenue:

The way that incomes have responded to the large changes in top marginal tax rates over the past 40 years suggests that if the richest 1% see a 1% fall in the proportion of each additional pound of earnings that is left after tax, then the income they report will rise by less than half that - only 0.46%. [The term used for this is taxable income elasticity.] Although a tentative estimate, this suggests that the government would maximise the revenue it collects by imposing an overall marginal rate on the highest earners of 56.6%, very close to the 53.0% currently charged in the UK (including income tax, national insurance contributions and indirect taxes). So there does not seem a powerful case for increasing the income tax rate on the very highest earners, even on redistributive grounds - it would not generate much if any extra revenue to transfer to the less well off.25

It is worth adding that the authors emphasized that their estimates of this behavioural response were subject to a great deal of uncertainty – from the paucity of the data they used, and the fact that during this period in the 1980s, not only was the top rate of tax was falling, but income inequality was increasing as well. As a consequence, this analysis might “confuse responses to the policy with any underlying factor increasing income inequality, and this might mean the estimated elasticity is too high.”26

In the course of their work, the IFS made an FOI request to the Treasury about its calculations in the 2008 PBR on the impact of the new 50p rate: in brief, the department used a figure for taxable income elasticity set at 0.35% - rather than the IFS’ figure of 0.46%.27 During the Committee proceedings of the Finance Bill the then Financial Secretary Stephen Timms stated that in doing so, Treasury officials had looked at the work on the UK experience in the 1980s, and “academic evidence available for a range of other countries, the USA in particular.” He went on to argue that two initiatives in the Government’s approach to tax avoidance in the last few years that would have been

22 Green Budget 2009, January 2009 p216, 218, 226 23 Mike Brewer, et al., Means-testing and tax rates on earnings: Prepared for the Mirrlees Review, April 2008.

This work was consolidated in the first report of this review into the UK tax system (see, chapter 2 of, Dimensions of tax design, September 2010).

24 The marginal effective tax rate (METR) measures how much of a small rise in gross earnings is lost to payments of tax and reduced entitlements to benefits.

25 Means-testing and tax rates on earnings … April 2008 p15, p1 26 Mike Brewer & James Browne, Can more revenue be raised by increasing income tax rates for the very

rich?, IFS briefing note BN84, April 2009 p6 27 IFS briefing note BN84, April 2009 p7

9 Income tax: the additional 50p rate

“likely to have had a downward impact on taxable income elasticity in the UK” – the Disclosure Regime, and the so-called Primarolo statement:28

• The ‘Disclosure Regime’, introduced in the 2004 Budget, is a scheme which requires accountancy firms and other practitioners to disclose any new direct tax avoidance schemes to the revenue departments.29

• In the 2004 Pre-Budget Report the then Paymaster General, Dawn Primarolo, issued a statement on possible retrospective legislation: that to “deal with any arrangements that emerge in future designed to frustrate our intention that employers and employees should pay the proper amount of tax and National Insurance contributions (NICs) on the rewards of employment”, the Government would be willing to introduce legislation to counter any avoidance scheme that subsequently came to light “where necessary”, with effect from the date of the PBR.30

The IFS re-examined these official estimates in their 2012 Green Budget.31 The authors’ conclusions are discussed below, but it is worth noting two points that underline the uncertainty surrounding these numbers: first, no allowance is made by the Treasury for any impact on revenues from indirect taxes – as, say, the responses of those affected by the 50p rate results in a drop in their expenditure, and thus a drop in the Exchequer’s VAT receipts.

Second, the Treasury do not factor in any possible ‘fiscal externalities’ from behavioural responses, counteracting the first of these effects. Efforts by taxpayers to postpone paying the 50p rate might mean more tax was collected at a later date; decisions to take remuneration in the form of capital rather than income might boost receipts from capital gains tax. All told, as the IFS observe, “the truth is that there remains a great deal of uncertainty over the revenue-maximising top income tax rate.”32

1.2 Budget 2009: announcement of the 50p rate In his Budget speech on 22 April 2009 the then Chancellor Alistair Darling announced two important revisions to his earlier proposals for income tax increases on the very rich:

I am not proposing to increase taxes on income for this year. However, as the economy recovers and wages start to grow again, it is right that we take additional steps. I believe that it is fair that those who have gained the most should contribute more. Only those with incomes over £100,000 a year—or 2 per cent. of the population—will be affected.

In November, I announced a new rate of income tax of 45 per cent. on incomes above £150,000—the top 1 per cent. of taxpayers. In order to help pay for additional support for people now and to invest in the future, I have decided that the new rate will be 50 per cent., and will come in from April next year—a year earlier. In November, I also announced that I was reducing personal allowances for the very highest earners with incomes over £100,000. These allowances are worth twice as much as those of basic rate taxpayers. I have now decided to withdraw fully the benefit of that allowance for those with incomes over £100,000 from next April.

28 Public Bill Committee (Finance Bill), 21 May 2009 cc89-90 29 The Disclosure Regime now covers VAT, NICs and other direct taxes. Guidance is collated on Gov.uk. 30 HC Deb 2 December 2004 cc44-6WS. Both initiatives are discussed in, Tax avoidance: a General Anti-

Avoidance Rule (GAAR) – background history, Commons Briefing Paper CBP2956, 13 April 2017. 31 “Chapter 9: the 50p income tax rate: what is known and what will be known?”, in, The IFS 2012 Green

Budget, February 2012 pp180-196. 32 op.cit. p193

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These measures are necessary to build our recovery and secure our country’s economic future.33

Details of the new income tax structure from 2010 were set out in a Budget note:

For 2009-10, there are two main rates of income tax. The 20 per cent basic rate of income tax applies to taxable income up to £37,400. The 40 per cent higher rate applies to taxable income above £37,400. From April 2010, a 50 per cent additional rate of tax will apply to taxable income above £150,000.

From 2010-11 there will be three rates of tax for dividends. Dividends otherwise taxable at the 20 per cent basic rate will continue to be taxable at the 10 per cent dividend ordinary rate and dividends otherwise taxable at the 40 per cent higher rate will continue to be taxable at the 32.5 per cent dividend upper rate. Dividends otherwise taxable at the new 50 per cent additional rate will be taxable at a new 42.5 per cent dividend additional rate. From 2010-11, the dividend trust rate will be increased from 32.5 per cent to 42.5 per cent and the trust rate will be increased from 40 per cent to 50 per cent.

The basic personal allowance provides an amount of tax free income. All individuals entitled to the basic personal allowance receive the same amount. From 2010-11, the basic personal allowance will be subject to a single income limit of £100,000. Where an individual’s adjusted net income … is below or equal to the £100,000 limit, they will continue to be entitled to the full amount of the basic personal allowance.

From 2010-11, where an individual’s adjusted net income is above the income limit of £100,000, the amount of the allowance will be reduced by £1 for every £2 above the income limit. The personal allowance will be reduced to nil from this income limit instead of the two-stage reduction announced at the Pre-Budget Report.

“Adjusted net income” is the measure of an individual’s income that is used for the calculation of the existing income-related reductions to personal allowances those aged between 65 and 74, and for those aged 75 and over. Adjusted net income is calculated in a series of steps. The starting point is “net income” which is the total of the individual’s income subject to income tax less specified deductions, the most important of which are trading losses and payments made gross to pension schemes. This net income is then reduced by the grossed-up amount of the individual’s Gift Aid contributions and the grossed-up amount of the individual’s pension contributions which have received tax relief at source. The final step is to add back any relief for payments to trade unions or police organisations deducted in arriving at the individual’s net income. The result is the individual’s adjusted net income.34

HMRC also published a number of worked examples to show how the new 50% rate, and the tapering of the personal allowances, would work in practice.35

At this time it was estimated that the new 50p rate on earnings above £150,000 would raise £2.5bn by 2011/12, and the withdrawal of the personal allowance from individuals with incomes above £100,000 would raise £1.4bn in the same year.36 At the time of the 2010 Budget these estimates were revised upward: to £3.1bn, and £1.47bn, respectively.37

The one other measure in the 2009 Budget estimated to raise equivalent sums was the proposal to increase the main duties on road fuel: first, by 2p a litre on 1 September 2008, and then, by 1p per litre in real terms on 1 April each year from 2010-13. It was

33 HC Deb 22 April 2009 c244 34 HM Revenue & Customs Budget Note BN01, 22 April 2009. Emphasis added. 35 The examples used the 2009/10 figure of personal allowance and basic rate band; as it transpired both

were frozen for the 2010/11 year. (HMRC, Additional Rate of Income Tax and Income Related Reduction of the Personal Allowance from 2010 -11 Supplementary Note and Examples, 23 April 2009).

36 These estimates took into account the revenue raised from the 2008 PBR proposals, along with the Budget 2009 changes: Budget 2009 HC 407 April 2009 pp153-4 (Tables A1 & A2; also Table A1 – footnotes 2&3).

37 Budget 2010 HC 451 March 2010 p140. These estimates were also given in a written answer several months later on the projected yield of the 50p rate (HC Deb 24 November 2010 c367W).

11 Income tax: the additional 50p rate

estimated that these increases would raise £1.75bn by 2011/12. By way of comparison, at this time it was estimated that changing the basic rate of tax by 1p would raise £3.9bn in 2011/12.38

Finally, the Chancellor also announced proposals to restrict higher rate relief on pension contributions made by individuals with incomes over £150,000 from April 2011. One reason to do this was to counteract the impact that the new 50p rate would have on the value of tax relief on contributions for those liable to the additional rate. The method chosen by Mr Darling to restrict relief was strongly criticized by the pensions industry, and the Coalition Government introduced provisions in the Finance Act 2011 to restrict relief in a simpler fashion while raising an equivalent sum of money.39

1.3 Initial reactions The Chancellor’s announcement of a new 50p rate dominated initial reactions to the Budget. Many commentators argued this marked a significant change in the Labour Government’s approach to personal taxation – even though its projected receipts were relatively small, in the context of the public finances. The Guardian’s economics editor, Larry Elliott, put it this way:

Having told us a year ago that the budget deficit would be £38bn in 2009-10, Darling revised the figure up to £118bn in the pre-budget report in November and to £175bn yesterday. That represents a deterioration of £137bn. In total, the new 50% tax rate, scrapping tax allowances and restricting tax relief on pensions will raise, at best, £7bn. Bringing the deficit down to more manageable levels will require years of implausibly high growth, a squeeze on public spending even more severe than during the Thatcher years and, after the election, widespread tax increases.40

An editorial in the paper commented that these measures were “a commendable attempt to share the pain – but it will not do much to plug the yawning gap in the public finances, seeing as it was not combined with measures on property or capital.”41 In the Independent, Hamish McRae said, “leaving aside the breaking of the New Labour covenant on tax rates, it is plain stupid to make a change that brings in less revenue, not more. If you need more revenue you have to be honest and acknowledge that it must come from higher basic rate income tax and higher VAT.”42 The Economist observed that the changes “will irritate the 1-2% of taxpayers affected; but it will hardly solve the problem. That will require broader, more painful measures in the medium term.”43

In an editorial the Times argued, “the Chancellor has not simply increased the top rate to 50 per cent, he also moved the starting date to within this Parliament in direct breach of a central manifesto pledge. As the birth of this pledge [in the 1997 general election] was symbolic, so is its death.” The paper was also doubtful as to the amounts of money that would be raised by the new rate:

The decision to raise the top rate of tax to 50 per cent will punish some bankers, but will simply send others scurrying to Geneva. The vast majority of the 350,000 people earning more than £150,000 will, of course, stay in the UK. They will not complain. They will call their accountants. A higher rate of tax is likely to generate much less revenue than the Treasury hopes, and much more avoidance. But Mr Darling is also guilty of tax avoidance. His Budget sidestepped the central issue of the public

38 HMRC, National Statistics: Table 1.6 (Direct effects of illustrative tax changes), December 2011 39 For details see, Restricting pension tax relief, Commons Briefing Paper CBP5901, 22 November 2016. 40 “Labour’s leaving present”, Guardian, 23 April 2009 41 “Editorial: Budget – cost of a crisis”, Guardian, 23 April 2009 42 “Age of New Labour draws to a close with deceit and dishonesty”, Independent, 23 April 2009 43 “Leader: Desperate Measures”, Economist, 25 April 2009

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finances: it answered the problem of future spending with a commitment to future borrowing but no clear or plausible route to reducing debt.44

The leader in the Financial Times went further, arguing that “the plans to raise taxes on the rich … are not about raising money”:

The most striking measures [in the Budget speech] were undoubtedly the plans to raise taxes on the rich. … There is force in the argument that a government needing to raise revenue should focus on those who have more money rather than those who have less. A fair tax system must be progressive. But the more a country raises money from a small number of rich people, the fewer of them it will find it has. Raising serious revenue requires a broad tax base, not an assault on a small minority of high earners. But these rises are not about raising money: indeed, the Institute for Fiscal Studies has argued that the current top rate of 40 per cent was the revenue-maximising rate, and that the planned increase would cost the exchequer rather than help plug the hole.

These tax plans exemplify the relentlessly tactical nature of yesterday's Budget - a mixture of populism and procrastination. Perhaps it is too much to hope for a strategic approach in the run-up to an election. But the Budget has at least set out the clear division between the main political parties over how to share the pain of getting public finances into shape. Now we need a truthful debate about what this should entail, including what activities the state undertakes that it should cease to perform. Credible politicians must engage with this argument.45

Writing in the Times, Anatole Kaletsky argued that the new 50p rate was “a pointless and unexpected gamble”:

The announcement of any significant tax increase, at a time when the Chancellor was trying to restore business confidence and boost housing and consumption, went completely against the logic of efforts of the Government's faith in fiscal stimulus … [In addition] by accelerating his tax plans, the Chancellor has probably delayed and weakened the recovery that the Treasury is expecting this year ... Third, and most alarmingly, Mr Darling's tax increase has kicked the most cyclically important part of the British economy when it is already down … in today's more cost-conscious environment, banks and multinational companies will be sorely tempted by the near-doubling of net pay that they can achieve for their employees simply by moving out of Britain before Mr Darling's new taxes and national insurance charges are imposed.46

Opinion polls carried out after the Budget found widespread public support for the new 50p rate. The Times reported on a poll by Populus which showed 57% of respondents welcoming the change, with 22% against. This contrasted with reactions to the rises in fuel duty rates: with just 20% in favour and 68% opposed.47 Commenting on the apparent mismatch between the responses of editorial writers and newspaper readers to the 50p rate, the Guardian suggested that this was “partly a case of self-interest … [but also] a more general failure on the part of the elite to grasp how exceptionally rich someone on £150,000 … really is.”48

Provision to allow the new additional 50p rate to be applied from April 2010 was included in the Finance Act 2009 (section 6). Income tax is an annual tax re-imposed each year by Parliament (even if the proposed rates are the same as for the previous year), so the Government anticipated that the Finance Bill the following year would introduce the charge to income tax for 2010/11, and set the additional rate, along with the basic and higher rates of tax. At the conclusion of the Committee debate, Sir Nicholas Winterton, Chairman of the Committee, explained that it was appropriate for the Bill to include this

44 “Leader: The avoidance Budget”, Times, 23 April 2009 45 “Leader: Too frail and vague to shore up credibility”, Financial Times, 23 April 2009 46 “Bad economics, timing and politics: but a good impression of Mr Bean”, Times, 23 April 2009 47 “Tax rise at the top wins applause as Brown denies the death of new Labour”, Times, 24 April 2009 48 “Middle England welcomes 50p tax for high earners”, Guardian, 25 April 2009

13 Income tax: the additional 50p rate

clause, though it did not provide exactly when the higher rate would come in: “The clause, in my estimation and on the advice that I have taken, is the setting of a top rate of tax, without specifying that top rate of tax, which could come in future legislation.”49

The 50p rate was mentioned a few times by Members during the second reading of the Bill on 6 May 2009. Justifying the change the then Chief Secretary to the Treasury, Yvette Cooper, said, “we think that it is fairest for those on the highest incomes to contribute more because over the past 10 years their incomes have increased by an average of £5,000 a year, compared with £600 a year for the average taxpayer.”50 Robert Syms took issue with the amount of money that this additional contribution might raise:

If we are honest, the only way to raise an awful lot of tax revenue is to raise tax on ordinary working people, not on a particular section of people. High tax rates might make a debating point, but the reality of the Government’s policy of raising the higher tax rates, restricting allowances and restricting what people can do with pensions is that people will look for others ways to recompense themselves. They might forgo salary in the short term or look for other ways, such as capitalising their salary.51

The then shadow Chief Secretary, Philip Hammond, criticised the change as a “political gesture” which would create “a yet more complex system of taxation.” Mr Hammond was also concerned about the associated increase in the tax rate on trusts:

In aligning the trust tax rate with the new, higher 50p rate, HMRC made the assumption that all beneficiaries of trusts are people who are likely to be subject to the top rate of income tax. That is simply not the case. Although it may have been a broadly reasonable assumption when the top rate of tax was 40 per cent., it is an unreasonable assumption when the top rate of tax affects only those people with an income of more than £150,000. There will be many beneficiaries of trusts with incomes far below the £150,000 threshold whose income will now be subject to tax at the 50 per cent. rate. That undermines still further the legitimate use of trusts, and should be carefully considered.52

Winding up the debate, the then Financial Secretary, Stephen Timms, responded to this point:

Rates were aligned in 2004 to prevent avoidance of the higher rate by routeing income through a trust. The trust rate will be increased in line with the higher rate, so we are not opening up opportunity for trusts to be used for avoidance. Those for whom the lower rate is appropriate can reclaim tax; many do so already. In the case of self-assessment, that will happen automatically. If, as was suggested, the trust is for a vulnerable beneficiary or a bereaved child, for example, an election can be made under the vulnerable beneficiary legislation, which has a special tax regime.53

Similar points were raised when these provisions were debated at the Committee stage of the Bill. The Financial Secretary explained why the Government had changed its proposals since the PBR in November 2008:

As you will recall, it was announced in the pre-Budget report in November that we would be introducing a 45 per cent. rate in April 2011. However, the global downturn has been worse than predicted and, as a result, more consolidation is required. That is why the additional rate has been brought forward and raised by five percentage points to 50 per cent … We have thought very carefully about how the further money

49 Public Bill Committee (Finance Bill) 21 May 2009 c95. The Act also contained provision for the tapering of

the personal allowance from individuals with incomes over £100,000 (section 4). 50 HC Deb 6 May 2009 c184 51 HC Deb 6 May 2009 c236. The Financial Times soon reported this trend in tax planning (”Investors seek to

shift away from tax traps”, 2/3 May 2009). 52 HC Deb 6 May 2009 cc197-8. The Chartered Institute of Taxation also argued the increase in the trust

rate is “punitive, forcing distribution of income” (CIOT Budget 2009, 1 May 2009 p1). 53 HC Deb 6 May 2009 cc310-11

Number 249, 26 September 2018 14

required for fiscal consolidation should be raised. We are clear that it is right to require those who benefited most in the last decade and who are in the best position to pay to contribute more. That is the basis for the clause.54

Speaking for the Conservatives, Greg Hands suggested that “the new tax rate’s implementation is largely the result of political posturing.” He raised concerns that the change of policy between the 2008 PBR and the 2009 Budget had undermined the UK’s reputation as having a ‘predictable and stable’ tax code, and questioned whether the new rate would raise as much as predicted, especially as it would increase the differential between the highest rate on income tax and the rate of capital gains tax.55

Jeremy Browne, speaking for the Liberal Democrats, took issue with what he termed the ‘ethical’ case for the 50 rate, that, “it was only right that the people who benefited from economic growth should pay more now that the economy is shrinking”:

First, those who are earning the most money already contribute a much bigger percentage of the total national income tax take than their numbers would otherwise indicate. One could argue that they should contribute more or that they should contribute less, but it is misleading to suggest that the top 1 or 2 per cent. of earners are not contributing in a substantial and meaningful way to the public finances; they most certainly are. Secondly, one should not necessarily assume that people who will be earning in excess of £150,000 from next year onwards benefited during the period of economic growth.56

1.4 Debate as to its potential yield At the IFS briefing after the 2009 Budget, Robert Chote, then director of the IFS, put the changes to income tax on the wealthy into some context:

Much attention has focussed on the income tax increases on the rich, which the Treasury hopes will raise £7 billion a year. Even if this estimate is correct, the gain will partly be offset by losses of VAT and other indirect tax revenues buried in other Budget forecasting changes. We should also bear in mind that increases in fuel duty and National Insurance will raise a roughly similar amount – and from a much broader range of families. And all the tax increases announced to date will in total raise only about 10% of the money the Treasury is looking for by 2017–18. So the main burden of the looming tightening – at least over the next few years – is likely to fall on the users of public services.57

In a presentation on the Budget changes to direct taxes and benefits, Stuart Adam of the IFS noted that there was “huge uncertainty about how much people will reduce their taxable income in response”, observing that they might “work less, retire earlier, emigrate, contribute more to [a] pension or charity, convert income to capital gains, incorporate, [or] invest in tax avoidance.” Moreover the Treasury’s estimate that the 50p rate would raise £2.4bn ignored any effect on consumer spending, and the consequent fall in indirect tax revenues.58

In its submission to the Treasury Committee on the Budget, the Institute of Chartered Accountants noted the IFS’ work on this issue, saying “given the weight of evidence that such rates may not be effective in raising revenue, we [are of] the view that a detailed economic analysis of the impact of the proposed 50% tax rate needs to be made, before

54 Public Bill Committee (Finance Bill) 19 May 2009 c45, c48 55 PBC 19 May 2009 c49, c61, c67 56 PBC (Finance Bill), 19 May 2009 c72 57 Reactions to Budget 2009: Opening remarks - Robert Chote, IFS 23 April 2009. The Budget projections for

2009-10 from VAT and corporation tax were £8.8bn & £7.7bn lower than those made in the 2008 PBR (Budget 2009, HC 407, March 2009 p231).

58 Stuart Adam, Budget 2009: Direct taxes and benefits, IFS 23 April 2009. On this theme see, “Ten ways to survive high-tax Britain”, Sunday Times, 26 April 2009.

15 Income tax: the additional 50p rate

any such policy is implemented.”59 For its part, the Committee heard evidence from the Treasury that it anticipated that individuals would be relatively successful in reducing their liability to the new rate; Mike Williams (Director, Personal Tax and Welfare Reform) explained the department’s modelling of these behavioural changes as follows:

The modelling exercise assumes that of the total theoretical yield that you would get from the extra 10 percentage points from 2011-12 onwards that we would get about 31% of that ... What it is about is of the total extra theoretically obtainable the best estimate made, taking into account behaviour, is that we will get just over 30% of that … If you take the costing in two parts, first, you look at how many people there will be with incomes above, say, £150,000 in 2011-12 and apply the 50% rate, where you were previously applying the 40% rate, and that gives you one figure, the maximum theoretically obtainable figure. What is scored and what we think is the best estimate after behaviour from 2011-12 onwards is 31%, but just to clarify yet further, because of course there is interaction with the pensions tax measure60, if you then take into account the pensions tax measure that in itself acts to reduce the behavioural effect from the 50% rate and if you take the two together, which you can choose to or you can deal with them separately, that takes the behavioural effect down so the yield goes up to about 38%.61

When the then Chancellor, Alistair Darling, appeared before the Committee, he was asked if this apparently high level of avoidance might not undermine public support for the measure; he responded by saying:

Tax-planning has been with us, presumably, since the beginning of the 19th Century when, you will remember, income tax was introduced on a temporary basis during the Napoleonic Wars and, I dare say, ye olde tax planners have been doing a roaring trade ever since. It is perfectly legitimate for people to tax-plan. They are only obliged to render unto Caesar what is due to Caesar and that has always been a feature of their case. What I tried to do here though, I am raising revenue both in indirect taxes and from next year from those earning over £100,000 in direct taxes, and of course I will always be vigilant about loopholes and indeed we announced various measures in the Budget there. I think the answer to your question is that to dig up the entire system at the present time would have been, I think, difficult to justify.62

At an earlier point in these exchanges, Mr Darling said:

If you see the yield that comes in from those measures, and this one, I think, is about £2.4 billion when it is there totally, it is quite a substantial sum of revenue. All I would say to people who tell me they do not want me to do it is, “Okay, so what else are you suggesting? Where else would you go?” There is no getting away from the fact that we do need to take steps to deal with the result of the fact of our corporate tax revenues, which could well come back in years to come, which, for as long as banks do not make any money, they will not be paying any taxes.63

Mr Darling was also asked why he had chosen to set the additional rate at 50p on incomes over £150,000:

You ask me why I chose the level of £150,000 and that was simply my judgment. I had to balance reluctantly, if you like, because, having spent the best part of 10 years in a government that had essentially two rates of tax, I think it is important that we are competitive, but in the present circumstances, and other governments are going to be confronted with this, we need to take action to support our economy and also to live within our means, and I thought this was a fair thing to do.64

59 ICAEW Tax Faculty, 2009 Budget Submission TAXREP 14/09, March 2009 p2 60 [As mentioned above, Budget 2009 also announced the tapering of tax relief on pension contributions for

individuals with incomes above £150,000.] 61 Eighth report: Budget 2009, HC 438-II, 6 May 2009 Q219 Ev30 62 op.cit. Q343 Ev45 63 op.cit. Q338 Ev 44 64 op.cit. Q336 Ev 43-4

Number 249, 26 September 2018 16

For its part the Committee raised serious concerns about the way in which the new structure had been designed, and the amounts of money that it could reasonably be expected to raise:

We … recommend that the Treasury, in the 2011 Pre-Budget Report, should report on the revenue raised, both nominally and as a percentage of the theoretical maximum revenue, by the new top rate of income tax. We also recommend that the Treasury assess at that time the yield obtained from the higher rate against its disadvantages. If the higher rate were to be continued it would be appropriate to consider what further reforms would be needed to prevent further leakage of potential revenue from this measure. The Treasury should indicate if it would revise the rate in the event that the estimated revenue yield fell well below their forecasts.65

The Government published its response to the report in July 2009, and made the following remarks in answer to this point:

The costings of the 50 per cent income tax rate are based on careful assessment of the impact, including any behavioural responses, on all relevant receipts and revenues. As the Government has made clear to the Treasury Select Committee, the Government has accounted for a proportion of high income individuals using various methods to reduce their tax and NICs liabilities. The Government believes that this represents a fair estimate of the impact of this measure. The Government is committed to ensuring that everyone continues to pay their fair share whatever their income. As with all taxes, the Government will keep the additional rate under review. HM Revenue and Customs update each year income tax information contained on their website.66

In November 2010 the IFS published the draft conclusions to a major review of the UK tax system, which had been chaired by Sir James Mirrlees. In their discussion of the taxation of earnings, the authors reviewed the work done by IFS researchers on the potential yield of the 50p rate, and the debate over a revenue-maximising top rate – but went on to argue that the significance of the 50p rate lay less in the “paltry sum it might raise (or cost)”, but in what it represented about wider attitudes about wealth and inequality:

Tax rises impose losses on those affected even if they raise no revenue: those who do pay more lose out financially, while those who change their behaviour to avoid the tax are still somewhat worse off—otherwise they would have changed their behaviour even in the absence of the tax. If we put any value at all on the extra satisfaction the rich derive from becoming even richer, the revenue-maximising tax rate will be too high. On the other hand, if we find extreme affluence so abhorrent that it is worth making the rich worse off even if it raises no money—indeed, worth making the rest of the population slightly worse off in order to make the rich significantly worse off—then the revenue-maximising tax rate will be too low.

Such considerations are particularly pertinent because, around the revenue-maximising tax rate, even sizeable changes in tax rates would have little impact on revenue, yet still impose significant losses on those affected. Society’s attitude to those losses is therefore as important as the precise revenue effect. The significance of the 50% income tax rate is less the paltry sum it might raise (or cost) than the substantial hit on high earners it represents.67

A longer extract from the final report, which was published in September 2011, is reproduced in an appendix to this paper.

65 HC 438-I 2008-09 para 100 66 Fifth special report, 10 July 2009 HC 890 2008-09 p12 67 “Chapter 4: Reforming the Taxation of Earnings in the UK” in, Tax By Design: the Mirrlees Review

(Preliminary version), November 2010 pp 35-7

17 Income tax: the additional 50p rate

1.5 The 2010 Budget Following the 2009 Budget and debates over the new 50p rate, there were a series of press reports of companies paying employees ahead of time to miss the new 50p rate,68 of the tax authorities signalling their determination to crack down on any new avoidance schemes,69 and accountants suggesting that many entrepreneurs and financiers were considering leaving the UK.70 On this last point, a survey of the banking sector after the new rate came in found little evidence of any exodus of senior executives to low tax havens in Geneva or Zurich, for the simple reason that typically they could still earn twice as much in London after tax, such is the relative size of London’s financial market.71

Over the next few months the focus of public attention moved to wider concerns: the severity of the recession, the continuing decline in the public finances, and the fact that whichever government took power after the 2010 General Election, it would have to consider much larger tax increases or major cuts in public spending, or, most likely, both.

In their Green Budget, published in February 2010, the IFS looked at a wide range of possible tax increases and benefit cuts that might be implemented to reduce the size of the public deficit. Income tax is the largest tax in terms of the money it raises for government; taken with the other two big taxes - VAT and NICs – these three raise about 60% of all Exchequer revenues. Changes to the rates of these taxes would raise very large sums: 1% of national income (£15.4 billion in 2011/12 terms) could be raised by putting up the basic and higher rates of tax by 3 percentage points. In their discussion of this and other possible revenue-raising changes to income tax, the authors explained, “we do not consider increasing the 50p ‘additional’ tax rate, which will apply above £150,000 from April 2010, as previous research has shown that, at best, very little additional revenue could be expected to be raised from doing so.”72

In his 2010 Budget speech the then Chancellor, Alistair Darling, simply confirmed the introduction of the 50p rate, along with a number of other pre-announced tax increases aimed at those on higher incomes:

First, on taxes, I have already made difficult decisions, and I have been guided by our values of fairness and the need not to undermine the recovery. The one penny increase in the main rate of national insurance contributions will not affect anyone earning under £20,000 a year; nor will it come into effect until April next year, by which time I expect that the recovery will be stronger and more secure.

The 50 per cent. rate of income tax will come in next month, but it affects only those with earnings over £150,000 a year-the top 1 per cent. of earners. For people with incomes over £100,000 a year - the top 2 per cent. - we will gradually remove the value of their personal allowances. Tax relief on pensions will be restricted from next year, but again only for those with incomes above £130,000 a year.

Among all the tax rises since the beginning of this global crisis, 60 per cent. of them will be paid for by the top 5 per cent. of earners. We have not raised these taxes out of dogma or ideology; we are determined to ensure that our overall tax regime remains competitive. But I believe that those who have benefited the most from the strong growth in incomes in the past years should now pay their fair share of tax. I have no further announcements on VAT, on income tax or on national insurance rates.73

68 For example, “Taxman loses as dividends spring forward”, Financial Times, 6/7 March 2010 69 “Revenue warns high earners of tax avoidance crackdown”, Financial Times, 8/9 October 2009 70 For example, two Financial Times reports: “Accountants warn of 50% tax exodus”, 19/20 September 2009

& “Tax rise may spark entrepreneur exodus”, 5/6 December 2009. 71 “Banking exodus fears on 50% tax overdone”, Financial Times, 17 May 2010 72 The IFS Green Budget, February 2010 p135, p138 73 HC Deb 24 March 2010 cc255-6

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Provision for the 50p rate was included in the Finance Bill, published at the end of the Budget debates on 30 March.74 The Bill was relatively shorter than usual, to take account of the fact that there would be a limited amount of Parliamentary time available before the General Election. As it transpired, the date of the Election was announced just a few days later, with the Dissolution of the House set for 12 April. This left 2 days of Parliamentary time for the conclusion of all legislative business, and the Finance Bill was debated, and approved, in its entirety in three hours on 7 April – with little reference being made to the changes to be made to the structure of income tax.75

The three major parties made no mention of any further changes to the new higher rate during the Election campaign.76 For their part, the Conservatives stated that they did not “regard the new 50p tax rate as a permanent feature of the tax system” but that they would not “abolish it for the rich while at the same time asking many of our public sector workers to accept a pay freeze.”77 In addition, the party made no mention of increasing the £150,000 threshold in line with inflation or earnings.

By way of comparison, a written answer in the Lords in January 2010 provides some figures for the top rates of tax in the other G7 countries:78

Asked by Baroness Valentine: To ask Her Majesty's Government how the top rate of United Kingdom income tax compared with other G7 countries in (a) 2000, and (b) 2010; and what plans they have to address that aspect of the United Kingdom's competitiveness.[HL5928]

The Commercial Secretary to the Treasury (Lord Sassoon): Top marginal tax and social security rates are not necessarily representative of the total burden of taxation on earnings, which depend on the income thresholds at which these rates apply as well as the burden of employer social security contributions.

Tax wedge data offer a more comprehensive measure of the total burden of taxation on earnings, as they account for both of these considerations. G7 tax wedge data for high income individuals are not immediately available for 2000 and 2010.

However, a limited range of data is published by the OECD in its annual Taxing Wages document (latest edition published May 2010).

As of April 2010, the top rate of income tax in the UK is 50 per cent. This rate was introduced by the previous Government, and will remain in place for the time being. However, we believe that high marginal tax rates are not good for the UK and we will continue to look at the yields from different taxes, including the 50 per cent rate, to ensure that they remain an efficient and effective way of raising revenue.

Top Statutory Income Tax rate Employee social security contributions (as % of gross income) at top of income tax threshold Combined (as % of gross income)

2000 2010 2000 2010 2000 2010 Canada 46.3% 45.6% 0% 0% 46.3% 45.6% France 58.3% 47.8% 11% 11% 69.6% 59.0% Germany 53.8% 47.5% 0% 0% 53.8% 47.5% Italy 45.9% 43.8% 9.2% 10.5% 55.1% 54.3% Japan 50% 50% 0.4% 0.4% 50.4% 50.4% UK 40% 50% 0% 1% 40.0% 51.0% USA 45.6% 41% 1.5% 1.5% 47.1% 42.5%

74 It is now set out in s1 of the Finance Act 2010. 75 HC Deb 7 April 2010 cc 1058-1105. In the very short Committee stage debates, the House considered 3

clauses, but not the clause setting the charge and rates of income tax for the coming tax year. 76 A summary of the three parties’ tax policies was provided in, Taxes and benefits: the parties’ plans:

Institute for Fiscal Studies Election Briefing Note BN100, 27 April 2010 77 Conservative Party, Where we stand: Economy, 2010 78 HL Deb 31 January 2011 cc240-1WA

19 Income tax: the additional 50p rate

*Notes:

Canada:

(1) Top Federal rate is 29%. Average of top provincial rates (including surcharges) is 16.6% (2010). Highest combined rate applies in Quebec (54%).

(2) Social Security contribution ceiling is CAN$45,000 (approx £23,000)

France:

(1) Top statutory rate of income tax is 40% (rising to 41% in 2011). Two Social contributions also apply to gross income, CRDS and CSG and are included in the calculation above.

(2) Social Security contributions are deductible for personal income tax.

Germany: Social security contribution ceiling is €64,000. Combined with high contribution rates means that individuals further down the income scale can face higher marginal rates than top earners. For example an individual earning €41,000 (approx. £35,000) and facing full social security contribution rates would face a marginal combined rate of 56%.

Italy: Top statutory rate of income tax is 43% in 2010. Regional up to a maximum rate of 1.4% also applies.

Japan: Top statutory rate of state income tax is 40%. 10% flat rate local tax also applies.

USA: Since 2001 top federal income tax rate is 35% but this is due to expire in 2013 and return to 2000 level of 39.6%. Average of state top income tax rates = approx 6%.

Number 249, 26 September 2018 20

2. The Coalition Government’s approach

2.1 The June 2010 Budget On 20 May 2010 the new Conservative-Liberal Democrat Coalition Government published their coalition agreement: this made no mention of the 50p rate, though it indicated that it would make a number of tax changes in its first Budget:

The Government believes that the tax system needs to be reformed to make it more competitive, simpler, greener and fairer. We need to take action to ensure that the tax framework better reflects the values of this Government.

We will increase the personal allowance for income tax to help lower and middle income earners. We will announce in the first Budget a substantial increase in the personal allowance from April 2011, with the benefits focused on those with lower and middle incomes.

This will be funded with the money that would have been used to pay for the increase in employee National Insurance thresholds proposed by the Conservative Party, as well as revenues from increases in Capital Gains Tax rates for non-business assets as described below. The increase in employer National Insurance thresholds proposed by the Conservatives will go ahead in order to stop the planned jobs tax.

We will further increase the personal allowance to £10,000, making real terms steps each year towards meeting this as a longer-term policy objective. We will prioritise this over other tax cuts, including cuts to Inheritance Tax.79

In his Budget statement on 22 June 2010, the Chancellor George Osborne announced that the personal allowance would rise by £1,000 to £7,475 from April 2011. The threshold at which taxpayers became liable to the 40% higher rate would be cut, to prevent higher rate taxpayers benefitting from this change. Mr Osborne also confirmed an increase in the threshold for employers paying NICs on their employee’s earnings from April 2011, as well as a rise in the rate of capital gains tax for higher rate taxpayers.80

However, the most significant tax change which the Chancellor announced, in monetary terms, was a rise in the standard rate of VAT from 17.5% to 20% from 4 January 2011. It was estimated that the new standard rate would raise £12.1bn in 2011/12. By comparison the £1,000 rise in the personal allowance would cost £3.49bn in 2011/12.81 On the additional 50% rate, the Budget report simply stated: “the 50p rate of income tax took effect from April 2010 and will remain in place for the time being.”82

Unsurprisingly comment on the new Government’s first Budget was dominated by the rise in the standard rate of VAT, though in a review of its approach the OECD suggested the EU should consider reducing the top rate of personal income tax: the top rate of Personal Income Tax [PIT] “is substantially above the OECD average and likely to adversely affect work incentives and entrepreneurship, particularly of high skilled workers. Consideration should be given to reducing the top PIT rate to close to 40 per cent.”83 In the weeks before the 2011 Budget, there was more speculation that the Government might review the 50p rate, given its concerns to ensure that the UK remains internationally competitive and updated predictions of the large share of income tax receipts paid by those with the

79 HM Government, The Coalition: our programme for government, 20 May 2010 p30 80 HC Deb 22 June 2010 c179 81 Budget 2010, HC 61, June 2010 p40 82 op.cit. p32 83 OECD, United Kingdom - Policies for a Sustainable Recovery, July 2010 p25

21 Income tax: the additional 50p rate

very highest incomes.84 Subsequently HMRC has estimated that in 2010/11 additional rate taxpayers were liable to pay £34.5bn, while total income tax liabilities were £152bn.85

In an opinion piece critical of the 50p rate, Jo Johnson MP noted that three quarters of those expected to pay it would be in sectors other than banking – “many of these will be precisely the entrepreneurs the UK must attract to stimulate job creation and quicken its sluggish recovery from recession”:

Those who seemingly despise bankers, a distressingly large proportion of the electorate, hail [the 50p rate] as a progressive tax on City "fat cats". It is rapidly becoming clear, however, that it is a rather crude instrument for the collective punishment of this banker class, somewhat like the EU fishing quotas that encourage trawlers to catch and discard more fish than they ever take to shore … In a letter to the parliamentary public accounts committee, [Sir Nicholas Macpherson, the permanent secretary to the Treasury] revealed that the 50p rate is paid by three times more innocent bystanders than bankers.86 Out of 275,000 affected, only 63,000 - 23 per cent - work in "financial intermediation". Many of these collateral victims, of course, will be precisely the entrepreneurs the UK must attract to stimulate job creation and quicken its sluggish recovery from recession.

The result is that, just as countries need to compete for highly skilled labour as never before, the UK is seen as a high-tax economy … It is also not clear that the 50 per cent rate will raise the revenue the then Labour government forecast in the March 2010 Budget … But even if the Treasury receives the revenues forecast in last year's Budget, they will be unlikely to compensate for the damage to the UK's international competitiveness.

This leaves the government facing a dilemma. On the one hand, there are huge political difficulties in even signalling an intention eventually to cut taxes for the well-off (in line with reductions in all other rates of taxation and only once the public sector pay freeze is lifted) at a time of hardship for the poor and difficulties for many lower- and middle-income families. On the other hand, in a global economy, no prudent government will want to lumber itself with Harold Wilson-esque rates of personal income tax for a second longer than necessary.87

2.2 The 2011 Budget: HMRC’s assessment In his Budget speech on 23 March 2011, Mr Osborne confirmed that there would be no change in the rates of income tax for the coming year, though he suggested that the case for the 50p rate should be re-examined once there was comprehensive data on the amounts of money it had raised for the Exchequer in its first year:

In an age when business and capital and people can increasingly move anywhere, high tax rates can do real damage. That is true for high corporate tax rates, and it is true for high personal tax rates too. They crush enterprise, undermine aspiration and often undermine tax revenues as people avoid them. I am clear that the 50% tax rate would do lasting damage to our economy if it were to become permanent. That is why I regard it as a temporary measure, just as my Labour predecessor, the right hon. Member for Edinburgh South West (Mr Darling), did when he introduced it. I have said before that now would not be the right time to remove it when we are asking others in our society on much lower incomes to make sacrifices, for we are all in this together, but I think it is sensible to see how much revenue it actually raises. I have asked Her Majesty's Revenue and Customs …to find out the truth when the self-assessment forms start coming in.88

84 “Top 1% of earners set to pay quarter of all income tax”, Financial Times, 12/13 February 2011 85 Income tax liabilities by taxpayer’s marginal rate: 1999/00-2014/15, May 2018 86 see, Banking support: written evidence from HM Treasury, HC 973, 16 March 2011 87 “Why a high-tax London is a disaster for Britain”, Financial Times, 17 March 2011 88 HC Deb 23 March 2011 c957

Number 249, 26 September 2018 22

Provision to set the rates of income tax for the 2011/12 tax year was included in the Finance Act 2011 (specifically section 1 of the Act). At the Committee stage of the Finance Bill, David Hanson MP, speaking for the Opposition, moved an amendment for HMRC’s review to be subject to a formal timetable, akin to a formal consultation: “it is inclement on [the Minister] to say to the House, ‘This is the time scale. This is who will undertake it. This is when it will report. This is how you put evidence into it. This is when we will make a decision for a future Budget on whether that 50p tax rate stays or goes’.”89 In response Treasury Minister David Gauke explained why HMRC had been given this task, but rejected the case for taking this approach:

HMRC is undertaking the review because it is important that all the information available on the 50% rate is considered, and only HMRC can analyse individual self-assessment returns, because they contain confidential taxpayer information … In looking at the issue, HMRC’s main challenge will be to isolate the impact of the additional rate from other factors. In light of that, it will conclude its analysis as soon as it is practical to do so.

Its findings will then be used to inform the Government’s wider thinking on taxation policy, with any announcements made by the Chancellor as part of the annual Budget process in the usual manner. Of course, the Government keep all taxes under review and reserve the right to announce changes at the appropriate time. Indeed, tax changes are generally made at Budgets. Given that, there is no reason to accept the amendment.

The Minister went on to explain that as self-assessment returns for the 2010/11 year would be filed by the end of January 2012, HMRC would be reviewing this data “in early 2012.”90 The amendment was put to a vote, and negatived by 16 votes to 14.

At the report stage of the Bill the Opposition put down an amendment to require the Office for Budget Responsibility to produce a report on the 50p rate. Moving the amendment David Hanson MP stated, “we want further explanation of the methodology that they will use to consider the 50p tax rate for future Budgets, and I think that the best organisation to do that is the Office for Budget Responsibility.”91 Opposing the amendment Mr Gauke argued that HMRC were best placed to review the data on the yield from the 50p rate, and criticised the way in which the Labour Government had introduced it:

As I explained during the extensive debate on this clause in Committee … HMRC will consider all the available evidence on the impact of the additional rate, including data from the 2010-11 self-assessment returns, which will become available next year. Data from tax returns are clearly essential in any assessment of the revenue raised, but of course they contain confidential taxpayer information and are best reviewed by HMRC. It already has the expertise in monitoring and evaluating tax measures and is resourced to do so in future. The Office for Budget Responsibility has a different remit in producing independent economic and fiscal forecasts, judging policy against the fiscal mandate and analysing the sustainability of the public finances …

As the additional rate was introduced by the previous Government, I can perfectly understand why the right hon. Member for Delyn [Mr Hanson] is so interested in establishing whether it was a successful policy, but when he talks about public scrutiny of Budget measures I must ask him what public scrutiny was there when the 50p rate was introduced? To what extent was the analysis published then, and to what extent was it published when the 10p rate of income tax was doubled? What information was put into the public domain at that point? As a Government, we have done much more on putting information into the public domain by publishing our

89 Public Bill Committee (Finance Bill), 10 May 2011 c10 90 op.cit. c22, c29. This point was also made in answer to PQs on this issue (eg, HC Deb 19 May 2011

c325W). 91 HC Deb 4 July 2011 c1324

23 Income tax: the additional 50p rate

analysis. Announcements in this area will be made by the Chancellor at the appropriate time. It is peculiar, however, to hear the Opposition proposing more evidence-based policy making only to reject the notion, it seems to me, that this Government should consider the evidence before making any further commitments.92

The amendment was put to the vote and negatived by 298 votes to 229.

Running up to the 2012 Budget there was a great deal of debate over the 50p rate, much of it in response to a letter published in September 2011 in the Financial Times, signed by DeAnne Julius, then Chairman of Chatham House, and nineteen other economists:

Sir, We welcome the government putting the promotion of growth at the top of its agenda given the fragile state of the UK economy. Other major economies have got back to pre-recession output levels; the UK has not. In this context, we are concerned that Britain's 50p income tax rate is doing lasting damage to the UK economy. It gives the UK one of the highest personal tax regimes in the industrialised world, making it less competitive internationally and making us less attractive as a destination for both foreign investment and talented workers.

The UK has already slipped from second to fourth place as a destination for inward investment. It punishes wealth creation by imposing on entrepreneurs and business people a marginal tax rate in excess of 50 per cent once national insurance contributions are added in. This is particularly damaging when the UK needs to create new businesses in new industries and promote growth by small companies, which can grow fast. It applies to just 1 per cent of taxpayers, who already pay 24 per cent of all income taxes.

If a small portion of these highly mobile workers move elsewhere because of the 50p rate then it is clearly a self-defeating way for the Treasury to try to raise money, and a reduction in tax avoidance would be more effective. It is often portrayed as a justified tax on the rich but the economic damage it causes means that it is against the interests even of ordinary workers who don't pay it. We call on the government to drop the 50p tax at the earliest opportunity as part of a package of measures to stimulate growth. Only by returning to an internationally competitive tax regime will Britain enjoy long-term sustainable economic growth.93

The paper published a series of letters from both supporters and critics of the 50p rate,94 and the debate continued elsewhere, as commentators speculated as to its future.95 The IFS examined the issue in some depth in their 2012 Green Budget, observing that “rarely has there been such a wide debate about an issue of tax policy based on so little empirical evidence.”96 The analysis drew on much of the research that has already been mentioned in this note, and it is not proposed to do it full justice here. That said, the authors made some striking points about the limitations to any data the Chancellor would have, to inform any decision about the 50p rate:

The first evidence on the revenue raised by the 50p tax rate will be contained in tax returns for the 2010–11 tax year, which need to be submitted to HMRC by 31 January 2012 … This gives less than two months for [HMRC to review these figures] … even assuming the data will be fully processed and available to researchers at the beginning of February. But tax records for just one year … are unlikely to provide a robust estimate of how much revenue the 50p rate will raise, for several reasons.

92 HC Deb 4 July 2011 cc1332-3 93 “Letters: Government must abolish 50p tax rate to grow UK economy”, Financial Times, 7 September

2011 – see also, “Debate goes on in wake of 20 economists' letter to the FT : Q&A”, 8 September 2011. 94 “Letters : Costs and taxes mean the take is not worth the effort”, 9 September 2011; “Letters : UK tax

debate needs to consider capital gains”, 12 September 2011; “Letters : Top-rate income tax will not lead entrepreneurs to move abroad”, 13 September 2011

95 For example, “Tax ‘staying for now’…”, Times, 8 September 2011; “Should high earners pay less tax?”, Sunday Times, 11 September 2011; “Head to head: Should the 50p rate go?”, Guardian, 8 September 2011; “Diving into the rich pool”, Economist, 24 September 2011

96 “Chapter 9: the 50p income tax rate: what is known and what will be known?”, in, The IFS 2012 Green Budget, February 2012 pp 180-196.

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First, the 50p tax rate was announced over a year before its implementation … this gave high-income individuals the incentive to bring forward income to 2009–10 to avoid paying the increased tax rate. So tax revenues in the first year of the 50p tax’s operation are likely to be particularly low and those in the prior year particularly high. Second, one year after the tax’s implementation might be too soon for some individuals to respond fully to the new tax rate. In particular, those who decided to leave the UK following the announcement of the 50p rate might not have had enough time to arrange this, such that the revenue implications might be higher going forward.

Third, because the Chancellor has said that he views the 50p rate as a temporary measure, individuals are likely to behave differently from if the tax change were believed to be permanent. On the one hand, individuals are more likely to engage in responses that involve shifting income to a future date when an increase is temporary. On the other hand, individuals are less likely to engage in responses that have a large fixed cost, such as moving away from the UK. A separate issue is that the ongoing economic crisis will likely make it difficult for HMRC staff to distinguish between the impact of the 50p rate on tax revenues and the impact of other economic forces on the incomes of the richest 1%. For example, many of the richest 1% are employed in the financial services industry and are likely to have seen their incomes fall significantly during the early part of the recent recession before rebounding strongly in 2010–11.

As they concluded, “Budget 2012 is almost certainly too soon to be making decisions on the future of the 50p rate if they are to be informed by reliable, robust empirical evidence.” Echoing themes in the Mirrlees review, the authors argued that the focus there had been on the potential yield from the 50p rate represented “an unduly narrow approach to tax policy”:

Even if it raised money, it may not be the least socially harmful way of raising the same amount of revenue, even from the same or similar people. Since most of the behavioural response to high tax rates appears to take the form of tax avoidance, an obvious way to increase revenue might be to reduce the opportunities that exist for tax avoidance – for example, by aligning income and CGT rates, thereby negating any advantage to taking remuneration as capital gains rather than income. But any reforms such as this would need to be carefully thought through and implemented as part of a wider strategy for tax policy.

Effective tax policy requires a clear strategy, an understanding of how the system as a whole works together, and a consistent and concerted approach to reform. Decisions about the abolition or retention of the 50p rate, and about any measures to increase revenues from the richest individuals, should be considered as part of a clear forward strategy. We can ill-afford poorly-thought-out, short-term and un-joined-up tax policymaking.97

2.3 The 2012 Budget: cutting the additional rate to 45p The Chancellor George Osborne delivered his third Budget on 21 March 2012. In his speech Mr Osborne referred to his earlier concerns over the 50p rate, and explained that the department had found evidence that the 50p rate had caused “massive distortions”, in particular with taxpayers, forewarned about the rate taking effect, shifting income into the 2009/10 year to avoid paying it. HMRC had revised its analysis of this behavioural impact, and this suggested that cutting the rate to 45p would cost relatively little – an assessment that the Office of Budget Responsibility found to be reasonable. This contrasted with the amounts of money the Government expected to raise from taxpayers on the highest incomes from a number of other Budget measures. As a consequence he proposed setting the rate at 45p from April 2013.

97 The IFS 2012 Green Budget, February 2012 p195, p196

25 Income tax: the additional 50p rate

An extract from the Budget speech is reproduced below:

[The 50p rate] is widely acknowledged by business organisations and international observers as harming the British economy. Like the previous Chancellor who introduced it, I have always said that it was temporary. But I also said, three years ago, that I would not be prepared to reduce it while we were asking the whole public sector to accept a pay freeze, and I will stick to those pledges.

A 50p tax rate, with all the damage it does to Britain’s competitiveness, can only be justified if it raises significant sums of money. In last year’s Budget, I asked Her Majesty’s Revenue and Customs to look at the evidence, and especially to look at the self-assessment tax receipts that have come in since this January. I am publishing its report today. What it reveals is that the 50p tax rate has caused massive distortions.

HMRC finds that an astonishing £16 billion of income was deliberately shifted into the previous tax year, at a cost to the taxpayer of £1 billion—something that the previous Government’s figures made no allowance for whatsoever. Self-assessment receipts this year are below forecast by some £3.6 billion, while other tax receipts have held up. The increase from 40p to 50p raised just a third of the £3 billion that we were told it would raise.

Of course, the previous Government initially proposed a rate of 45p and then increased that to 50p. Let me tell the House what HMRC says about the difference between 50p and 45p. … The direct cost is only £100 million a year. Indeed, HMRC calculates that the loss of other tax revenues may even cancel that out. In other words, it raises at most a fraction of what we were told, and may raise nothing at all. So from April next year, the top rate of tax will be 45p. … No Chancellor can justify a tax rate that damages our economy and raises next to nothing—it is as simple as that...

These days the direct costing that the Treasury applies to every Budget measure is independently assessed and certified by the OBR. Unlike the previous Government, it also assesses the cash flow consequences of forestalling. When it comes to the £100 million direct permanent costs of this measure, the OBR says this: “we believe that this is a reasonable and central estimate”. It also assesses as reasonable the estimate that the new taxes that I have introduced on the rich today directly raise five times that amount. That is half a billion pounds that we can now use to help people on lower and middle incomes keep more of their earnings.98

The ‘new taxes’ to which the Chancellor referred were a new 7% rate of stamp duty on properties worth £2m or more, provisions to prevent individuals avoiding the tax by buying property through a company, and a cap on certain income tax reliefs.99

HMRC’s assessment is set out in a detailed report.100 It would be infeasible to précis this work here, though there are some points which are worth underlining.

First, the report anticipated about 300,000 people would be liable to pay the 50p rate – around 1% of taxpayers. The share of total income tax revenues paid by this top one percentile of taxpayers has been steadily growing over the past twenty years: from about 15% in 1990/91 to an estimated 27% in 2011/12. Almost half of these individuals work in business services or financial intermediation.101

Second, as discussed in the earlier sections of this note, the critical tool used to estimate the amounts of money higher rates can raise is the ‘taxable income elasticity’ (TIE) - the percentage change in total taxable incomes in response to a one per cent change in the net-of-tax rate (the proportion of each additional pound earned received by the individual

98 HC Deb 21 March 2012 cc805-6 99 The Budget report estimated that together these changes would raise £565m by 2015/16: Budget 2012,

HC 1853, March 2012 p50 (Table 2.1 – items 4,5 & 6). 100 HMRC, The Exchequer effect of the 50 per cent additional rate of income tax, March 2012 101 op.cit. pp 12-13. This was the projected tax base in March 2010. It is now estimated that 236,000 people

paid the 50p rate in 2010/11: HMRC, Number of individual income taxpayers (Table 2.1), May 2018.

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after tax, also known as the marginal retention rate). In the March 2010 Budget the Treasury had used a TIE of 0.35 – suggesting that behavioural responses to the 50p rate would reduce its yield by about two-thirds, reducing the extra liabilities of the affected individuals by about £4.5 billion, to £2.4 billion in 2010/11. This estimate was on a liabilities basis, as opposed to a National Accounts basis:102

• The “liabilities basis‟ shows the impact of the measure on tax liabilities in any particular tax year, as opposed to a “cash basis‟, which shows the impact on tax payments (there is often a lag between a tax liability arising and the date at which it must be paid to HMRC).

• The National Accounts basis is a mixture of liabilities and cash, depending on the type of tax. In particular, PAYE receipts are recorded on a liabilities basis, while self- assessment receipts, which are partly due in the year after the liability arises, are scored on a cash basis. This basis is used in the published Budget measures table.

So, while the yield for the 50p rate was estimated to be £2.4bn for 2010/11 and 2011/12 on a liabilities basis, the Budget report, using a National Accounts basis, gave estimates of £1.3bn and £3.1bn respectively.103

Work by researchers at the IFS prepared for the Mirrlees Review had suggested a TIE of 0.46,104 and academic studies using US data “have shown that TIEs tend to be higher for those with higher incomes as they engage more in tax planning and are more mobile.” Moreover, the data HMRC had received on payments made under self-assessment for 2010/11 suggested a much greater behavioural response than initially expected. Overall, incomes among those with incomes above £150k increased 14% in 2009/10 but fell 25% in 2010/11. This trend was strongest for dividend income – which grew 78% among this group in 2009/10 and then fell 73% in 2010/11.105 To ascertain the impact of the 50p rate HMRC had to make an estimate of the counterfactual to these figures – how incomes would have grown if tax rates had been unchanged. Then, in looking at how receipts would be affected by future tax changes, it was necessary to make allowance for the fact that forestalling – simply moving income from one tax year to another – would have a short-run impact on receipts, compared with other behaviours (such as emigration).

All told, HMRC estimated that the 50p rate had raised about £1 billion at most: behavioural responses had decreased the yield from the 50p rate by at least 83% - an implied TIE of 0.48. As they concluded, “these results are more in line with those that would be produced using the behavioural response estimates contained in academic literature. This conclusion is also consistent with the £3.6 billion shortfall in self-assessment tax revenues observed in January and February 2012 (the months in which balancing payments relating to 2010-11 liabilities are received).”106

The last step was to use this estimate of taxpayer responses to estimate how much the Exchequer would lose from cutting the 50p rate. In general, studies of TIEs have not taken a consistent approach on whether taxpayers would react differently to rate reductions compared with rate increases – though there are reasons to doubt that their behaviour would be symmetric: “Up-front investment in tax planning could lead to some “stickiness” when the income tax rate is reduced – for example avoidance scheme would still be more tax efficient and may have been setup to operate for a number of years.

102 op.cit. p16 103 Budget 2010, HC 451, March 2010 p140 (Table A11 – item l) 104 This work is discussed in section 1 of this note. 105 The Exchequer effect of the 50 per cent additional rate of income tax, March 2012 p20, pp28-9 106 op.cit. p45

27 Income tax: the additional 50p rate

Taxpayers who shifted to evasion behaviours may still under report their income. Where individuals have migrated it is possible that they may not moved back to the UK.”107

HMRC decided to use a slightly lower TIE of 0.45 – and based on this, estimated that setting the additional rate at 45p from 2013/14 would only lower total yields by about £100m a year.108 At this time many commentators noted this was a critical assumption – including Stephanie Flanders, then the BBC’s economics editor:

There is clearly room to wonder whether the behavioural change will be symmetrical. If you have spent a lot of money setting up a company, for example, to avoid the 50p rate, it's not obvious you will break that up now the rate is 45p. On the other hand, it's plausible that some other money will come back into the system. It really is too soon to say. What is certain is that millions of basic and higher rate taxpayers people will pay less tax next year as a result of this budget. And that the UK is less than half way through an unprecedented seven-year programme of tax rises and spending cuts that - the chancellor suggested on Wednesday - could involve a further £10bn in welfare cuts from 2014-15.109

In a piece before the Budget, in the light of speculation that the Chancellor would cut the 50p rate,110 Ms Flanders noted that any claim that the rich would be paying more, say from cracking down on tax avoidance, would be “rather tricky to prove … it’s not that forecasts are dishonest. It’s just that, to put it bluntly, the money all looks the same when it comes in. The wealthy entrepreneur doesn’t usually attach a note saying that he usually manages not to pay much tax but this year he’d been forced to cough up.”111

In their commentary on this assessment the Office for Budget Responsibility agreed that the TIE of 0.45 was a “reasonable and central estimate”, but went on to underline the considerable uncertainties to these forecasts:

Taken at face value the HMRC study might suggest an even higher TIE, but this would risk placing put too much weight on a single year’s outturn evidence – especially given the complications from disentangling the forestalling effect. There is also reason to believe that the behavioural response to the cut in the tax rate may be smaller than to the increase, because of the costs involved in swiftly reversing expensive decisions on retirement, migration, tax planning and evasion. But it is very important to emphasise the significant uncertainties around all such estimates.112

Robert Chote, head of the OBR, was asked about HMRC’s assessment when he gave evidence to the Treasury Committee after the Budget. He suggested that this was a particularly difficult exercise because it was necessary to disentangle the impact of forestalling from other behavioural responses. Mr Chote was also pressed by Teresa Pearce MP as to why HMRC had thought future forestalling would be equivalent to £6.5bn, a much lower figure than the £16bn estimates of forestalling that was thought to have happened before the 50p rate took effect:

Q85 Teresa Pearce: … Looking at some of the figures, it is estimated that £16 billion of income was shifted then, but what is obviously going to happen is that people are going to shift again, but the other way. Yet you have estimated only £6.25 billion for that, which seems quite low to me …

Robert Chote: One issue is obviously that the differential in the tax rates is half of what it previously was.

Q86 Teresa Pearce: Half of quite a lot is still quite a lot.

107 op.cit. p23 108 op.cit. p51 109 “Budget 2012: A big debate about small numbers (cont'd)”, BBC News online, 21 March 2012 110 “Top tax rate to fall to 45p after bitter budget talks finally end”, Sunday Times, 18 March 2012 111 “Budget 2012: A big debate about small numbers”, BBC News, 20 March 2012 112 Economic & Fiscal Outlook, Cm 8303, March 2012 p109

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Robert Chote: It is quite a lot. The other point is that in the case of avoiding the 50p rate, there were several years in the future that you could shift the income out of into the year prior to the rate change happening. In this case, you have only this year to shift it out of into the future year in order to take advantage of the lower rate, so there is a smaller pool of time period to shift your income out of.

Q87 Teresa Pearce: Even so, in your estimate, it looks as though in 2012/13 there will be a £3 billion drop in revenue, because of people shifting the income.

Robert Chote: That is right. Roughly, if you have £6 billion, that is the impact.

Q88 Teresa Pearce: That is a big number, and the assumption is that it will come in the later year.

Robert Chote: As I say, you are looking there specifically at the forestalling effect—the simple time shifting. There is then the separate issue of what has been the underlying behavioural response that you might expect to persist as a result of labour supply responses or of permanent changes to tax planning behaviour and so on. It is a heroic exercise to try to disentangle those two components and to quantify them.113

In his commentary on the Budget the director of the IFS, Paul Johnson, contrasted the uncertainties to this estimate with the fact that, without any change, cutting the additional rate to 45p would cost £3bn a year:

HMRC’s analysis suggests that the 50p rate only raised around £1 billion in 2010/11, a lot less than the £2.6 billion previously forecast by the Treasury and – prior to yesterday – assumed in the OBR’s forecasts. As the HMRC put it, “it is difficult to construct a plausible outcome consistent with a yield estimate as high as those original forecasts”. And some of the data they base this on are certainly dramatic. They find an astonishing 25% drop between 2009/10 and 2010/11 in the recorded incomes of those with incomes over £150,000.

That said, they also acknowledge the very considerable uncertainty around their estimates. The estimates depend on a range of assumptions about what might have happened in the absence of the 50p rate, and especially on how much of the drop in recorded income is down to one-off “forestalling” – that is people taking income a year early before the 50p rate was introduced. The truth is we still do not know the true effect of the 50p rate on revenues.

The worry for the Chancellor is that the estimate that cutting the top rate to 45% will only cost £100 million is particularly uncertain. It assumes a “no behaviour change” cost of £3 billion offset by a behavioural change of £2.9 billion. The first number we know reasonably accurately; the second number is estimated with great uncertainty. Even if we knew the effect of introducing the 50p rate – which we don’t with any precision – responses may not be symmetric. Those who have got a taste for avoiding the 50p rate may continue to avoid the 45p rate (even if they wouldn’t have done so had the 50p rate never existed) …

Perhaps one worry for the Chancellor as the dust settles on his third Budget is that in his attempt to achieve a fiscally neutral package he has created some risks. We know pretty much for sure that the increase in the personal allowance will cost about £3.5 billion in 2014-15. We do not know with anything like such certainty that the cut in the 50p rate will cost only £100 million. We do not know that the proposed caps on tax reliefs will bring in the £300 million or so the Chancellor is banking on. Nor do we know that the stamp duty changes will raise the nearly £300 million that he has pencilled in.

This Budget may turn out to be less fiscally neutral than intended.114

113 Thirtieth report: Budget 2012, HC1910-II, 18 April 2012 Ev11. See also Mr Chote’s presentation of the

OBR’s Economic and Fiscal Outlook (E&FO Speaking Note, March 2012 pp7-11). 114 Budget 2012- Opening remarks: Tax changes do not amount to a reform programme, Institute for Fiscal

Studies, 22 March 2012. At this presentation, James Browne provided a detailed discussion of HMRC’s analysis : The 50p income tax rate, IFS 22 March 2012

29 Income tax: the additional 50p rate

Mr Johnson also raised these concerns when he gave evidence to the Treasury Committee, while making the point that HMRC’s findings chimed with other studies of taxpayer behaviour in similar circumstances:

A number of things are striking about the HMRC report, the most striking of which is the scale of change in incomes of the people on over £150,000. It is extraordinary that we see a fall in their recorded income of 25% in the years just before and after the introduction of it. The problem the HMRC had was that a lot of that was forestalling: how do you think about the counter-factual? What it has done, broadly speaking, as much as it could given the information, is try to compare what happened to the incomes of people between £115,00 and £150,000, with what happened to the incomes of those earning over £150,000 ...

The real issue is: does it look from what it has done that its central estimate is broadly sensible? Probably, yes, but as you can back out from what it has said, it is incredibly uncertain, to the extent that we think that its estimate suggests there is only a two-thirds probability that a revenue-maximising rate lies between 30% and 75%. Those numbers are absurd in some sense, but that gives you a sense of the level of numbers of assumption and uncertainty that underlie what it has done. If that were the only thing we knew, we would be pretty sceptical that its results bore a lot and sceptical about how much weight you put on the results. The thing that makes us think that you may want to put more weight on them is that they are actually pretty much in line with what previous studies here and elsewhere have got.115

The Committee concluded that, “the cost and benefits of reducing the additional tax rate to 45p are both highly uncertain, and could be significantly more or less than the cost included in the Budget. We recommend that HMRC publish in due course a comprehensive assessment of the effect on the Exchequer of the new 45p rate.”116

Initial reactions in the press were divided about the Chancellor’s decision. An editorial in the Times argued that the change was “good for business … the new rate raises no money and deters people from bringing business here. It cannot be defended. Mr Osborne has made a political gamble, but it is the right bet for Britain.”117 By contrast the Guardian characterised it as “an unnecessary tax cut … four months ago [at the time of the Autumn Statement], cutting taxes for the super-rich was not what the Chancellor saw as a priority; not it’s among his top priorities. This raises one simple question: why?”118 In an editorial before the Budget the Financial Times had argued that while “calls for its abolition from business people and Tory back benchers grow ever more insistent … the Chancellor would be wise to leave it be – at least for now”:

There would be a stronger case for cutting the 50p rate if it could be shown that it was a significant break on the growth of the economy’s supply side. But with growth arguably suffering from a lack of demand rather than supply, it is hard to make this argument. And anyway, if one could make it, one would certainly not respond with a half measure like a 5p cut.119

After the Budget the paper acknowledged that “the economic case for the higher rate is weak … but the move risks undermining the Coalition’s claim that the burden of austerity is being shared fairly.”120 The Economist argued that the politics of the Chancellor’s decision would be “rough, but it was the right thing to do. Because Britain specialises in high-value services such as banking, accountancy and insurance, it needs to attract the world’s brightest … this week’s change may be more symbolic than fiscal … but symbols

115 Budget 2012, HC1910-II, 18 April 2012 Ev24 Q171 116 Budget 2012, HC1910, 18 April 2012 para 97 117 “Leader: A 50p bet on Britain”, Times, 22 March 2012 118 “Editorial: George Osborne’s misplaced priorities”, Guardian, 22 March 2012 119 “Editorial: Osborne’s choice and the 50p rate”, Financial Times, 17 March 2012 120 “Editorial: An audacious gamble from the artful Osborne”, Financial Times, 22 March 2012

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matter.”121 In a second article on HMRC’s assessment of the 50p rate, the paper suggested that the future of the 45p was unlikely to be a long one:

The results suggest that the tax take from incomes over £150,000 is little different whether you set the tax rate at 45% or 50%. Setting the rate much higher than 45% is pointless; beyond 50% it is self-defeating. The additional revenue loss of abolishing the higher rate altogether is estimated at a few hundred million. That is unlikely to have escaped the Chancellor’s notice.122

Writing in Taxation, Mike Truman, who was then editor, pointed out that the rate schedule retained the other major change made by Alistair Darling in 2010: the withdrawal of the personal allowance for those on incomes over £100,000:

The prize for most leaked announcement probably goes to the reduction in the 50% rate to 45%. From the pre-Budget press coverage, some might have thought that this was going to happen from 6 April 2012. It is in fact going to come in from April 2013, just like the other changes. Indeed, where this government deserves great credit is that it has stuck to its promise that it will have a proper process of consultation on significant tax changes, leading to draft legislation issued four months before the Budget.

So the top rate of tax from April 2013 will be 45%, right? Wrong. There will still be an effective 60% charge on income between £100,000 and £118,200, as the personal allowance is withdrawn at a rate of £1 for every £2 of income. Exactly the same taper is seen as a candidate for simplification when applied to age allowance, so why not simplify it at the top of the income scale too? Rather than withdrawing personal allowances (or the nil-rate band of income tax as it should properly be described), start the 45% rate at a point which raises about the same amount in total; say about £85,000.123

Many Members raised this issue in the debates following the Budget statement; in his speech the then Shadow Chancellor, Ed Balls, argued that the cut in the 45p rate would cost much more than the Government had estimated:

The Chancellor tries to claim that the top rate of tax does not raise any money, and that he is raising in stamp duty and tax avoidance five times the cost of cutting the top rate of tax. But his own HMRC report makes the true position clear, in table A2 on page 51. It says that next year he will give £3.01 billion in tax cuts to existing and legitimate top rate taxpayers, paid more than £150,000. That is a fact. That is six times more in tax cuts to the richest than he is raising in the stamp duty and tax avoidance measures. He is gambling that this will then bring in £2.9 billion in new tax revenues from people currently not paying tax, without any hard evidence to justify that claim—an estimate that the OBR says in the Budget documentation is “highly uncertain” and could lead to a much higher cost.124

In response the then Vince Cable, Secretary of State, argued that the Labour Government’s original decision to introduce the 50p rate had been shown to be fundamentally flawed:

I agree with the Chancellor that the decision to cut the top rate of tax from 50p to 45p was economically the rational thing to do. I want to focus the debate not on symbols but on substance. I share the emotional reaction of the many people who are disgusted to hear pampered financiers whinging about their taxes. On an emotional level, nobody can sympathise with that. However, we have to deal with the practical realities that were burned on my consciousness as a result of sitting in my place on the Opposition Benches for 13 years, exchanging views on the top rate of tax with successive Labour Ministers from Blair to Brown to Balls. Year after year, they would

121 “Leader: This way, sir”, Economist, 24 March 2012 122 “Falling flat : The 50% tax rate”, Economist, 24 March 2012 123 “Complexification”, Taxation, 22 March 2012 124 HC Deb 22 March 2012 c960. Mr Balls is referring to the ‘static’ cost of the cut in the additional rate – an

estimate that makes no allowance for any behavioural change.

31 Income tax: the additional 50p rate

tell the Liberal Democrats that it was economically stupid to raise the top rate of tax above 40%. That was their message, year after year. Then, a few weeks before the end of their Government—I think it was 57 days—they introduced the 50p rate in order to create a political dividing line. That decision had nothing whatever to do with economics. The point that they had been making over all those years was that raising the top rate in that way would raise relatively little revenue.

Despite the casuistry of the shadow Chancellor’s intervention a few moments ago, in trying to argue that vast sums of money had been sacrificed, line 3 of the scorecard makes it absolutely clear that we are talking about a revenue loss of £100 million a year. That figure has been endorsed by the Office for Budget Responsibility. The changes that have been introduced in the Budget, including increased taxation of high-value property, plugging loopholes and much tougher anti-avoidance rules, will bring in at least five times that amount.125

At a later stage in the debates Alistair Darling argued that the inherent uncertainties in the forecasting exercise, given the size of forestalling effects, made the Government’s case for change quite weak:

I want to say a word about the 50p rate of tax, since I introduced it. At the time, I said it was a temporary measure. I did not particularly want to introduce it, but I took the view that, at a time when we were asking many people in this country to share the burden of meeting the increased cost of the downturn, it was right that those who had done well over the previous 10 years or so should bear their fair share of it. I do not have a philosophic attachment to that rate at all, therefore, but this is not a Budget in which I would have returned to the topic, simply because the incomes of many other people in this country are currently being squeezed and they are going to lose out this year. I would have tried to have done something about their position first.

The documentation that the Treasury has produced on the measure reminds me of the stuff that was produced for the five tests in respect of the euro, in that so much evidence has been adduced in support of the Government position. Why did they not just say that they philosophically did not want the 50p rate so they were going to cut it? As the OBR says that its calculations are highly uncertain and it is very difficult to estimate behavioural effects, especially after only a year, and given that there are so many uncertainties and there will be so much forestalling, it is difficult for the Government to say, “Look, this wasn’t actually raising anything.”

At a time like this, I think the fact that the rate brought in £1 billion and that we are talking about smaller sums in relation to some of the welfare reforms means that the Government cannot simply write it off. If they want to bring the rate down to 45p, that is fine, although I am bound to say that I have never understood the argument that someone will still work harder if the rate comes down to 45%, yet they will also work harder if they are told at the same time that they will be paying five times as much tax in the future. That seems a very odd argument to run.126

In HMRC’s assessment of the 50p rate, it was noted that further years’ data could add something to this exercise, but a definitive answer was infeasible, given the difficulties of stripping out other influences on incomes and tax yields:

The results can only be considered an estimate of the yield in the very short term and as such may be higher than the long term yield, particularly as some behavioural responses such as the possibility that those affected might leave the UK may take place over a number of years. Similarly, the fact that the additional rate may have been viewed as temporary may mean that behavioural responses such as migration are smaller than if it had been a permanent change. Conversely, a temporary increase may make it more likely that individuals postpone withdrawing income from investments in anticipation of the rate going down, thereby increasing the size of the behavioural response.

125 HC Deb 22 March 2012 c966 126 HC Deb 26 March 2012 cc1199-1200

Number 249, 26 September 2018 32

Although the analysis is only based on one year’s data, this does not invalidate the results. Future years’ data may improve the reliability of estimates, although estimating what incomes and tax revenues would have been in the absence of the additional rate also becomes more difficult as time elapses further from the ‘base’ year (the year before the additional rate became effective).127

As noted above, in his Budget speech the Chancellor announced a number of measures to increase tax receipts from the wealthiest taxpayers, including a cap on certain unlimited income tax reliefs. This proved quite controversial as many charities argued a cap would have a very serious impact on the incentives for those on higher incomes to make charitable donations. In an interview with the Telegraph, Mr Osborne said he had been shown some analysis of tax returns illustrating the problem that a cap could tackle:

The Chancellor personally studied the “anonymised” copies of the tax returns submitted by some of the country’s wealthiest citizens which showed some people are able to avoid paying income tax entirely. The analysis convinced Mr Osborne that millionaires must pay a minimum rate of tax equivalent to about a third of their earnings, which has been described as a “tycoon tax”.

Mr Osborne told The Daily Telegraph: “I was shocked to see that some of the very wealthiest people in the country have organised their tax affairs, and to be fair it’s within the tax laws, so that they were regularly paying virtually no income tax. And I don’t think that’s right. … I’m not allowed to be shown the names of the individuals but I’ve sat with the most senior people at the Inland Revenue, the people who run some of the high net worth units there. They have given me examples, anonymised examples, and so we are taking action.”

The report found that Britain’s 20 biggest tax avoiders have used three main loopholes to legally reduce their income tax bills by a total of £145 million in a year. Two thirds of them wrote off business losses in one of their companies against their income tax bill, reducing it by as much as half. Several of them offset the cost of business mortgages or borrowing on buy-to-let properties against their income tax bill, while others took advantage of relief on donations to charity.128

2.4 Finance Bill 2012 During the second reading debate on the Finance Bill on 16 April the then Chief Secretary to the Treasury, Danny Alexander, cited some figures showing that a small, but significant number of the very highest earners had exploited the rules regarding unlimited income tax reliefs to pay very little tax:

The basic principle that the wealthiest in the land should pay a fair proportion of their income in income tax must be absolutely right, not least because last week we published data showing that last year some of the wealthiest people in the country had reduced their tax bills to below the basic rate of income tax …

The figures [are] based on the tax system from 2010/11, under the tax rules put in place by [the previous] … Government. They show, for example, that 6% of those earning over £10 million a year were paying tax at under 10%, that 3% were paying it at 10% to 20%, that 8% were paying it at 20% to 30%, that 12% were paying it at 30% to 40%, and that 72% were paying it at above 40%.129

The figures were widely reported in the press, though not officially published at the time;130 subsequently Treasury Minister David Gauke set out these estimates in answer to a number of PQs – from which the following is taken:

127 HMRC, March 2012 p20, pp2-3 128 “George Osborne: I'm going after the wealthy tax dodgers”, Daily Telegraph, 9 April 2012 – see also

“Wealthy face cap on income tax relief”, Financial Times, 14/15 April 2012 129 HC Deb 16 April 2012 cc32-3 130 For example, “Treasury reveals how little tax the super-rich pay”, Guardian, 16 April 2012

33 Income tax: the additional 50p rate

Mr Gauke: The information requested is as follows:

(i) The proportion of taxpayers liable to income tax by their total income and average income tax rate are shown in the following table:

Proportion (%) of individuals reporting various average tax rates by total income category (2010-11)

Income Average £100k to £150k to £250k to £500k to £1m to £5m to Over tax rates £150k £250k £500k £1m £5m £10m £10m Above 40% 0 6 73 81 80 81 72 30% to 40% 67 77 18 11 10 8 12 20% to 30% 24 13 5 4 5 4 8 10% to 20% 8 3 2 2 2 3 3 Under 10% 1 2 2 2 3 4 6

Figures are based on an analysis of self-assessment (SA) returns for the 2010-11 tax year, as available at Budget 2012. Income bands include those with average rates at the lower limit (e.g. a tax rate of exactly 30% falls in the “30% to <40%” category).

(ii), (iii) Rates of capital gains tax range from 10% to 28% in 2011/12.131

When the figures were first reported, Robert Peston suggested this put the Government’s case for cutting the additional rate in a new light:

Today's data shows that more than 73% of those earning over £250,000 were paying an average tax rate above 40% in 2010/11. And even among those earning between £5m and £10m and those earning over £10m, the proportion paying more than 40% in tax was 81% and 72% respectively.

All of which implies that many tens of thousands of people were (and are) paying the 50% tax rate, and were unable to dodge it. To state the bloomin' obvious, all of those people were given a very lovely tax cut in the budget - which will doubtless add fuel to Labour's campaign that the budget rewarded the rich at the expense of the rest. Now it is possible, I suppose, that vast numbers of people artificially reduced their income below the threshold of £150,000 (by deferring dividends for example) to avoid the 50% rate. That is certainly the implication of HMRC's study of what was happening.

But even so it is striking quite how many people paid tax greater than 40% - a proportion 10 times greater than those who succeeded in paying almost no tax. Or to put it another way, perhaps the highest earners have had a slightly unfair press, because the majority of them seem to have been paying their proper share.132

Although the Government persisted with its plans to introduce a cap from April 2013, in June 2012 Ministers confirmed that it would not apply to relief on charitable donations.133

Turning back to the second reading debate in April 2012, Owen Smith MP, speaking for the Opposition, argued that these estimates suggested that it was misleading to think that the 50p rate had been ineffective in raising additional revenues for the Exchequer:

Only this morning, we heard the Exchequer Secretary trying to justify the proposed changes on charitable giving and the 25% cap on tax relief. He did so by revealing that a handful of people in this country who earn more than £1 million and more than £10 million succeed in dodging paying their tax. There is no news in that. One would have thought that a competent Government who understood what they were doing would have realised that the flipside of that argument was to reveal that more than 75% of higher rate taxpayers—those paying 40% and 50%—do pay all of their

131 HC Deb 25 April 2012 cc898-9W 132 “More than 70% of high earners paid 50% tax rate”, BBC News, 16 April 2012 133 see, Income tax – cap on unlimited reliefs, Commons Briefing Paper CBP6303, 25 October 2013.

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taxes … Page 52 of the review by Her Majesty’s Revenue and Customs of the 50p rate, in table A2 … states in black and white that £3 billion a year will be forgone as a result of the changes, not the £100 million figure that is arrived at with smoke and mirrors about the taxable income elasticity calculation that Treasury Ministers signed off. What does the Office for Budget Responsibility say about that? … It says that there is huge uncertainty about that calculation. We contend that we should rely on the absolute numbers, as revealed this morning—that £1 billion was raised from the 50p rate last year, not the nonsense £100 million figure.134

In response Treasury Minister David Gauke argued that the 50p rate had proved to be a particularly poor way of raising money from the wealthiest taxpayers:

What is the effect of the 50p rate? We have the assessment of HMRC. What has the 50p rate achieved? More people work overseas; total income has fallen by between £2.9 billion and £4.4 billion; and GDP is between 0.2% and 0.3% lower. … Both HMRC and the OBR have made a central estimate, and that is what we have used. I am sorry it does not fit into Labour’s ideology, but the reality is that HMRC’s assessment is that the 50p rate raised less than half the expected amount and might even have cost the Exchequer. The OBR’s assessment is that it is a reasonable and central estimate.

It takes a special kind of incompetence to produce a policy that sends a terrible signal to our competitors, drives higher earners out of the country, damages GDP and fails to raise revenue. There are better ways of raising revenue from the wealthy—for instance, by addressing SDLT avoidance, raising the SDLT rate on properties worth more than £2 million and capping reliefs to ensure that the wealthy cannot opt out of income tax. Both sides of the House want to raise more money from wealthy people. The reality is that we are better at doing it.135

2.5 Subsequent debate of the 45p rate In the months after the 2012 Budget there was much less discussion of the 50p rate,136 though in their Green Budget published in February 2013 the IFS noted that, although “much uncertainty” remained over its impact on revenues, “several things are clear”:

First, even on the Treasury’s original assumptions, raising the top rate of tax to 50p would have had major behavioural effects. Second, HMRC’s analysis quite clearly demonstrates significant amounts of behavioural change by affected individuals, and especially the shifting of incomes between years (‘forestalling’). Such large distortions to behaviour are indicative of an economically inefficient tax and remind us that it is important not to fixate simply on how much the 50p rate raised (or cost) and how much the move back to 45p will cost (or raise). There are likely to be better ways of raising money from a similar group of high-income individuals that entail less avoidance or distortion to economic activity than a 50p income tax rate.137

In contrast there was much more discussion about income tax for those on lower incomes, first in connection with the Government’s approach to substantially increasing the personal allowance in each of its first three Budgets,138 and second, with a speech by the then Labour leader, Ed Miliband, in February, in which he stated that a Labour Government would reintroduce a 10p starting rate of income tax, funded by an annual 134 HC Deb 16 April 2012 cc127-8 135 HC Deb 16 April 2012 c131. Similar arguments were made when provision in the Bill to set the rates of

income tax from 2013 were debated two days later by the Committee of the Whole House (HC Deb 18 April 2012 cc327-8). The clause was approved by 323 votes to 256.

136 HMRC’s assessment of the 50p rate has been cited in answer to some PQs on this issue: for example, HC Deb 10 January 2013 cc427-8W & 22 January 2013 cc 144-5W.

137 “Chapter 7: Tax and welfare reforms planned for 2013/14”, IFS Green Budget 2013, February 2013 p193. Chapter 9 of the report discusses various options for increasing tax receipts from the rich.

138 For a discussion of the impact of this policy see, Adam & Roantree, The coalition government’s record on tax, Institute for Fiscal Studies, March 2015

35 Income tax: the additional 50p rate

levy on residential property – a ‘mansions tax’.139 These differing approaches were the subject of a debate just before the 2013 Budget, when Members also touched on the anticipated cut in the additional rate. Opening the debate for the Opposition, Chris Leslie contrasted the Government’s approach to reforming tax credits and social security benefits with the impact of the 45% rate for those on the very highest incomes:

Let us consider the contrast that now exists as a result of Government decisions. Those who are on low and middle incomes—that is, the vast majority of the British public—have seen their tax credits cut, their child benefits squeezed, their cost of living rise as a result of higher VAT and their wages fall in real terms. However, the richest 1%, including the lucky few who earn £1 million a year, will see an average tax cut of £100,000 in four weeks’ time, and banking executives will not have to pay that annoying bonus tax, all thanks to the Chancellor’s generosity.140

As part of his response to the debate, Treasury Minister David Gauke reiterated the Government’s case for cutting the 50p rate:

Let me say something that I hope is not controversial: the principal purpose of income tax is to raise revenue. So we commissioned HMRC to analyse just how effective the 50p rate was in raising revenue.

That HMRC report, laid before the House, set out thorough and compelling evidence on the impact of the 50p rate. It showed that the rate was uncompetitive, distortive and inefficient. Not only did it not raise much revenue, but it could even have cost the Exchequer money when the indirect impacts on other taxes were taken into account. This Government were not prepared to maintain a rate of income tax that was both ineffective at raising money and that left us with the highest statutory rate of income tax in the G20, so we acted, in the interests of the country, and the top rate of tax will fall to 45p from April this year. This will see our top rate of tax drop below that of Australia, Germany, Japan and Canada, which will send a signal to businesses taking decisions on investment and location that the UK is a competitive environment.141

The Chancellor did not discuss the additional rate in his 2013 Budget speech, though the Budget report noted the very large share of total income tax receipts paid by the wealthiest: “over a quarter of all income tax is paid by just 1 per cent of taxpayers, with the top 5 per cent paying around half of all income tax.”142

Income tax is an annual tax, so that the annual Finance Bill has to make provision for the tax to be levied each year. Section 1 of the Finance Act 2013 imposes the tax for 2013/14, and this provision was one of those from the Finance Bill selected for debate on the floor of the House, at the start of the Bill’s Committee stage. On this occasion the Opposition put down an amendment to require the Government to review the impact of the new 45p additional rate; Catherine McKinnell, then Shadow Exchequer Secretary, set out the party’s position:

What we got in this year’s Budget, and in the very first clause of the Finance Bill, is the coalition’s unjustifiable and grossly unfair decision to reduce the top rate of income tax from 50p to 45p, a cut that benefits just 267,000 people earning more than £150,000, 13,000 of whom are lucky enough to earn more than £1 million. Indeed,

139 The proposal for a ‘mansions tax’ is discussed in, Land value taxation, Commons Briefing Paper CBP6558,

17 November 2014. 140 HC Deb 12 March 2013 c162. At this time the Labour Party claimed that 13,000 individuals with incomes

over £1m would get a tax cut worth £100,000. This was based on HMRC’s projected figures for total incomes and tax liabilities for 2012/13; the figure was revised to 12,000 (see, HMRC, Income tax liabilities by income range (Table 2.5a), May 2018. These estimates were examined in a post by FullFact (“Are 13,000 millionaires getting a £100,000 tax cut?”, 27 February 2013).

141 HC Deb 12 March 2013 c181 142 Budget 2013, HC 1033, March 2013 para 1.202-3. See also, HL Deb 27 March 2013 cc252-3WA & HL

Deb 24 June 2013 cc500-2. For more data on the distribution of income tax receipts see, HMRC, Shares of total income … and income tax (Table 2.4), May 2018.

Number 249, 26 September 2018 36

those lucky few are receiving an average tax cut of a whopping £107,000 according to HMRC figures …

We have made it perfectly clear from day one that we do not support the cut to the 50p rate now, and we call on the Government to analyse the impact of the introduction and premature removal of the 50p rate. When we come to publish our next manifesto, we will review the state of the economy and whether a 50p rate would be the right response. I hope that Members of other Opposition parties, as well as Liberal Democrats, will support our amendment, because it would help to establish whether the 50p rate would bring in the additional Exchequer revenue that was anticipated—but if the Government refuse to back it today, we will never know.143

In response Treasury Minister David Gauke argued, “the fact is that a 50p rate was not effective”:

HMRC published a thorough and very well-researched report at Budget 2012 that showed the effect of the additional rate of income tax. Those matters were debated at considerable length last year and the report shows that the rate was not raising the money that the previous Government intended it to raise. It is illogical to maintain a tax rate that is not effective at raising revenue from high earners and that risks damaging growth. We have found better ways of raising money from the wealthy that raise more money but do less damage to the economy.

We always keep tax rates under review ... It seems to me that the purpose of the amendment is not just to enable us to have another debate on the 50p rate today but to enable the Labour party to find an escape route from its policy. Until a few days ago, it was against getting rid of the 50p rate. Labour will not answer the question, however, of what it will do at the next election. Its holding position is clearly that it will have a review.144

In January 2014 the then Shadow Chancellor, Ed Balls, made a speech, committing a future Labour Government to reintroducing the additional rate, if returned to office in 2015. In his speech, Mr Balls said “for the next Parliament, we will restore the 50p top rate of tax for those earning over £150,000”:

The latest figures show that those earning over £150,000 paid almost £10 billion more in tax in the three years when the 50p top rate of tax was in place than when the government conducted its assessment of the tax back in 2012. And when the deficit is still high, when tough times are now set to last well into the next parliament, when for ordinary families their real incomes are falling and taxes have risen …… it cannot be right for David Cameron and George Osborne to have chosen to give the richest people in the country a huge tax cut. That’s why, for the next parliament, the next Labour government will reverse this government’s top rate tax cut so we can finish the job of getting the deficit down and do it fairly.145

In an interview the next day with Andrew Marr on the BBC, Mr Balls was asked about the amount of money he anticipated raising from increasing the additional rate, and whether a Labour Government might raise this rate above 50%. An extract from their exchanges is given below:

Andrew Marr: So now we come to the crucial question, which is how much will it or won’t it raise? A huge argument about it. You say I think something like £100 million, a £100 million - is that right - in a year?

Ed Balls: Well no, the Conservatives tried to claim that, but that was a sort of political decision a couple of years ago … The OBR and the IFS said this is all highly uncertain. They didn’t say the Government was wrong to say £100 million, although many people think it could be … But what’s happened since then is we now know in the 3 years when the 50p tax rate was in place £10 billion more money came in from people earning over £150,000 … So the idea that having the 50p rate deterred

143 HC Deb 18 April 2013 c508, c512 144 op.cit. cc535-6. In the event the amendment was negatived by 264 votes to 203 (c537). 145 “Ed Balls’ address to Fabian Society New Year Conference 2014”, Labour List.org, 25 January 2014

37 Income tax: the additional 50p rate

people, it didn’t, because what’s happened - as we all know - is that living standards have gone down for most people, but they’ve continued to rise at the top. Now we’re saying it would raise revenue, it would raise a substantial amount of revenue, but there are different views whether it’s £100 million, over a billion pounds …

Andrew Marr: On the 50p rate, is this a sign that there’s going to be more tax rises ahead - this is a kind of political flag, this is the way I’m going - or not?

Ed Balls: Well we’ve said a mansion tax to cut the 10p rate for families; we’ve said that we would have to raise the 50p rate in the next Parliament while we get the deficit down we’ve said there’ll be spending cuts; there’ll be rises in the pension age; we wouldn’t go ahead with the winter allowance for the richest pensioners; we have a zero based spending review. What I can’t do to you is say … what our tax policy and our tax decisions would be in budgets 3 years out when we don’t know what will happen to the economy ...

Andrew Marr: Which strongly suggests to me that if you had to, you’d raise the top rate back to the rate that it was during the Thatcher years, which is 60p; that you could keep going on in that direction.

Ed Balls: No.

Andrew Marr: Absolutely not?

Ed Balls: No, absolutely not.146

As before, reactions in the press to Mr Balls’ proposal were highly mixed. An editorial in the Times suggested that “politically, Mr Balls’ announcement may prove to be well-timed for Labour, since in recent polls 60 per cent of Britons have supported a 5 per cent increase from the current 45 per cent top rate… [However] the 50p rate is stupid only from the point of view that actually matters — that of the economy and everyone it employs. … [It would] raise little if any extra money for the Exchequer, while punishing those entrepreneurs who cannot go elsewhere and sending an unmistakably hostile signal to those who can."147 By contrast an editorial in the Guardian argued the announcement was “warmly welcome”, because it indicated the Opposition’s “newfound willingness to trample on two post-Thatcher taboos. For the first time in a quarter of a century, its manifesto will not be able to contain a line saying "no rise in income tax rates". That opens the possibility of a more rational discussion about how we sustain public services that are currently set to be savaged by the coalition's lopsided retrenchment … Second, it gives some meaning to otherwise-empty words about fair sharing of the pain.”148

The Financial Times noted that “the restoration of the top rate to the 50p level … would certainly damp animal spirits and arguably raise little revenue. But it would not be a wildly confiscatory measure and certainly could not be compared to the punitive rates that applied in the late 1970s, when the top rate was 83 per cent.” The ‘problem’, as the paper went on to argue, “is not so much with the 50 per cent rate itself. It will almost certainly raise limited cash for the exchequer. The difficulty lies in the political symbolism. This looks like yet one more measure to punish enterprise.”149 The paper quoted several business leaders as being critical of the announcement on these grounds.150 The BBC’s business editor, Robert Peston, observed “the amounts of money gained or lost from the tax rise … may be pretty trivial, probably less than a percentage point of the annual hole

146 “Andrew Marr interview with Ed Balls MP, Shadow Chancellor”, BBC One: The Andrew Marr Show, 26

January 2014 147 “Leader: Less tax, more growth”, Times, 27 January 2014 148 “Editorial: 50p tax rate: more than small change”, The Guardian, 26 January 2014 149 “Editorial: Labour’s growing gulf with business”, Financial Times, 27 January 2014 150 “Businesses blast 50p tax plans by Labour”, Financial Times, 26 January 2014; see also, “Newspapers give

Labour's 50p tax rate proposal the thumbs down”, Guardian, & “Labour 50p tax plan: Why are some people staying quiet?”, BBC News, 27 January 2014.

Number 249, 26 September 2018 38

or deficit in the government's finances … which is why what is more interesting about the planned tax rise is what it says about battle lines in politics, and the parties' attitudes to high earners and businesses.”151

Paul Johnson & David Phillips at the IFS published a short note on this debate, in which it suggested “at the moment, the best evidence we have still suggests that raising the top rate of tax would raise little revenue and make, at best, a marginal contribution to reducing the budget deficit an incoming government would face after the next election”:

[HMRC’s analysis published alongside the 2012 Budget] suggested that cutting the 50p rate to 45p could reduce revenues by about £3.5 billion in 2015/16 if there was no change in behaviour by affected individuals. However, once one allows for behavioural response, their central estimate was a cost of just £100 million – a very small amount of money. The best available estimate of what reversing the cut would raise is therefore about £100 million too.

The authors went on to look at Mr Balls’ assertion that individuals liable to the 50p rate had actually paid £10bn more in tax over the period 2010/11 to 2012/13 than had been expected when HMRC completed their analysis in early 2012:

The statistics in question are estimates and projections of tax liabilities based on the Survey of Personal Income, which is itself based on a sample of tax records. The versions of these tables from 2012 and 2013 do show a difference of around £10 billion in the total amount of tax paid by those paying the 50p rate in the years between 2010/11 and 2012/13.152 Is that an indication that the 50p rate was more successful in raising revenue than HMRC assumed in their analysis?

Looking carefully at the notes that accompany the 2012 tables cited by the Labour Party shows that the figures for 2010/11 to 2012/13 were projected tax payments based on how much tax was paid in 2009/10, before the 50p tax rate was introduced. Had the HMRC’s analysis of taxable income elasticity been based on these original, lower, projections for tax revenues then we might have good reason for questioning their analysis. In fact it was not.

In their analysis, HMRC made use of the actual 2010/11 tax returns of people paying by self-assessment (who make up the vast majority of people who were paying the 50p rate of tax). This is pretty much the same data (bar a few late filers and those few 50p rate tax payers not required to fill in a self-assessment form) that then goes into producing the Survey of Personal Income data used in the most recent 2013 tables. These tables show 50p tax payers paid £34.5 billion in income tax in 2010/11 on an income of £86.5 billion (and HMRC’s analysis assumed their income was £87 billion). So in fact there is little additional evidence to suggest that a 50p rate would raise more than was estimated by HMRC back in 2012.

Johnson and Phillips also suggested that there was a case for HMRC to carry out this exercise again, as they would soon have data for actual returns for 2011/12 and 2012/13:

The uncertainty around HMRC’s estimates mean it is also possible that the 50p rate would be somewhat more effective at raising revenue than their initial analysis suggests. HMRC made their calculations at great speed on the basis of one year’s data that had only just become available. Indeed only around 95% of the data was available at the time they made the calculation. By now they have data for 2011/12 too, and soon they will have data for 2012/13 as well. Given this there is certainly a case for HMRC looking again. IFS researchers also now have access to much of the relevant data and we will also be looking at this issue over the course of the year.153

151 “The meaning of Labour’s tax rise”, BBC News, 27 January 2014 152 [The 2012 edition projected annual receipts over these three years of £31.4bn, £38.1bn & £38.2bn. The

2013 edition projected receipts at £34.5bn, £41.3bn and £41.6bn. The difference between the two sets of figures is around £10bn.]

153 Paul Johnson & David Phillips, “50p tax: strolling across the summit of the Laffer curve?”, IFS Observations, 27 January 2014

39 Income tax: the additional 50p rate

In the Financial Times John McDermott argued that the wider significance of this data was that “there is a structural dependence on higher rate taxpayers”:

Mr Balls’s “official figures” are projections of taxable income in the years 2010/11 to 2012/13 from the Personal Income Survey. He is right that they imply an additional £10bn. But as the IFS points out, these projections are based on receipts from 2009/10, whereas the HMRC analysis is based on actual data (albeit missing 5 per cent of high income taxpayers) from 2010/11. The latter is still the better source, though of course what is required is for someone to run the numbers using real receipts from 2011/12 and 2012/13. Until then, Mr Balls does not have the figures he claims to have.

Behind these rather esoteric debates lies an important point for Mr Balls’ party. When it comes to Britain’s revenue from income tax – at about £150bn per year it equates to more than one-quarter of our £550bn total tax revenues or about 10 per cent of GDP – there is a structural dependence on higher rate taxpayers. This top 1 per cent of taxpayers pays between 25 and 30 per cent of all income tax. More needs to be done to stop the avoidance practices that are still readily available. But if Labour is going to argue that a 50p tax rate is needed to reduce the deficit rather than, say, to reduce inequality, then it is essential that it actually raises revenue.154

In the 2014 Budget the Coalition Government made no changes to the three rates of income tax for the 2014/15 year. When provision to set these rates was debated at the Committee stage of the Finance Bill, the House debated the question of a second review of the revenue impact of cutting the additional rate.155 Moving an amendment for the Opposition, Shabana Mahmood argued that new data on tax receipts would provide a more accurate assessment:

It might have fitted the Government narrative for them to imply that they knew for certain that the 50p rate would raise only £100 million, but even on their figures and HMRC’s report, there is a huge margin for error and this is all very uncertain. That is not the only thing that was wrong with the analysis. The HMRC report was based on only one year’s worth of data—the data related to 2010-11—which is a weakness in itself. It came too early … The Government should, at the very least, update the analysis based on the more recent data ... A comparison of 45p and 50p rates for those on incomes over £150,000 and £1 million would be instructive to the public debate about the top rate, especially as some Members on the Government Back Benches want to reduce the rate to 40p.156

Treasury Minister David Gauke argued a review was “entirely unnecessary”:

When increasing taxes, it is not enough merely to look at theoretical income tax liabilities. Let me assure hon. Members, once more, that this Government already consider the impact of any policy decisions taken. The HMRC report on the additional rate concluded that the underlying yield from the introduction of the 50p rate was much lower than originally forecast due to large behavioural effects. It even said that it is possible that the 50p rate could have reduced income tax revenue instead of increasing it. It would be illogical and unfair to reintroduce a tax rate that is ineffective at raising revenue from high earners and that would end up making ordinary taxpayers pay more and risk damaging growth …

The reports proposed [by Plaid Cymru, the SNP and the Labour Party] … are entirely unnecessary. The impact of reducing the additional rate of income tax has been examined in great detail. The 50p rate was ineffective and meant risking the recovery for which everyone in this is country is working hard.157

154 “Off Message blog: Balls’ misleading tax sums – and why they matter”, Financial Times, 28 January 2014 155 HC Deb 8 April 2014 cc174-207 156 op.cit. c194 157 op.cit. cc197-9. In the event the amendment was negatived by 295 votes to 231 (c199).

Number 249, 26 September 2018 40

3. Recent developments The Coalition Government did not make any further changes to income tax rates for the remainder of its time in office. Legislation to set the rates of income tax for 2015/16 was included in the Finance Act 2015.158 Scrutiny of this legislation was compressed into a single day’s debate in the Commons, so that the Act would receive Royal Assent in time for Parliament’s Dissolution – although one of the few provisions debated on this occasion was an Opposition amendment, calling for an assessment of the impact of restoring a 50% additional rate.159 Speaking for the Opposition Shabana Mahmood argued that HMRC’s assessment of the impact of the 50p rate should be updated: “more data are now available and could help to calculate a truer picture of the yield of a 50p tax rate as opposed to a rate of 45p.” Treasury Minister David Gauke rejected this, on the grounds that “the Government always keep tax rates under review and monitor receipts, and on this basis I do not believe the amendment is necessary.”160

One of the striking features of the 2015 General Election campaign was that none of the major parties proposed increasing the main rates of any of the three major taxes: income tax, NICs and VAT. In its manifesto the Conservative Party stated that, in government, it would “not increase the rates of VAT, Income Tax or National Insurance in the next Parliament.”161 In its manifesto the Labour Party stated in government it would “not increase the basic or higher rates of Income Tax or National Insurance. Nor will we raise VAT”, though, as previously announced, it proposed reversing the cut made to the additional rate by the Coalition.162 The Liberal Democrats’ manifesto stated that “our plans do not require any increase in the headline rates of Income Tax, National Insurance, VAT or Corporation Tax.”163

In its analysis of the parties’ tax and spending proposals the IFS noted that these commitments did not discount increases in these taxes through other measures:

The Conservatives’ manifesto … contains a number of pledges not to raise certain taxes or cut certain pensioner benefits. They have pledged not to increase the rates of income tax, National Insurance contributions (NICs) or value added tax (VAT) during the next parliament. Note, however, that this does not rule out raising revenue from these taxes in other ways …

Like the Conservative Party, Labour has pledged not to implement certain kinds of tax rises or certain kinds of cuts to pensioner benefits. In particular, their manifesto rules out increases to the basic and higher rates of income tax or rates of National Insurance; and it rules out increasing rates of VAT, as well as extending the VAT base to include food, children’s clothes, books, newspapers or public transport fares.

This does not rule out raising more revenue from these taxes in other ways: they could, for example, change income tax or National Insurance thresholds, or implement further restrictions to income tax relief on pension contributions. These could affect many of the same people, via the same tax, as the hypothetical tax rises that they have ruled out.164

158 Section 1 of FA2015 set the charge to tax, and the 3 rates of tax, for the 2015/16 year. 159 HC Deb 25 March 2015 cc1497-1513 160 HC Deb 25 March 2015 c1503, c1509. The amendment was defeated by 309 votes to 230. 161 Conservative Party, The Conservative Party Manifesto, April 2015 p27 162 Labour Party, 2015 General Election Manifesto, April 2015 p18, p27 163 Liberal Democrats, Manifesto 2015, April 2015 p19 164 Taxes and Benefits: The Parties’ Plans - IFS Briefing Note BN172, April 2015 p12, p29. See also, “Triple tax

lock puts other revenue sources in spotlight”, Financial Times, 28 May 2015.

41 Income tax: the additional 50p rate

In their analysis of the Labour Party’s manifesto, the authors reconsidered the evidence, such as it was, on the impact of the additional rate – highlighting some research on the characteristics of this small group of taxpayers:

HMRC expects that in 2014/15, the additional rate of income tax was paid by the highest-income 313,000 adults, or roughly two-thirds of one per cent … This small group of taxpayers are expected to contribute around 28% of total income tax in 2014/15, which in itself is 8% of total tax revenue … These individuals are disproportionately likely to be male, aged 35–55, live in London or the South East of England, and work in financial services or be self-employed.165

The most recent evidence we have on the responsiveness of this group comes from a study by HMRC officials following the introduction of the additional rate of income tax in 2010/11. HMRC’s central estimate – signed off by the Office for Budget Responsibility as reasonable – is that the cut in the additional rate from 50% to 45% introduced in 2013/14 would cost just £110 million in 2015–16 once one allows for behavioural response by the affected individuals, suggesting that one could expect a similarly small increase in revenue by increasing the rate to 50% again … it is well within the range of possibility that increasing the tax rate could yield more revenue for the exchequer than this, or lead to a reduction in total tax revenues.

They went on to acknowledge that measures to reduce tax avoidance might boost revenues from a higher additional rate, but that the sums of additional money at stake were unlikely to be significant:

It is possible that Labour’s attempts to reduce tax avoidance and to restrict the extent to which those with the highest incomes can avoid paying the additional rate of income tax by paying more into a private pension could increase the yield from raising the additional tax rate. It is a common result from the studies in this area that much of the response of high-income individuals to higher tax rates takes the form of increased use of tax shelters and deductions rather than real reductions in income.166

Reductions in the opportunities available to individuals to avoid tax may therefore not only increase the revenue raised at a given tax rate, but also increase the revenue-maximising tax rate. The extent to which this happened in practice would depend on the effectiveness of Labour’s anti-avoidance measures. Evidence from Denmark has found much more modest responses to high marginal tax rates than those found by HMRC, perhaps because the tax base is very broad in Denmark and there is little scope for individuals to reduce their taxable income through the use of deductions.167

However, what is clear is that Labour cannot rely on significant additional revenues as a result of increasing the additional rate to 50%.168

Following the Conservative Party’s victory in the General Election, there were some calls, from Lord Lawson and some Conservative Members for the Government to cut the 165 Manning (2015) shows that in 2010---11, 86% of additional-rate taxpayers were male, 67% were aged

35 to 55, 55% lived in London or the South East of England, 29% worked in financial services and 33% were self-employed. See A. Manning, ‘Top rate of income tax’, Centre for Economic Performance Paper EA029, 2015

166 see, for example, J. Gruber and E. Saez, ‘The elasticity of taxable income: evidence and implications’, Journal of Public Economics, 2002, 84, 1---32.

167 See H. Kleven and E. Schultz, ‘Estimating taxable income responses using Danish tax reforms’, American Economic Journal: Economic Policy, 2014, 6(4), 271---301. The authors conclude that ‘[t]he fairly low taxable income elasticities that we find for Denmark, despite the presence of very high marginal tax rates, suggests that the Danish system offers small opportunities for avoidance and evasion. There are two main reasons for this. First, tax bases are very broad and offer limited opportunities for deductions and negative capital income to count against the income tax base. Second, as shown by Kleven et al. (2011), tax enforcement is very effective and overall tax compliance is high due to the widespread use of double-reporting by third parties such as employers and financial institutions (“Unwilling or unable to cheat? Evidence from a tax audit experiment in Denmark”, Econometrica, 2011;79:651–692). The overall conclusion that emerges from the two studies together is that a tax system with the broadest possible bases and extensive use of information reporting can impose high marginal tax rates with fairly modest behavioural responses.’

168 Taxes and Benefits: The Parties’ Plans - IFS Briefing Note BN172, April 2015 pp33-34

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additional rate to 40p.169 In an editorial on possible tax reforms, the Financial Times suggested that the Chancellor should abolish the separate tax regime for non-domiciles, boost council taxes and cut tax relief on pensions – using these resources to simplify the structure of income tax: “Labour bequeathed an income tax system in a mess: three rates, including an upper rate now at 45 pence, and a tapering tax allowance that leaves some facing marginal rates of 60 per cent. It is an ugly, ineffective aberration that impedes the trading economy Britain needs to become.”170 Writing in the paper’s Free Lunch column Martin Sandbu argued that, just as there was limited evidence that a 50p rate raised large sums, there was limited evidence to prove the contrary: that a 40p rate would boost revenues in any substantive way, and, as such, should be a priority for tax reform.

Not long ago, Owen Zidar from the Chicago Booth School of Business showed that, in US data, cuts for lower- and middle-class taxpayers account for the bulk of job growth stimulated by lower taxes. That result dovetails with research from the International Monetary Fund, which finds that economies that redistribute towards the poor and the middle class can boost their growth rates significantly. In contrast, those that make the rich richer hurt economic growth … For a government which, like Mr Osborne's, is determined to shrink the government's tax take while boosting growth, there are better tax reforms to undertake than cutting the top rate.171

In some analysis published at this time, researchers at the IFS modelled the redistributive impact of the tax and benefit system from a lifetime perspective. This suggested that policymakers looking to target the lifetime rich could do so reasonably well by using the higher 40% rate of income tax:

Measures aimed at the cross-sectional rich, such as increases in the higher rate of income tax, do a reasonably good job of targeting the lifetime rich too … This is in contrast with the reforms aimed at redistributing to the lifetime poor that we investigated … An important reason for this is the differing degree of mobility in the two tails of the income distribution: in simple terms, rich individuals more often remain rich than poor individuals remain poor … As a result, policymakers wishing to target the lifetime rich can do so reasonably effectively using the higher rate of income tax.172

The authors noted that “it would be interesting to understand how effective the additional rate of income tax … is at targeting the lifetime very rich”, but “unfortunately, our modelling framework does not capture individuals on the highest incomes sufficiently well enough to be able to answer this question.”173

The Chancellor George Osborne presented the Conservative Government’s first Budget on 8 July. In his Budget speech Mr Osborne confirmed that “in the coming weeks” the Government would legislate to “prohibit any increase in the main rates of income tax, national insurance and VAT for the next five years.”174 The Budget report explained that provision to this effect would be included in the Finance Bill to be presented on the conclusion of the Budget debates:

The government will legislate to set a ceiling for the main rates of income tax, the standard and reduced rates of VAT, and employer and employee (Class 1) NICs rates,

169 “George Osborne urged to cut top tax rate to 40p”, Financial Times, 24 June 2015; “160 Tory MPs 'back

cutting top tax rate to 40p'”, Daily Telegraph, 28 June 2015 170 “Editorial: Osborne’s opportunity for audacious tax reform”, Financial Times, 24 June 2015 171 “Free Lunch: The wrong tax reform”, Financial Times, 25 June 2015. The academic work Mr Sandbu cites

is, Owen M. Zida, “Tax Cuts For Whom? Heterogeneous Effects of Income Tax Changes on Growth and Employment”, National Bureau of Economic Research Working Paper No. 21035, March 2015; and, Dabla- Norris et al., Causes and Consequences of Income Inequality: A Global Perspective, IMF, June 2015

172 Levell, Roantree & Shaw, Redistribution from a Lifetime Perspective: IFS Working Paper W15/27, September 2015 p63

173 op.cit. p63 174 HC Deb 8 July 2015 c336

43 Income tax: the additional 50p rate

ensuring that they cannot rise above their current (2015-16) levels. The tax lock will also ensure that the NICs Upper Earnings Limit cannot rise above the income tax higher rate threshold; and will prevent the relevant statutory provisions being used to remove any items from the zero rate of VAT and reduced rate of VAT for the duration of this Parliament. (Summer Finance Bill 2015).175

It is worth adding that the Budget included a series of measures to increase taxes as well as measures to reduce public expenditure. As Paul Johnson, director of the IFS, noted in his post-Budget presentation: “The figures are quite clear though – this was a tax raising budget … we told you before the election that post-election budgets tend to raise at least £5bn in tax – and this one expects to bring in a little more than that.”176 The analysis cited by Mr Johnson was published in the IFS’ Green Budget in February 2015.177 The Budget report estimated that, taken together, tax policy measures announced in the Budget would raise £5.1bn by 2017/18, rising to £6.5bn by 2020/21.178

On 14 July the Government published the Finance Bill 2015; clauses 1 & 2 of the Bill made provision for the ‘tax lock’ for income tax and VAT. At the same time the Government published a National Insurance Bill to bar any rise in the rates of Class 1 NICs, and prevent the UEL exceeding the higher rate threshold for income tax (that is, the point at which individuals start to pay income tax at the higher rate). The higher rate threshold is the sum of the personal allowance and the basic rate limit - the band of income which is charged tax at the 20% rate.179

There was relatively little debate of the Government’s ‘tax lock’ following the Summer Budget. Speaking for the SNP after the Chancellor’s Budget statement, Stewart Hosie observed, “the Chancellor promised at the election that he would introduce a tax lock to prohibit any increase in the main rates of income tax, national insurance and VAT and would legislate for that. He is not a stupid man, and I gently say to him that legislating to stop tax rises is just a gimmick and no one is going to buy it.”180

There was also some mention of the tax lock when the Finance Bill received its Second Reading on 21 July. Speaking for the Labour Party Shabana Mahmood said:

Back in 2009, the current Chancellor was very critical about Chancellors passing laws to ensure that they fulfil the promises they make in general election campaigns, and I think that that criticism applies just as much to him now. However, we support the principle of the lock. We have pledged not to raise VAT, national insurance or the basic and higher rates of income tax, so we welcome those measures.181

Ms Mahmood was referring to Mr Osborne’s criticism of the legislation the Labour Government introduced in 2009-10 – the Fiscal Responsibility Act 2010 – which imposed a number of obligations on HM Treasury to reduce government borrowing and debt.182 Speaking during the debates on the Queens Speech in November 2009, when the legislation was announced, Mr Osborne argued that these provisions would achieve “a constitutional first of imposing no legal sanction on the person who is likely to break it. No

175 Budget 2015, HC 264, March 2015 para 2.53. see also, HMRC, Tax lock: Income Tax, NICs and VAT: tax

information & impact note, 8 July 2015 176 “Paul Johnson’s opening remarks”, IFS Summer post-Budget briefing, 9 July 2105 177 “Chapter 10: Options for increasing tax”, IFS Green Budget, February 2015 pp228-9 (Figure 10.1. Taxes

and the electoral cycle). See also, “Taxes and elections: are they by any chance related?”, IFS Observations, 15 March 2010.

178 Budget 2015, HC 264, March 2015 p74 (Table 2.1: Total Policy Decisions) 179 For details see, National Insurance Contributions (Rate Ceilings) Bill 2015-16, Commons Briefing paper

CBP7260, 29 February 2016. 180 HC Deb 8 July 2015 c348 181 HC Deb 21 July 2015 c1401 182 For details see, Fiscal Responsibility Bill, Commons Briefing Paper RP09/96, 22 December 2009

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other Chancellor in the long history of the office has felt the need to pass a law in order to convince people that he has the political will to implement his own Budget.”183

Speaking for the SNP in the Second Reading debate, Tommy Sheppard also discussed the tax lock. Mr Sheppard noted that legislation in one year’s Finance Bill to fix income tax and VAT rates could be reversed in the following year’s Bill: “If these provisions are included in what will become the Finance Act 2015, it will only take a clause in the 2016 Finance Bill to overturn them. They are therefore literally not worth the paper on which they are written.”184

Provisions in the Finance Bill to set the ‘tax lock’ for income tax and VAT were debated and agreed to, without a vote, at the Committee stage of the Bill on 17 September. On this occasion Treasury Minister, David Gauke, was asked about the Government’s position on ‘declaratory legislation’, in the light of Mr Osborne’s criticisms, mentioned above:

Nick Thomas-Symonds : On the passing of the Fiscal Responsibility Act 2010, which, like the clause, had declaratory effect, the then shadow Chancellor, who is now the Chancellor of the Exchequer, said that it was “vacuous and irrelevant”. Is the Minister as surprised as I am about the Chancellor’s U-turn on declaratory legislation?

Mr Gauke: I would draw a distinction between a Government who had no reputation for fiscal responsibility seeking to obtain such a reputation by passing such legislation and a Government who have a record of controlling income tax by increasing the personal allowance and not increasing rates, notwithstanding the challenges we face in the public finances. The clause underlines the Government’s commitment not to increase taxes, and income tax in particular, on the British people, because that is the wrong response. That is consistent with what we have done in office. The problem the last Labour Government had was that, in response to the fiscal crisis, rather than coming forward with clear proposals to reduce the deficit or even to accept a need to get to grips with that deficit, they simply sought to pass legislation. That was the wrong response then, whereas this is the right response now.185

The rates of income tax have remained unchanged since the Summer 2015 Budget, and, in line with its ‘tax lock’, the Conservative Government did not announce any changes to the rates of VAT or Class 1 NICs for the remainder of the Parliament.

In his Spring Budget in March 2017, the Chancellor Philip Hammond announced a two-stage increase in the rates of Class 4 NICs paid by the self-employed, to reduce the differential between the self-employed and employees. Concerns that this infringed the spirit of the tax lock saw the Chancellor scrap these proposals a few days after his Budget speech.186 In a letter to the Times, IFS director Paul Johnson expressed the view that one of the lessons of this incident was that “it is a mistake to commit in a manifesto to not raising the three most important taxes”187 and for its part the Conservative Party did not include any ‘tax lock’ in its manifesto for the 2017 election.188

By contrast in its 2017 General Election manifesto the Labour Party proposed “no increases in personal National Insurance Contributions or the rate of VAT”, and an increase in income tax only for those on incomes above £80,000.189 The Party proposed “lowering the threshold for the 45p additional rate to £80k (Top 5%) and reintroducing

183 HC Deb 26 November 2009 c708 184 HC Deb 21 July 2015 c1441 185 Public Bill Committee (Finance Bill), First Sitting, 17 September 2015 c9 186 For details see, National Insurance Contributions (NICs) and the self-employed, Commons Briefing paper

CBP7918, 7 September 2018. 187 “Letters: Hammond’s U-turn over national insurance”, Times, 16 March 2017 188 Conservative Party, Forward Together: 2017 Election Manifesto, May 2017 189 Labour Party, For the many, not the few: 2017 Election Manifesto, May 2017 p9

45 Income tax: the additional 50p rate

the 50p rate on earnings above £123k.”190 There was limited coverage of the proposal in the press,191 though the IFS published a detailed briefing which suggested that the anticipated receipts from this tax increase were ‘highly uncertain’:

1. Labour proposes to increase income tax for the 1.3 million people with taxable income exceeding £80,000 per year: the highest-income 2% of adults, or 4% of income tax payers. Currently this small group receive more than 20% of all taxable income and pay more than 40% of all income tax.

Figure 1. Income tax schedule in 2017–18 with and without proposed Labour reforms

Source: Authors’ calculations using HMRC income tax statistics.

2. The tax revenue that Labour’s proposal would raise is highly uncertain. If no one changed their behaviour in response, it would raise around £7 billion per year. But some of those affected would respond by reducing their taxable incomes, reducing the amount raised. The size of the response is highly uncertain and the revenue raised is highly sensitive to the size of the response. Labour expects the policy to raise in the region of £4.5 billion per year. Based on the available evidence this looks a little on the optimistic side, but it is entirely possible. However, it is also possible that the policy would raise nothing.

3. High-income individuals could respond to the policy in a number of ways. One straightforward response for many would be to increase their contributions to private pensions, which bring up-front income tax relief. They could also work less, make greater efforts to avoid or evade tax, emigrate, or not come to the UK in the first place.

4. Losses in cash terms would be highly concentrated on those with the highest incomes. If no one changed their behaviour then the 500,000 people with income between £80,000 and £100,000 would lose an average of £400 a year, while the 50,000 people with income over £500,000 would all lose at least £22,900 a year.

5. Labour’s proposal would be the latest in a series of income tax increases for this group. Since April 2010 the introduction of the 50% rate (later reduced to 45%), the withdrawal of the personal allowance from those with incomes above

190 Labour Party, Funding Britain’s Future: 2017 General Election, May 2017 p5. The anticipated yield from

this was £6.4 billion though a fraction was not included in the Party’s total costings: “owing to the inherent difficulty of forecast receipts from new taxes, bands and thresholds, we have allowed for a degree of uncertainty and not allocated full tax receipts from the listed measures.” (fn24, 37).

191 For example, “Who would be affected by Labour’s higher taxes?“, BBC News, 16 May 2017; “Labour manifesto 2017: the key points, pledges and analysis”, Guardian, 1 June 2017

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£100,000, and a succession of restrictions to tax relief on pension contributions have all increased the income tax paid by those with the highest incomes.

6. The proposals would miss an opportunity to rationalise the income tax system for those on higher incomes. The planned overhaul of the taxation of those on higher incomes would have been an obvious chance to remove the absurd and arbitrary marginal income tax band between £100,000 and £123,000, which arises from the policy described as withdrawing the personal allowance. Instead Labour’s proposals would leave this in place, and would increase the marginal income tax rate from 60% to 67.5% within that band - or from 66.6% to 73.2% once employer and employee National Insurance contributions, as well as income tax, are included.192

Following the Election the IFS published further analysis on the responsiveness of those on higher incomes to income tax rate changes, based on three new papers:

The first paper updates and critiques HMRC’s 2012 analysis of responses to and the revenue effects of the UK’s short-lived 50% income tax rate on incomes above £150,000 (which was in place between April 2010 and March 2013). The second uses individual (rather than aggregate-level) data to analyse responses to the 50% tax rate, and looks in more detail at the nature of the responses. It also proposes a new approach for estimating the long-term responses to a tax rate change, when temporary re-timing effects are significant, after finding that existing approaches perform poorly for the 50% tax rate. The third paper looks at how taxpayers respond to income tax thresholds where marginal rates change (such as the higher rate threshold where the rate increases to 40%, and £100,000, where the personal allowance is tapered away, creating a 60% marginal rate).

The authors suggested that each paper provided important “empirical and methodological contributions”, but that “even with careful analysis, it has not been possible to obtain precise estimates of the responsiveness of high income individuals to income tax rates”:

What about Labour’s recent plans?

Our research finds evidence that the overall high degree of responsiveness of high earners to the former 50% rate was driven by those with the very highest incomes: those with incomes between £150,000 and £200,000 appear to be only a third to a half as responsive to tax rates as the £150,000+ group as a whole. This implies that Labour’s recent proposals – increasing tax rates above £80,000 – would likely raise additional revenues, although probably not as much as Labour were claiming. Furthermore, the estimates suggest that this additional revenue would likely have come predominantly from those with incomes between £80,000 and £200,000, rather than those with the very highest incomes.

What types of taxpayers and responses drive the overall results?

The new research also provides evidence on the types of response and the income sources driving overall measures of responsiveness to income tax.

As shown in Figure 1, individuals with dividend incomes, such as owner-managers of incorporated businesses, are more responsive to changes in tax rates than those with employment income. Incomes from this source jumped substantially in 2009–10 (prior to the introduction of the former 50% tax rate), fell substantially in 2010–11 (after the introduction of the 50% tax rate), and remained relatively depressed the following year. In contrast, income from employment was more stable. A similar pattern is found when examining tax thresholds: company owner-manages respond much more to these thresholds than other taxpayers, with virtually no response among employees.

This pattern is likely to reflect the fact that company owner-managers have an additional mechanism through which they can respond to income taxes: they can manipulate the timing of their income by retaining it in or taking it out of their company at a time that lowers their overall tax bills: such as bringing it forward to

192 Stuart Adam et al., Labour’s proposed income tax rises for high-income individuals, 16 May 2017

47 Income tax: the additional 50p rate

avoid the 50% tax rate. (This benefit comes on top of the fact that the income they take in dividends gets taxed much less, on average, than the income of employees, as IFS researchers have highlighted).

Figure 1. Trends in different income sources and deductions for groups with incomes greater than £150,000, 2001–02 to 2011–12

Note: The blue vertical line shows when the 50% tax was announced (in March 2009) and the red line when it was implemented (in 2010–11).

Source: Authors’ calculations using SA302 data from 2001–02 to 2011–12.

Evidence from the US typically shows that increases in tax deductions play a major role in taxpayers’ responses to increases in income tax. We find no evidence of this for the UK; Figure 1 shows that the cost of deductions reported on tax returns fell when the 50% tax rate was introduced. This may reflect restrictions to pension contributions tax relief and associated anti-forestalling rules introduced at around the same time. By reducing allowable deductions, these policies would have tended to push up taxable income, offsetting some of falls in taxable income as people responded to the 50% rate. Analysis of the change in taxable incomes would therefore lead to an underestimate of the extent to which taxpayers reduced their incomes in response to the 50% tax rate. Estimates of responsiveness based on the larger falls in pre-deductions income (which should have been affected by these deduction rule changes) imply a 50% tax rate would likely yield lower revenues than a 45% tax rate on incomes above £150,000.

However, it should be borne in mind that not all deductions relevant for the revenue effects of income tax rate changes are observed in the tax return data we use. First, as already mentioned, income can be retained in companies, so will not be picked up on personal tax returns. Second, contributions to occupational (rather than personal) pensions are deducted from salaries before incomes data is submitted to HMRC. Future work should explore the scale and potential revenue effects of responses via these margins in more detail by linking personal income tax data with corporate tax and occupational pension contributions data.193

193 James Browne & David Phillips, How do the rich respond to higher income tax rates?, Institute for Fiscal

Studies, 22 August 2017

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4. Appendix: The Mirrlees Review on the 50p rate

In September 2011 the Institute for Fiscal Studies published a major review of the UK tax system, which had been chaired by Sir James Mirrlees.194

A central theme to the review was that politicians and policy-makers needed to consider the system as a whole. Certainly whatever the merits of the debate there has been over the 50p rate, supporters and critics have tended to discuss it in isolation. While the Mirrlees Review did not make any particular recommendations about the 50p rate itself, in their examination of the taxation of earnings, the authors discussed the work that had been done on the money the 50p rate might raise, before making some wider points about taxing the wealthiest in society. An extract is reproduced below:195

*

From 2010–11 a new 50% rate of income tax applies to incomes above £150,000. The government estimates that this directly affects only 275,000 individuals, out of an adult population of about 49 million. Yet the income tax rate applying to the very highest earners has an importance out of proportion to their numbers, simply because they are such an important source of revenue: even before this reform took effect, almost a quarter of income tax was paid by the top 1% of income tax payers, just over 300,000.196 That is a fact worth repeating. Almost one pound in every four collected by the income tax system comes from just 1% of income tax payers. Of course this largely reflects just how much more pre-tax income the top 1% of taxpayers earn than the bulk of the population do.

As noted in the previous chapter, the responsiveness of taxable income, and hence tax receipts, to tax rates may be quite high at the top of the earnings distribution—not because high earners’ employment decisions or hours of work are particularly responsive, but because they may find other ways to minimise the amount of tax they pay: by reducing their effort per hour worked or by, for example, changing the form of their remuneration, contributing more to a pension or to charity, converting income into capital gains, setting themselves up as a company, investing in tax avoidance, illegally hiding their income, or even leaving the country altogether (or not coming when they otherwise would have). In fact, it is not clear whether the 50% rate will raise any revenue at all.

There are numerous ways in which people might reduce their taxable incomes in response to higher tax rates; at some point, increasing tax rates starts to cost money instead of raising it. The question is where is that point? Brewer, Saez and Shephard (2010)197 address precisely this question for the highest-income 1%. Their central estimate is that the taxable income elasticity for this group is 0.46, which implies a revenue-maximising tax rate on earned income of 56%.198 This in turn (accounting for NICs and indirect taxes)

194 The review is available online here: http://www.ifs.org.uk/publications/5353 195 “Chapter 4: Reforming the Taxation of Earnings in the UK” in, Tax By Design: the Mirrlees Review,

September 2011 pp 108-110 196 Sources: For the number facing the 50% income tax rate—HMRC statistics, table 2.1; for the top 1%’s share of income tax

revenue—HMRC statistics, table 2.4,; for total population—ONS 2008-based national population projections,; for the number of dependent children in the population—HMRC, Child Benefit Statistics: Geographical Analysis, August 2010.

197 Brewer, M., Saez, E., and Shephard, A. (2010), ‘Means-Testing and Tax Rates on Earnings’, in J. Mirrlees, et al., Dimensions of Tax Design: The Mirrlees Review, Oxford: OUP Institute for Fiscal Studies.

198 Brewer, M., and Browne, J. (2009), Can More Revenue Be Raised by Increasing Income Tax Rates for the Very Rich?, IFS Briefing Note 84.

49 Income tax: the additional 50p rate

corresponds to an income tax rate of 40% - the introduction of the 50% rate would actually reduce revenue.199

However, there is no escaping the uncertainty around the estimate of a 40% revenue-maximising income tax rate. It was based primarily on what happened to incomes when tax rates changed in the late 1980s; but people’s ability to respond to tax changes may well have changed since then. Increases in international mobility and in the availability of complicated financial products may have increased people’s scope to respond, while a succession of anti-avoidance measures may have reduced it. Changes to capital gains tax have at different times made it easier and harder to escape tax by converting income into capital gains. And the government increased the likely yield of the 50% income tax rate by also announcing a limit on the tax relief that high earners can obtain by saving their income in a pension. So the elasticity might have risen or fallen. And even if nothing had changed since the late 1980s, statistically there was only a two-thirds chance that the revenue-maximising rate was somewhere between 33% and 57%.200

So we do not know with confidence what the revenue-maximising top tax rate is. But governments do not have the luxury of stopping there: policy must be decided, so in the absence of compelling evidence they must take a best guess. The Treasury’s best guess is that the 50% rate will raise some revenue. That is certainly not impossible, but it is certainly uncertain.

Whatever the precise revenue-maximising tax rate, it seems unlikely that much additional revenue can be raised simply by increasing the income tax rate for this group. But this is not the only tool available for extracting money from this group. Widening the income tax base—removing reliefs and clamping down on avoidance—not only raises money directly but also reduces the scope for shifting income into tax-free forms and thereby makes tax rate increases more effective revenue-raisers. And there are, of course, other taxes aimed at the wealthy (notably inheritance tax), which might have the potential to raise revenue.

In addition, we should not forget that the revenue-maximizing rate is itself not necessarily the rate that we should impose on this group. If we value their welfare at all, or have concerns over long-term behavioural effects, then we might want a rate below the revenue-maximizing rate in any case.

199 Increases in rates of NICs and VAT announced since this analysis was done will further reduce the income

tax rate that corresponds to a given overall tax rate on earnings. 200 Brewer, M., and Browne, J. (2009). The estimate of the revenue-maximising top tax rate also relies on two

other debatable assumptions. The first is that, were it not for tax changes, the incomes of the top 1% would have evolved in the same way as those of the next richest 4%, which we cannot know. The second is that any reduction in taxable income would be matched one-for-one by a reduction in spending (and therefore indirect tax revenues)—likely to be broadly accurate if the reduced taxable income reflected a real reduction in economic activity in the UK (less work effort or less net immigration, for example), but not if it reflected more tax avoidance or evasion, say.

BRIEFING PAPER Number 249, 26 September 2018

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