The demands for reform of the tax system is widespread in many countries but in this article James Alston1 argues that the prospects for serious tax reform are poor while so many politicians fail properly to understand the basics of their own tax systems.
Whether someone favours higher rates of tax or not can tell you a lot about their political views. As a general rule, conservative politicians — at least since the 80s — have favoured fewer tax brackets and relatively lower rates of tax. The argument goes that this encourages people to work harder because they keep more of their money, which means more money remains in the economy; eventually it will trickle down to those not so rich. On the other end of the spectrum, more left-wing politicians argue that higher taxes on top-earners are an effective way of raising government revenue for public services, which help out those who need support, and that a few more dollars or pounds taken off of someone who earns astronomical sums already is a drop in the ocean.
Always one of the key issues between left and right, the debate over higher tax rates has again seen some action over the last few years in both the UK and the US. Currently there are four brackets in the UK, including one for tax-free personal allowance. From £12,501 to £50,000 you then pay 20 per cent, from £50,001 to £150,000 you'll pay 40 per cent, and anything above that 45 per cent.The Labour Party in the United Kingdom proposed in 2017 a 50 per cent tax rate for earnings over £123,000 and a 45 per cent for earnings over £80,000, with the plan that the top 5 per cent of earners pay a little more to fund the country and relieve the burden on the poor. This relatively moderate proposal resulted in a barrage of arguments for and against. And the issue blew up in America at the beginning of 2019, too, when Alexandria Ocasio-Cortez suggested that a 70 per cent income tax rate on incomes over $10 million might not be too bad an idea. As might be expected, conservative politicians pushed back hard against the idea, Rep. Steve Scalise, for example, tweeting that the Democrats would ‘take away 70 per cent of your income and give it to leftist fantasy programs’.2 Grover Norquist, head of Americans for Tax Reform, compared it to slavery, tweeting ‘Slavery is when your owner takes 100 per cent of your production… Ocasio-Cortez wants 70 per cent… What is the word for 70 per cent expropriation?’3
On the surface these tweets show either a total misunderstanding, or worse, a deliberate misrepresentation, of how marginal taxation works. Ocasio-Cortez’s proposed tax, for example, would only tax 70 per cent on every dollar a person earns over $10 million, which is not exactly the majority of Americans. And less than three percent of Britons earn over £100,000, meaning very few would be liable for Labour’s proposed tax bracket increase.4 This is how progressive tax brackets work: you pay more tax only on money earned that falls within the new bracket; any percentage increase doesn’t apply to every dollar or pound you earn. The issue of a large tax increase currently isn’t in question: Joe Biden hasn’t been particularly vocal about tax reform, and hasn’t backed AOC’s Green New Deal which was the catalyst for her proposed change. He's only committed to a modest 2.6 per cent income tax increase on those earning over $400,000 and plans to raise corporate tax rates from 21 per cent to 28 per cent. Across the pond, Labour leader Keir Starmer has promised an increase on tax for the top 5 per cent of earners in order to pay for the economic downturn due to the coronavirus Covid-19 pandemic; however, he hasn’t confirmed where the top tax bracket will sit, as predicting the size of the debt accrued as a result of the pandemic is difficult, seeing as it’s still going on. But regardless of the new leadership’s reluctance to discuss the matter, the issue of comprehensive reform hasn’t been put to bed.
Nothing is certain
A common argument against a higher top tax bracket is that it won't mean that the richest will pay more, but that they will retire earlier, figure out ways to keep their income from being taxed, and ultimately end up paying less. (In the 1970s in the UK something similar happened, the tax avoidance industry exploding due to extremely high upper tax rates.) Moreover, experts such as investment adviser Mark Dampier argue that traditional alleviations on tax, such as a decrease in VAT, won’t be felt by the regular person on the street while buying their shopping (whereas it would be felt by a rich person buying a yacht, for example).5 Instead, a simplification of the tax system and a raising of personal allowances will make much more of a difference to your average Joe Bloggs, in comparison to a redistribution of taxes on the rich which may not make that much money anyway if they can find ways of not paying. Dampier’s criticism was in response to the UK Labour Party’s aforementioned proposed tax rate increase. Since Ocasio-Cortez’s proposal, too, other big names have come out suggesting it’s a bad idea. Bill Gates argued in an interview with the Verge that in America, the highest earners gain their money through selling assets, rather than through their income: ‘the top 400 earners in the US,’ he argued, ‘are only paying something like a 20 percent tax rate.’6 This means the higher tax rate won’t affect them as much of their money isn’t earned through their incomes anyway, and those it would affect would simply move their money around so they won’t have to pay.
Other arguments have a more political, and less economic, basis. A flat or flatter rate tax system, in which everyone pays the same or more similar rates of tax, is sometimes argued to be fairer for the simple fact that everyone is treated the same. Moreover, some say a lack of differing tax rates encourages the poor to work harder and to earn more money, striving to reach the top. After all, being able to make of yourself anything you wish was what underpinned the Thatcher-Reagan political reforms of the 70s and 80s; it stands to reason, then, that the way they taxed the population would change in line with these policies. On a more basic level, fewer tax brackets also means simplicity in the overly-bureaucratic process of state finance.
And yet, taking all of the above into account, history tells us that fewer tax brackets and lower higher rates is the exception, not the rule, and that the policies of the 80s did not make our societies more equitable. In Eisenhower’s day, the top US tax bracket was 91 per cent. In the 60s, the top rate dropped to 70 per cent, before Reagan slashed it even further to 50 per cent. The number of tax brackets in the US steadily decreased also, from 33 in 1965 to 7 today. The results of this decrease in both brackets and the top taxation rate (though this of course wasn’t the only cause) were steadily rising inequality, and a higher proportion of wealth being in the hands of the rich, particularly since the mid-80s — something that with hindsight seems very predictable.7 Currently, the richest 0.01 per cent of Americans control around 11 per cent of the country's wealth, and the top 0.1 per cent's share of national wealth roughly equates to that of the bottom 90 per cent. This is significantly less equal than in the 60s and 70s, as reported by Vox in 2015.8
It’s perhaps no surprise, then, that many of the world’s wealthiest and economically equal countries have higher top rates of tax. Denmark and Sweden have top tax rates of around 60 per cent and 56 per cent respectively, two of the most prosperous countries on the planet. (Admittedly, they have a relatively flat taxation system, meaning many people get taxed at such high rates, not just the rich.) Germany has a progressive tax system, with the rate, after the personal allowance limit of €9,169 increasing linearly as income increases, up to 42 per cent when you earn €265,327, before jumping three percent to 45 per cent on all income after this. The system also means that a taxable income will never result in lower net income.
Other, better, systems exist, and it’s evident some kind of tax reform is critical if we are to make society fairer. But what's the best way to go about this? Will more tax brackets help? Or is simply a higher top bracket rate necessary?
Except death and taxes
70 per cent sounds like a huge increase in the top rate of tax, but some argue it’s not quite enough. A 2012 paper from MIT by Peter Diamond and Emmanuel Saez argued for a top bracket of 73 per cent on incomes over $400,000. The main argument for this was that after a certain amount, an extra dollar doesn’t make a dent in a rich person’s bank account, but for a poorer person, those few bucks could mean the difference between eating or going hungry. The paper’s authors calculated that any tax rates higher than 73 per cent lead to people working less and evading tax. And there’s a social argument for higher taxation, too: many talented people currently move into legal or financial roles, because they can earn more money. However, if taxes were high over a certain level of income, these roles would be less appealing, because you’d keep less of that additional money.9 Evidently a second part of this would be to make currently lower-paying jobs, such as teaching and academic roles, more enticing, with higher pay and better benefits — not something necessarily related to tax. (That being said, it isn’t inconceivable that revenue generated from higher top bracket tax rates could be redistributed to make civil servant jobs more financially appealing.) The social benefits of having a bunch of talented bankers and lawyers, especially if the lawyers simply work for the bankers, are incomparably small compared to those of having extremely brilliant teachers and academics.
Consider, moreover, when a company decides what it does with its revenue. With high brackets in place, instead of giving those at the top huge incomes and bonuses which simply get taxed away, that money gets sent downwards, invested back into the company, which includes in workers who normally would never see it. And so it was in the 1960s: bosses earned significantly less than today, and more money was invested into businesses at the lower levels, partly because of the influence of unions but also due to higher top tax brackets which meant paying bosses astronomical sums made no sense. As argued in The Week by Jeff Spross, when this system began to change in the late 70s — combined with union collapse and increasing unemployment — the US saw money rocket to the top of the chain, and inequality increased massively.10 Naturally the reasons for economic prosperity are complex, but in the years in both the UK and the US when tax brackets were more numerous and rates of taxation at the top higher, economic growth was greater and continued for longer, and living standards were higher.
Mainstream politicians are unwilling to have a considered debate on the topic, preferring instead to make misleading comments that miss the point and fail to grasp the nature of tax reform. There are other obvious social reasons for higher taxes, too. Ocasio-Cortez’s suggested tax rates rise was directly related to the Green New Deal, a plan put together by young activists in the Sunrise Movement to combat climate change. It consists of a program of investments into renewable and clean energy, which, it argues, will make the economy environmentally friendlier and simultaneously juster. The money that will go into alleviating climate change isn’t money that will be spent, but rather invested; it’s clear that investment in renewable energy is essential not just for saving the planet but also for helping to keep the economy afloat and fixing inequality. Indeed, without it, there won’t be much of an economy left. But some, such as aforementioned Nobel Laureate Peter Diamond, have said the 70 per cent suggested by Ocasio-Cortez is too little to fund the Green New Deal, arguing the top bracket must be higher to raise the funds necessary to save the planet.
An important yet often ignored part of this debate is that tax reform can’t just consist of raising rates and including more brackets. It must also focus on making the system less complicated, less bureaucratic, and less easy to cheat. It needs to come down hard on tax evasion, as well as closing loopholes and placing restrictions on the movement of capital to make tax avoidance more difficult. The common argument that fewer brackets equals a simpler and fairer system is disingenuous. Working out which tax bracket one falls into takes very little time and some simple maths. The difficult part is actually working out your income and declaring your tax, at least for self-employed workers or those working in complex systems such as the US.
The solution is surely threefold: simultaneously raise the highest tax bracket rates to increase government revenue, improve the system to make it significantly harder to evade and avoid tax, and increase the amount of tax brackets in order to lessen the leaps between incomes, thus making the progression fairer. These solutions aren’t mutually exclusive; indeed, it’s essential they are implemented in tandem with one another, else reform will fail. Some polls suggest the majority of people in the UK support a higher rate of taxation, showing public opinion is moving away from the received wisdom of neoliberal politics. And due to the economic effects of the pandemic, some tax reform will be necessary to pay for the massive debt accrued since March 2019. Unfortunately, as the backlash to Labour’s and Ocasio-Cortez’s suggestions shows, some politicians are unwilling to have a considered debate on the topic, preferring instead to make misleading comments that miss the point and fail to grasp the nature of tax reform. Until they can sit down and discuss this broken system in a reasonable manner, taxes will remain as they are: inadequate and unfair.
1 James Alston is Content Marketing Manager at INOMICS. An earlier version of this article appeared in the INOMICS 2020 Handbook., https://inomics.com/handbook
2. Scalise, 2019.
3. Norquist, 2019
4. Cannochi, 2016
5. Collinson, 2008
6. Mohamed, 2020
7. Chang 2019
8. Yglesias, 2015
9. Diamond and Saez, 2011
10. Spross 2015
Canocchi, Camilla. ‘Do more than a million Britons really earn more than £100k a year? Survey claims a raft of high-earners and that nearly 50,000 make over a £1m.’ This Is Money, 2016. https://www.thisismoney.co.uk/money/news/article-3621852/More-1m-people-say-earn-100k-year-nearly-50-000-make-1m-survey-finds.html.
Chang, Alvin. ‘100 years of tax brackets, in one chart.’ Vox, 2019, https://www.vox.com/2015/10/26/9469793/tax-brackets.
Collinson, Patrick. ‘Case study: “It's back to the 1970s, old Labour and the politics of envy"’ The Guardian, 30, https://www.theguardian.com/business/2008/nov/25/case-study-45p-tax.
Diamond, Peter, and Emmanuel Saez. ‘The Case for a Progressive Tax: From Basic Research to Policy Recommendations’, Journal of Economic Perspectives, vol. 25, no. 4, 2011, pp. 165-190. American Economic Association, https://www.aeaweb.org/articles?id=10.1257/
Mohamed, Theron. ‘“The rich should pay more” – Bill Gates calls for higher taxes on the wealthy in New Year's Eve blog post’, Business Insider, 2020, https://markets.businessinsider.com/news/stocks/bill-gates-calls-tax-hike-wealthy-new-years-eve-blog-2020-1-1028791394.
Norquist, Grover. Twitter, 2019, https://twitter.com/
Scalise, Steve. Twitter, 2019, https://twitter.com/
Spross, Jess. ‘In praise of taxes’, The Week, 2015, https://theweek.com/articles/549702/praise-taxes.
Yglesias, Matthew. ‘Everything you need to know about income inequality’ Vox, 2015, https://www.vox.com/