Here\’s a nice little admission from Ritchie:

Now we can argue forever about whether tax is a disincentive to work, or not. I happen to think it probably is – but only when tax rates persistently above 50% at higher rates of income, although accept that this can also be the case at lower tax rates when income is lower. In other words, the disincentive effect is related to rate and income, and the disincentive effect may well be greater when income is lower. There’s nothing radical in saying that – this is an argument for steadily progressive taxation and  I stress, this is based on observation and my interpretation – nothing more.

So, marginal tax rates above 50% are a disincentive to work. He\’s right of course, there\’s nothing very surprising or radical in this. It\’s a common enough supposition.

What makes this admission interesting though is that there was a report for Compass, \”In Place of Cuts\”, which argued that by raising marginal tax rates to 75% we would get an increase in revenue.

And after a lot of faffing about we were able to discover the assumption which led to this quite remarkable argument.

Which was that such high marginal rates would be an incentive to work, not a disincentive.

The Compass report was written by one Richard Murphy.

Remarkable how the effects of marginal tax rates vary dependent upon what conclusion Ritchie wants to reach really, isn\’t it?

High marginal tax rates caused by student loan repayments will have the most appalling effects. Even higher marginal tax rates caused by Ritchie imposing even higher marginal tax rates will have entirely beneficial effects.

I really do wish I could be as inventive in my use of facts, theory and logic as our favourite retired accountant from Wandsworth.

9 comments on “Blimey

  1. not related to Richie, but on subject of incentives, I was talking to big name tax economist last night who told me the data shows higher income taxes on high earners do not appear to affect hours worked nor participation decisions, but they affect reported taxable income, which he explained by high earners choosing how they pay themselves (for instance, use of stock options). He reckons the data does not support the theoretical treatment of income taxes and their effect on efficiency in optimal taxation design (aka Mirrlees review). He said if you look at relative tax rates (capital gains, income, corporation taxes) you can see very clear changes … he gave an example of different ways of using stock options so the tax is either deductible at the firm level or the individual level.

    also a question for you: if you think that corporate taxes are ultimately born by workers, can you also believe that corporate taxes act as a disincentive to investment?

    Tim adds: Of course: for corporate taxes acting as a disincentive to investment is what causes the economic burden to be carried by the workers. For it is the absence of investment which lowers average productivity and thus average wages.

  2. isn’t that still inconsistent? Why are “corporate taxes acting as a disincentive” if you don’t think any tax incidence falls upon shareholders?

    It would make sense if you thought that taxes were paid by shareholders, and that reduced investment, which then reduced wages. Then you end up in an equilibrium in which taxes are causing output to be lower than it would otherwise be, but in which you still have to say taxes are hurting shareholders because if they weren’t eating into capital earnings, they wouldn’t be depressing investment.

    Tim adds: But that is what I’m saying. The short term incidence is upon capital: which means less capital invested which means, in the long term, that the incidence is upon workers in the form of lower wages.

  3. Ritchie must be nudging £150,000 of income and has discovered at a visceral level just what working more for the state than yourself means.

    This is the essence of socialism: good intentions in public, craven behaviour in private (or until caught).

  4. no, sorry, still don’t see it. I mean, I don’t see how we can have long-run equilib with incidence 100% on workers. What would that equilib look like? Lower capital stock (which should increase returns on capital) and no tax incidence on shareholders so what’s stopping them investing more? I need to go away and do some reading, but right now it still looks to me like there ought to be some incidence on shareholders in long-run.

    Tim adds: Ah, I see the problem.

    It’s not “100% of the incidence”…’s “incidence of 100%”. This is what Stiglitz’s 1980 paper shows. That the total incidence of the tax can be greater than 100% of the tax raised. And it could be that 100% or more of the tax raised is bourne by the workers.

    This is very different from saying that x% of the incidence is bourne by one group or another.

    Just to make it even clearer. Imagine that we raise £100 in revenue from a tax. But the way that we’ve done so cause, long term, losses of £150. If that £150 loss was allocated 70/30 (well, roughly) to workers and shareholders, then we’ve a 100% incidence upon the workers plus a 50% incidence upon the shareholders.

    This would make it a very bad tax indeed of course, losses being greater than revenue collected.

  5. aha! thanks for clearing that up.

    I really need to look into this some more – I had assume that holding the capital stock constant, firms with some pricing power may adjust prices and wages to move the incidence around, but I’m now getting the impression that the main mechanism is changes to long run levels of capital.

    Tim adds: Yup….the opening analysis is that there’s a world return to capital (Smith’s natural rate of profit if you like). So if the return to capital is taxed in one country, this lowers the return to capital in that country, below the world level. Which means that capital leaves that taxing jurisdiction, seeking the world return. Such a lowering of capital investment will lead to a rise in the return to capital (because of scarcity) in that taxing jurisdiction to the world level. So post tax equality of return to capital (properly risk adjusted of course) is still there.

    However, as a result of that induced capital scarcity local labour will be less productive (labour plus capital improves productivity) and given that average wages are determined by average productivity, wages will therefore be lower.

    The incidence of the tax is thus on local labour, local immovable capital, not capital that can move in or out of the jurisdiction.

    Of course, if you stop capital moving around then incidence will indeed be on capital. But autarky’s not that much fun.

  6. interesting that it works mainly through the level of capital … what are its distributive consequences? if in these models the rich own capital and the poor work, what does it do to income distribution (and how to reconcile that with data on corp taxes and inequality).

    Tim adds: Dunno, beyond me. But a major point would be that if you think the incidence of corporate taxation is progressive (because it falls upon capital, that being owned by the rich) then perhaps you should rethink that idea?

  7. @Kay Tie: He doesn’t need to be raking in £150K to get stung under the new higher rate tax system. I believe that above £100K you are paying as much if not more on each marginal pound, due to the withdrawal of allowances, or some such wheeze. Somewhere I saw a graph of marginal rates that goes up to 60% at £100K until about £120K, then back down to 40% until £150K, then 50% above that.

    So my guess is that Ritchie has just worked out what his income was for the tax year 2009/10, as tax payments are due by 31 Jan, and its worryingly close to/above £100K, and he doesn’t like the idea of parting with over half of his marginal efforts.

    ‘Petard hoist & on his own’ are words that spring to mind.

  8. @Jim

    Ah yes, I forgot: the basic allowance is withdrawn, given a peculiar effective marginal rate.

    So Ritchie has hit £100K probably. He should work harder, then.

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