Here\’s how we should be measuring the top marginal tax rate in a US sense:
For the U.S. economy, the current top income marginal tax rate on earnings
is about 42.5 percent, combining the top federal marginal income tax bracket of
35 percent with the Medicare tax and average state taxes on income and sales.
Note that there is no inclusion of social security taxation because that is capped at below the level of income we are talking about (the top 1%).
In more detail, the calculation is:
The top tax rate ? is 42.5 percent for ordinary labor income when combining the top federal individual
tax rate of 35 percent, uncapped Medicare taxes of 2.9 percent, and an average combined state top
income tax rate of 5.86 percent and average sales tax rate of 2.32 percent. The average across states is
computed using state weights equal to the fraction of fi lers with adjusted gross income above $200,000
that reside in the state as of 2007 (IRS, 2009a). The 2.32 percent average sales tax rate is estimated as
40 percent of the average nominal sales tax rate across states (as the average sales tax base is about
40 percent of total personal consumption.) As the 1.45 percent employer Medicare tax is deductible for
both federal and state income taxes, and state income taxes are deductible for federal income taxes, we
have ((1 – .35) × (1 – .0586) – .0145)/(1.0145 × 1.0232) = .575, and hence ? = 42.5 percent.
In the same paper we have the finding that this marginal tax rate should be much higher than it is:
the optimal top tax rate using the current taxable income base
(and ignoring tax externalities) would be ? * = 1/(1 + 1.5 × 0.57) = 54 percent,
while the optimal top tax rate using a broader income base with no deductions
would be ? * = 1/(1 + 1.5 × 0.17) = 80 percent.
Now, here\’s the thing. That 54% or 80% top marginal tax rate is not the marginal income tax rate. It is the marginal total tax rate. And what would be interesting is to find out whether we in the UK are under, at or above that recommended rate. This recommended rate being the peak of the Laffer Curve by the way. Tax the top 1% until trying totax them any more reduces tax revenues (and it also ignores long term effects but we\’ll ignore that too here).
So, given the US taxes that they include in their calculation of the best top marginal rate, what UK taxes do we have to include?
Well, firstly, obviously the 50% tax band for income tax. Then we\’ve got to add the uncapped part of employees\’ national insurance. 1% isn\’t it? Or did they raise it to 2%?
So already we can see that we\’re very close to that peak of the Laffer Curve given the current tax base of 54%. But how clo9se do we get to that 80%?
That I think is the more interesting question. We need to add the uncapped employers\’ NI of 13.8%. Because yes they are assuming that the incidence of such \”employer paid\” taxes is on the worker\’s wages. And, of course, we\’ve got to add the effect of 20% VAT (for they include sales taxes). ONS I think publishes tables of how much each decile pays in VAT as a protion of income, don\’t they? That would be a good starting point.
Now, someone better with numbers than I am could actually work this out: what is the current UK top marginal tax rate calculated the same way that Diamond and Saetz have calculated their one.
And I am certain that we\’ll find that the current rate is above the Laffer Curve peak rate given the current method of determining the tax base. And I wouldn\’t be at all surprised to find out that it\’s above the higher one they give as well, or perhaps just approacing it.
BTW, do note that the UK cannot actually get to that much wider tax base that the US can: because UKites can just bugger off across the channel to dodge taxes, something Americans cannot do. So the UK Laffer peaks could well be lower than the US ones anyway.