LibLink: Jonathan Portes on wealth taxes & ensuring the ‘rich’ pay their fair share

Jonathan Portes, director of NIESR and former senior Treasury official, is not a Lib Dem — he recently contributed to LibDemVoice to critique the Coalition’s economic policy — but he is addicted to robust evidence. And the recent spate of right-wing commentators rubbishing the Lib Dems’ call for increased wealth taxes to help tackle the current economic crisis has roused his ire:

The Liberal Democrats call for a “mansion tax” (that is, a higher rate of council tax for the most expensive properties), possibly supplemented by some form of wealth tax seems to have provoked a peculiarly illogical misuse of one particular statistic among economic commentators who really should know better. Their objective appears to be to show that the “rich” are already paying more than their “fair share”, and that any additional imposition would be both unfair and economically damaging. This is, of course, an entirely legitimate argument, both as a matter of ideology and of economics. But they will have to come up with some rather more convincing facts and evidence than they have so far.

Why? Because they — he names Dominic Lawson, Allister Heath and Fraser Nelson — have tended to focus exclusively on what top-earners pay in income tax.

But what does this tell us about ability to pay, “fairness”, or the feasibility or desirability of a wealth tax? Almost nothing. To make arguments about the fairness, or otherwise, of the UK tax system purely on the basis of the burden of income tax is simply absurd. Income tax is the largest single tax; but it constitutes only about 27% of the overall tax take.

So what can we say about the fairness of the current tax regime. Jonathan Portes looks at the Office for National Statistics (ONS) figures and notes:

… the top 10% have gross income averaging £107,500, of which they pay £35,000 – just under a third – in all taxes, direct and indirect. Meanwhile, the average household has income of £37,700, of which they pay £12,700, or just over a third, in taxes. … Overall, it is impossible to avoid the conclusion that for the vast majority of the population the UK tax system is at most modestly progressive.

Ah, but what about benefits? Surely this leads to a massive redistributive skewing, with vast dollops of income transferred from the wealthiest to the poorest. Again, it’s not quite that simple:

The benefit system is highly progressive, so, overall, the system is indeed redistributive, especially for the bottom two quintiles; their share of total income doubles as a consequence. But much less so at the top. The share of original income that goes to the top tenth of the population is about a third: their share of final income, after all taxes and benefits, is only slightly less, at about 29%. Hardly confiscatory. … the middle class is a “net recipient of government largesse” [Dominic Lawson’s contention] only in the sense that they pay into the system when they are working and take out of it when they are retired.

His conclusion:

It is clearly possible on the basis of the facts to argue that the UK tax and benefit system is progressive; that top earners are paying their “share”; and (a separate argument) that there are significant potential disadvantages to wealth and property taxes (although I am sceptical that there is any serious economic or fairness argument at all against making council tax less regressive than it is at present). But to argue any of these on the basis simply of the share of income tax paid by top earners is at best disingenuous, particularly when the numbers giving the broader picture are so easily available.

You can read Jonathan Portes’s post in full here.

* Stephen was Editor (and Co-Editor) of Liberal Democrat Voice from 2007 to 2015, and writes at The Collected Stephen Tall.

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6 Comments

  • It also ignores the equally obvious point that income tax derives from income, and if the richest slice of the population is paying a large proportion of income tax this is because they are receiving the lion’s share of the nation’s income. Similarly the growth in the proportion of income tax being paid by the wealthiest reflects the staggering growth in income inequality under the last government, rather than any inherent justice hard-wired into the tax system.

  • Richard Dean 2nd Oct '12 - 11:02pm

    Very interesting, thanks Stephen. So basically, when all taxes including VAT and fuel/tobacco/drink duty is taken into account, everyone but the bottom 20% is paying about one third of their income in taxes? This would be one definition of “fair share”.. Some might feel instead that higher incomes should pay a higher percentage.

    The original ONS report that Portes gets his information from was linked to on his blog and is here:

    http://www.ons.gov.uk/ons/rel/household-income/the-effects-of-taxes-and-benefits-on-household-income/2010-11/etb-stats-bulletin-1011.html

    The report finds that taxes and benefits have a major effect of redistributing wealth from rich to poor. Which is good. Could it be better? Maybe. Less welcome is the news that income inequality increased during the 1980’s and then remained fairly static to 2011 – no reduction in equality since the early 1990’s..

  • Richard Dean 2nd Oct '12 - 11:14pm

    Typo, apologies (had to rush): … no reduction in INequality since the 1990’s. Not good

  • Alex Sabine 3rd Oct '12 - 4:15am

    Thanks for the link Stephen. It’s an interesting and generally rigorous piece. A few observations to amplify and, in some respects, qualify Jonathan’s analysis:

    1. I agree with his central argument: We can’t judge how progressive or regressive the tax system is simply by citing the figures for the proportion of income tax revenue paid by various percentile groups of the population. This is because income tax only accounts for about 27% of the total tax take. Most other taxes are less progressive, and some – like council tax and most indirect taxes – are regressive. The tax system as a whole is proportional: most households pay about one-third of their income in tax.

    What’s more, to rebut an argument for higher wealth taxes by pointing to the distribution of the income tax base rather misses the point that income and wealth are quite different things, and that wealth is much more unevenly distributed than income. I’m not a fan of either an all-encompassing ‘wealth tax’ since I think it would be a bureaucratic nightmare that would bring in precious little revenue. I think there are smarter and less economically damaging ways of taxing wealth where this is appropriate; we could start by sorting out the three wealth taxes we already have (CGT, inheritance tax and council tax). But I don’t think objections should be based on specious arguments about the income tax base.

    2. That said, the statistics for the proportion of income tax paid are striking all the same, and should give pause to those who blithely assert that Britain’s high earners get off lightly and are generally a bunch of selfish tax-dodgers. The top 1% – those who earn £156,000 and above, pay 24% of all income tax. In response to Ian’s point above, this is NOT because they earn 24% or more of national income. Their income share is 11%. Likewise, the top 10% of earners – those earning £50,500 and above – will pay 55% of all income tax, again vastly more than their income share which is 33%. So there is no question that the income tax system is highly progressive.

    3. It’s also striking that it has remained so, indeed appears to have become more progressive, despite (or because of) the reduction in top income-tax rates from 83% in the 1970s to 40% in the 1980s. In the 1970s the top 1% earned between 6% and 8% of income and contributed about 11% of income tax revenue, whereas today they pay more than double their income share. Judged by the actual outcome, Nigel Lawson was (in respect of income tax at least) a more progressive Chancellor than Denis Healey!

    4. We’ve established that the current income tax system is highly progressive. National Insurance is also progressive across most of the income distribution, but then becomes regressive as the Upper Earnings Limit kicks in and reduces the rate from 12% to 2%. (This feature isn’t unique to Britain: In most OECD countries, social security charges are less progressive than income tax because there is often a ceiling on contributions to maintain a notional or actual link between contributions paid and benefits received. Of course in Britain this link has become highly tenuous.) NI makes the direct tax system as a whole less progressive than the income tax system in isolation, but it’s still quite progressive. As a rough snapshot, the marginal tax rate taking account of income tax, employee and employer NI is 40.2% for average earners and 53.4% for high earners.

  • Alex Sabine 3rd Oct '12 - 4:15am

    5. By contrast, indirect taxes – VAT, petrol duty, alcohol and tobacco duties etc – are generally regressive with respect to income, because poorer people spend a larger proportion of their income than their richer counterparts (although this may not be the case from a lifetime perspective). One difficulty in quantifying this on the same basis as the direct tax statistics is that we can’t simply take, say, total VAT revenues and then sub-divide them by income groups. The ONS approaches this by ranking and grouping households based on both their level of expenditure and their disposable income; direct taxes are individually assessed.

    (Of course, the amount of indirect tax paid is determined by expenditure rather than income. As we’d expect, when households are grouped by their level of expenditure, indirect taxes constitute a lower proportion of income for the bottom quintile than the top quintile. So indirect taxes are progressive with respect to expenditure but regressive with respect to income. See for example: http://www.ons.gov.uk/ons/rel/household-income/how-indirect-taxes-can-be-regressive-and-progressive/2001-02—2008-09/index.html)

    These caveats aside, the overall picture is that indirect taxes are regressive with respect to income. Excise duties like tobacco duty are more regressive than VAT. Petrol duty bites heavily into the incomes of those in the middle of the distribution, but not so much the poorest who often don’t own cars.

    6. The regressive nature of indirect taxes offsets the progressive nature of direct taxes, so that overall the UK tax system is proportional across most of the household income distribution, as Jonathan says.

    Means-tested benefits and tax credits are effective in redistributing from rich to poor, although as we know they have a number of important drawbacks and aren’t always be the best way of boosting the long-term prosperity of the recipients. Universal benefits are simpler to administer, have higher take-up rates and create fewer perverse incentives, but are also less redistributive and less effective in targeting scarce resources to those in need.

    7. The flagship Lib Dem policy of raising the income tax personal allowance to £10,000 – and eventually to £12,500 – has much to commend it. It makes little sense to have a minimum wage and then tax people on a portion of that wage, so in principle capping the personal allowance at the level of the full-time minimum wage is a sound aspiration. It reduces the marginal tax rate at low levels of earnings by 20 percentage points and thus helps to ‘make work pay’. Letting people keep more of their own money is preferable to deepening their dependence on benefits. And in political terms it’s easy to grasp and popular with voters of all persuasions.

    All that said, I have some reservations about this policy. Firstly, raising the allowance by a further £2,500 – more if the minimum wage rises before the policy is fully implemented – would be a very expensive commitment, of the order of £10 billion if done early in the next Parliament. As Nick Clegg has acknowledged, this will be in the context of continuing austerity whoever is in power. Even if his wealth tax ideas were to be implemented at some stage, there is no prospect of these raising anything like that amount. And anyway, this revenue is supposedly being earmarked for deficit reduction, ie to reduce the scale of spending cuts that would otherwise be required. The only way this circle could be squared would be to raise taxes on a much larger swathe of the population – including the swing voters of ‘Middle Britain’ – or to cut spending more deeply than required for deficit-reduction purposes.

    And while the single-minded focus on this single tax policy has political attractions – income tax being the most obvious and visible impost – it would make desirable long-term tax reforms like merging income tax and National Insurance trickier to accomplish, because the thresholds for income tax and NI would move further and further apart. In many ways it would make more sense, having raised the income tax allowance to £10,000, to do the same for the NI starting threshold so that these were once again aligned. This would also be more progressive than raising the income tax allowance, since NI now cuts in at a significantly lower level of earnings.

    8. Finally, if the overriding aim of tax policy is to be progressive/redistributive (and I don’t think it should be, but for some people that seems to be the only yardstick that matters), then it would be more to the point to slash indirect taxes. Raising the personal allowance is more progressive than, say, cutting the basic or higher rates of income tax; but the biggest cash benefits go to dual-income couples in the middle and upper-middle part of the household income distribution. Making deep cuts in petrol duty, tobacco duty and other excise duties would probably be better targeted at those on low-to-middle incomes. This wouldn’t be my tax priority necessarily (I would prefer more reform-oriented measures) but my point is simply that it is indirect taxes that introduce the regressive elements in our tax system. Or to put it another way, the reason the top 20% of the population pay a similar proportion of their income in total taxes as the bottom 20% is that indirect taxes are so high, not that direct taxes are low. And it is our excise duties rather than VAT that set us apart from other OECD countries.

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