Introduction
THIS CHAPTER LOOKS AT THE USE OF THE TAX SYSTEM FOR REDISTRIBUTION. It points out that most developed economies already do a lot to redistribute using taxes and benefits (sometimes with negative long-term effects on motivation), and the scope for doing much more may be limited.
But smart use of the tax system might both raise more revenue and make it have more positive effects in reducing inequality and especially poverty while at the same time improving incentives.
The chapter looks first at the extent of current redistribution through the tax and benefits system in a range of countries. It then looks at the limits of this process. Then it looks at particular tax issues:
(1) The optimal top rates of tax.
(2) Voluntary taxes.
(3) Taxing wealth not income.
Redistribution
There is already substantial redistribution through the tax and benefit system in most countries; indeed it is possible that in more than a few the attempt to redistribute through the tax and benefit system has been extended beyond the point of maximum effectiveness.
The key OECD study on this argues that tax and transfers reduce income inequality, although this analysis presumes that pre-tax and transfer incomes are unaffected by the redistribution. It argues that three quarters of the reduction in inequality reflects transfers and a quarter reflects taxes on incomes and capital. In most countries indirect taxes play a relatively small role one way or the other.1
It is claimed that in the UK indirect taxes in fact play a significantly regressive role in the redistribution of income,2 but more detailed analysis disputes this. The IFS says that total tax payments in the UK are ‘concentrated’ which implies a net progressivity.3
However, the Brookings study in the US quoted elsewhere suggests that the scope for further redistribution through the tax and benefit system might be limited even in the US. And clearly if – even in an economy like the US with limited mobility out of the country – there is little scope for redistribution through the tax system, there will be even less scope in countries in Europe, for example, with higher marginal rates of tax and much higher international labour mobility.
The optimal top rate of tax
Table 13 shows the top rates of tax in a range of countries.
Table 13. Top marginal tax rate
| Denmark | 60.2% |
| Sweden | 56.6% |
| Belgium | 53.7% |
| Spain | 52.0% |
| Netherlands | 52.0% |
| France | 50.7% |
| Austria | 50.0% |
| Japan | 50.0% |
| Greece | 49.0% |
| Finland | 49.0% |
| Portugal | 49.0% |
| Italy | 48.6% |
| Canada | 48.0% |
| Ireland | 48.0% |
| Israel | 48.0% |
| Australia | 47.5% |
| Iceland | 46.2% |
| United Kingdom | 45.0% |
| United States | 41.9% |
| South Korea | 41.8% |
| Switzerland | 41.7% |
| Luxembourg | 41.3% |
| Slovenia | 41.0% |
| Chile | 40.0% |
| Norway | 40.0% |
| Turkey | 35.7% |
| New Zealand | 33.0% |
| Poland | 32.0% |
| Mexico | 30.0% |
| Singapore | 22.0% |
| Estonia | 21.0% |
| Slovakia | 19.0% |
| Hungary | 16.0% |
| Czech Republic | 15.0% |
| Hong Kong | 15.0% |
Sources: various, based on an article by George Eaton, ‘Which Countries Have the Highest Top Rate Taxes?’, New Statesman, 27 January 2014. http://www.newstatesman.com/politics/2014/01-countries-have-highest-top-tax-rates. This data is slightly out of date though top tax rates do not change dramatically over time.
In most Western economies the scope for raising more income from higher rates of tax on wealthy people is limited. Studies around the world suggest the top revenue-raising marginal rate of tax is 35-40%.4 Yet virtually all major economies have top marginal rates at or above this, as Table 18 above shows. While higher rates may initially reduce inequality by making the rich poorer, they risk, by reducing government revenue, making the poor poorer as well.
What Table 13 suggests is that in some countries there is scope for higher rates of tax to reduce income inequality. Studies (see the discussion of the Scully curve in Chapter 7) show that reducing top rates of tax much below 30% do not seem to boost economic activity. But it also sug-gests that in many others the cost in lost economic growth resulting from the high compulsory marginal rates of taxes almost certainly creates more damage than is gained from the income redistributed.
Voluntary taxes
The difficulty with redistributing through the income tax system comes from the damage to incentives. And this is exacerbated, particularly in a small country, if taxes are much higher than elsewhere, because rich people move to lower tax environments. And even if they don’t move, it is easy for effort to be reduced if the benefits from work are low.
I once had a call on a Friday evening for an important piece of analy-sis for one of my clients which had to be presented to the then Mayor of London, Boris Johnson, on the Monday afternoon. I worked hard all weekend with countless phone calls to the US and elsewhere. And yet, after paying employers’ national insurance contributions, employees’ na-tional insurance contributions and income tax, my take home was roughly a third of my gross earnings, working out at £100 per hour worked over the weekend. Had I not been highly committed to customer service I would hardly have considered it worthwhile. I certainly didn’t do it for the money. Meanwhile the tax man, who hadn’t done a stroke of work over the weekend while I was up early and to bed late each day and worked all day, got twice as much as me.
Having said that, although compulsory taxation reduces incentives and also often creates a sense of unfairness, a case can be made for voluntary taxation for redistribution. Most people don’t work actually for themselves. They work to earn income for many other people – both their direct family and many others as well. Moreover, if you are well-off, you tend to spend over your lifetime a remarkably small proportion of what you earn.
There is a case therefore for setting up a system of voluntary income tax supplements. The suggestion is that the maximum compulsory rate is say 35% but that income earners are encouraged to pay an additional voluntary amount of up to 20%. They might be given some limited say in how the money is used based on how much they have contributed. All this would have to be very public and any choices would have to be made very openly to prevent the danger of corruption.
There is a history of such behaviour from a century ago: Stanley Baldwin, the future Prime Minister, was appointed to the junior ministerial post of Financial Secretary to the Treasury in 1917, where he sought to encourage voluntary donations by the rich to repay the United Kingdom’s war debt. He relinquished to the Treasury one-fifth of his own fortune, a total of £120,000, and wrote to The Times about this, signing himself with the initials associated with his position, FST.5
In June 2017 Norway announced a system whereby people could pay additional taxes voluntarily. At time of writing this has produced little revenue, but this may not be surprising since Norway already has high rates of compulsory tax. In the UK Westminster Council has proposed a voluntary ‘mansion tax’ on properties worth more than £10 million, though this has also not yet attracted much enthusiasm except from those who would not be expected to pay it.6
Looking back further, the respected former MP and Cabinet Minister Peter Lilley suggested a voluntary income tax, particularly for those who are especially concerned about inequality. The ideas set out here have some resemblance to his.
Where the present is different from the past is that many wealthy people now feel guilty about their excess wealth and income and are keen to show that they are not socially uncaring. The fashion has gone against the ‘loadsamoney’ style. It has also gone against conspicuous consumption (see the discussion of the two restaurants Pidgin and Sketch in Chapter 4). The rich now give substantially to charity despite the evidence that quite a lot of their donations do not go to charitable causes. The latest data for the UK show that 60% of larger charities’ incomes does go to the intended recipients, but some charities account for their incomes net of fund-raising costs which make this an exaggerated figure.7 In these cases far better to give to government where, even if there is some inefficiency, it is much clearer that the money is likely to go to those who need most.
Normally when rich people make large charitable contributions they like some sense that their contributions are appreciated by being made visible, or having something named after them, or possibly linking these taxes to the honours system. It shouldn’t be beyond the wit of the many working in government to find some way of doing it. In London the Royal Parks, which until recently has been a government arm but is becoming a charity, has raised additional funding by getting the relatively wealthy people who live by the main London parks to sponsor a tree. Quite a few residents including my wife (who happens to be the Chairman of the Friends of Regents Park and Primrose Hill) and I have sponsored a series of cherry trees in Regents Park for a few thousand pounds each.
My theory is that the money raised from voluntary taxes could go to a fund for redistribution. I am not entirely convinced by the case for predistribution promoted by organisations like the Resolution Foundation in the UK which involve giving significant lump cash sums to people when they reach the age of 25, since giving large cash sums to people who are not used to the money might be a recipe for disaster (there is some evidence from football pools and lottery winners!).8 My instinct would be to use this fund instead to support education for the least well-off, which ought to yield a better return in reduced inequality. But it might make sense to conduct some pilot experiments to see what works best.
Taxing wealth not income
Taxing income can ossify the economic system by limiting growth and preventing new money from entering the system. But taxing wealth and using this to fund a degree of redistribution doesn’t face the same drawbacks through negative effects on incentives.
The most obvious way of redistributing which minimises the impact on incentives is to tax inheritance. There are practical problems, but one suspects that the degree of political resistance to a substantial inheritance tax on all inheritances other than those to partners would be much less than people imagine.
An inheritance tax of 50% (other than on inheritance to spouses and partners) does face the objection that this is tax on money on which tax has already been paid when it was earned in income or inherited from the past. So it could only be introduced with substantial consultation. It should be noted that in many countries inheritance taxes are already high. In such countries, the issue is more to do with the moral legitimacy of the tax, particularly when it is combined with already high rates of income tax. Without legitimacy, people will strive to reduce their tax bill through transfers and complicated international arrangements.
The key is for taxes to be seen to be well spent and for the tax authorities not to be greedy. And for governments to applaud the payment of tax and treat high income tax payments as a cause for congratulation rather than as another excuse for assaulting the rich.
One way of boosting inheritance tax yields might be to combine a top inheritance tax rate of 50% with a reduction in top rates of compulsory income tax to a maximum rate of 35%, possibly combined with a system for additional voluntary taxation income and wealth taxation. The yields from inheritance tax should be used for redistribution while those from other taxes can be used to fund other government services and investments.
Conclusion
The trick with taxation is not to be greedy and to encourage compliance. It is important that the tax is seen to be legitimate and well spent and that the methods used by the fiscal authorities are not such as to encourage a dangerously adversarial attitude. It is also important that money used by the public sector is not obviously wasted or abused for political purposes.
In general it is better to tax wealth than income. Meanwhile there are plenty of ways in which voluntary taxes could be encouraged, provided compulsory tax rates are not excessive and certainly not above the points of optimal income raising of around 35%.