The Laffer Curve comes to life - 50% of nothing is nothing

Three linked articles in The Times today looks at the efforts HMRC is putting into chasing down top earners and ensuring that they pay the full amount of tax that they owe. The issue revolves around the definition of residency – those who are classified as non-resident and not ordinarily resident – and the way in which earnings both in the UK and worldwide are treated for tax reasons as a result. There is a team at the Revenue of about 500 staff who each investigate about ten wealthy individuals, and whose work apparently yielded £373m in tax revenues last year. Those who are being investigated can expect that their offshore trusts and companies in particular will be under scrutiny, using new computer systems and a budget of £1bn to carry out the enquiries. This appears to have been a successful initiative which has generated a far higher revenue from those higher earners – but the suggestion is that this close scrutiny will drive those individuals away from the UK so that their earnings are no longer eligible for UK tax. A number of comments within the article focus on accusations that the Revenue keeps changing their rules, which makes it impossible for wealthy UK individuals and foreign nationals coming to the UK to undertake ‘legitimate’ tax planning and comply with the rules.

The risk that is emphasised is that high-earning professionals and employers will look overseas for more favourable tax systems. As well as targeting so-called ‘non-doms’ the new 50% tax rate for the highest earners and higher rates of National Insurance for employees and employers are a deterrent - and a second article reports on the effect that raising and lowering the tax rate has on the total tax revenue received, which implies that the new 50% rate is likely to actually lower total revenue by driving higher rate tax payers out of Britain.

Using figures from the 1970’s, when the top tax rate was 83%, and contrasting with the current figures with the top rate of 40%, Ian King shows that the top earners now pay a far higher percentage of all income tax revenue than was the case in 1978-9; in the late 1970s the top 5 per cent of earners paid 24 per cent of all income tax, but now they pay 43.1 per cent. In the late 1970s the top 10 per cent of earners paid 35 per cent of all income tax, but now pay 53.3 per cent.

As the Laffer curve illustrates, higher tax rates will generate a lower tax revenue for government, but the supply-side incentive of lower tax rates will incentivise entrepreneurs to earn more, and also to create jobs for others who will also pay more tax to the treasury.