Alexandria Ocasio-Cortez, the newly elected Democrat congresswoman, has floated the idea of US income tax rates as high as 70%. Although only an idea for now, her intervention raises questions over whether such a policy might work in another country with sharp economic divisions: the UK.
Potentially applying to earnings above $10m a year, she argued that the wealthiest Americans needed to pay their “fair share” in taxes to help fund a “Green New Deal” for the US to combat climate change, while also tackling inequality.
Britain was used to higher top rates of income tax as recently as the late 1970s, when the highest rate was set at 83% under the Labour government of Jim Callaghan, before the rise of neoliberal economic policy under Margaret Thatcher.
The prevailing logic in UK government since has tended to be that lower headline rates of tax help to encourage individual enterprise; empowering wealth creators and jobs, and to attract the brightest and best to Britain, boosting economic growth.
Thatcher oversaw reductions in the top tax rate to 60% and then to 40% by 1988, where it has remained until Gordon Brown introduced a 50% additional rate on earnings above £150,000 after the 2008 financial crisis.
George Osborne, however, cut that additional rate to 45% in 2012, arguing that Brown had not managed to bring in any additional revenue because wealthy taxpayers altered their arrangements to avoid the tax.
Debates have raged over the optimum levels for individual taxation in the UK ever since income tax was first introduced in 1799 in preparation for the Napoleonic wars.
Governments in the 21st century have tended to worry that higher tax rates might cause the richest in society to change their behaviour to avoid taxes, losing them potential revenue, or to flee the country altogether.
During the 1970s, the US economist Arthur Laffer argued that higher tax rates would only generate higher revenue up to a certain level, before revenue declined, a theory known as the “Laffer curve”.
The idea was that the more money the government took, the less incentive there was to work. If the government took 100% of your income, there was no point in working.
Higher income tax rates could result in wealthy individuals shifting their earnings into company shares, which attract a lower rate of taxation as capital gains, or into offshore vehicles. Globalisation has increased in recent decades, meaning that the super-rich can more easily relocate their tax affairs.
Higher tax rates may also stand to reduce household spending, as the state takes money that individuals would otherwise spend, damaging the economy. On the flipside, however, the state may have more money to spend to boost the size of the economy, for example through more investment in education or infrastructure.
Economists say for this reason, among others, the evidence is mixed that lower rates can boost revenue from taxes, or the size of the economy. Scandinavian economies such as Sweden have higher rates than the UK, without falling behind in the global economic league tables.
Stuart Adam, a senior research economist at the Institute for Fiscal Studies, said: “All the scare stories that everyone will leave the country are clearly nonsense. But saying there will be no response is clearly nonsense also. The question is where we are in between – and it’s difficult to know.”
Rising levels of inequality since the 2008 financial crisis, as well as the ballooning government budget deficit, have, however, raised renewed questions over whether higher income tax rates could be used to redistribute wealth.
There is a sixfold difference between the income of the top 20% of households and those of the bottom 20%. Meanwhile, wealth inequality is much worse, with 44% of the UK’s wealth owned by only 10% of the population, five times the total wealth held by the poorest half.
Today the UK has a basic rate income tax of 20% for earnings above £11,500; a higher rate of 40% on earnings more than £45,001, and the additional rate of 45% for income more than £150,000.
As much as the actual rate of taxation, these thresholds matter. First, they mean that not all of a person’s earnings are taxed at the same level: someone earning £200,000 a year, for example, would only hand over 45% to the government on £50,000. The rest would attract lower rates of taxation.
There are about 31 million people in Britain paying individual income tax. About 26.3 million pay the basic rate, while 4.3 million pay the higher rate and only 393,000 pay the additional rate – about 1% of all taxpayers.
However, despite being in the minority, the top 50% paid 90.6% of total income tax (about £178bn) collected in 2015-16. The top 1% of taxpayers paid 28.8% of the total.
Given the low numbers of high tax-payers involved, Ocasio-Cortez’s suggestion of a 70% rate for those earning more than $10m (about £6.3m) would mean very few people outside of FTSE 100 chief executives and hedge fund bosses would pay such a rate.
For this reason, many economists say that higher tax bands are more useful as signals of political virtue, rather than as revenue raisers.
Wealth taxes – levied on items such as property and inheritance money – might instead be a better idea, according to Carys Roberts, a senior economist at the IPPR thinktank.
Total household wealth has rapidly risen to almost £13tn, with the top 10% owning half of it, and is taxed at comparatively low rates.
“We need to have conversation on tax, about recapturing some of the huge gains that are being made at the top of society. The only point where I differ is in how best to do that,” she said.