Cutting the budget deficit is a key government objective, but at the moment it seems to be in conflict with another objective, namely economic growth and thereby avoiding a double-dip recession. In order to raise tax revenue and meet the cries for more equity, the 50% tax rate above £150,000 was imposed, affecting some 310,000 people. However, in a recent letter from some top economists to the Financial Times, they called for the scrapping of the top rate of tax. They argue that it is hindering entrepreneurship and encouraging potential top rate tax payers to leave the UK, thereby hindering the economic situation. George Osborne has asked HMRC to evaluate just how effective the top rate of tax has been at generating government revenue.
In contrast to these calls for scrapping this top rate of tax, some of the richest people in the world have said that they would be happy to pay this rate of tax. In the words of Sir Stuart Rose, the ex-boss of Marks and Spencer:
“How would I explain to my secretary that I would pay less tax on my income, which is palpably bigger than hers, when her tax is not going down.”
Those against scrapping the tax argue that it will be ‘monstrously unfair’ and ‘phenomenally immoral’. This, combined with official figure that suggest by 2015/16 the top rate tax will bring in an extra £3.2bn more revenue than had the tax remained at 40%, certainly adds weight to their argument. In total, over the five year period, it is predicted to bring in an extra £12.6bn.
The policy to increase the tax threshold to £10,000 will meet with the critics’ approval, but less so, if it is accompanied by a scrapping of this top rate tax. Furthermore, the government’s coffers will take a significant beating if both of the above occur!
Another option to replace the 50% tax rate is a higher tax on high value homes – the so-called ‘mansion tax’. Whatever happens with taxation, one thing is clear: the government needs to find a way to generate tax revenue, without putting the economy back into recession. If the 50% tax rate encourages people to leave the UK to avoid the tax or to forego entrepreneurship, it will directly be acting as a disincentive. Fewer jobs will be created due to a lack of entrepreneurship, output may be lower and hence growth will not reach its potential. Crucially, the international competitiveness of the UK economy is being badly affected, as it becomes a less attractive place for investment and talented workers. The following articles consider the 50% tax rate and the controversy surrounding it, despite it only being a temporary policy.
Stuart Rose ‘would pay more tax’ BBC News (9/9/11)
Lawson: ‘dangerous’ and ‘foolish’ to keep 50p tax rate Telegraph, Louisa Peacock (10/9/11)
Rose calls 50p tax rate ‘only fair’ Financial Times, Elizabeth Rigby (9/9/11)
Top 50p tax rate damages economy, say economists BBC News (7/9/11)
George Osborne loses nerve on plan to cut 50p top tax rate Independent, Nigel Morris (8/9/11)
Top tax rate will raise £12.6bn more in revenue, official figures reveal Guardian, Polly Curtis (7/9/11)
Laffer curves and the logic of the 50p tax Financial Times, Tim Harford (9/9/11)
Row over ending of 50p tax rate threatens to spark Tory rebellion Guardian, Patrick Wintour and Polly Curtis (7/9/11)
I’d happily pay more tax, says former M&S boss Sir Stuart Rose Independent, Andy McSmith (10/9/11)
Questions
- What are the main arguments in favour of keeping the 50p tax rate?
- What are the main arguments in favour of scrapping the 50p tax rate?
- What does the Laffer curve show? Is it relevant in the case of the 50p top rate of tax? What does it suggest about the ability of the tax to generate income?
- How does the top rate of tax affect the international competitiveness of the UK economy?
- Why is there a trade-off between raising tax revenue and boosting economic growth through the use of the 50p tax rate?
- Why is there concern about the highest rate of tax actually causing tax revenue to fall?
- What are the equity arguments concerning the scrapping of the 50p tax and raising the tax threshold? Is there an equity argument in favour of the 50p tax rate?
Over recent years, labour markets have become more flexible. Both firms and workers have been much more adaptable to changing market conditions.
This has been illustrated by responses to the 2008/9 recession and the minimal recovery since then. Many firms have seen a drop in demand for their products and have responded by producing less. But this has not necessarily meant laying off workers. But why not? The following include some of the reasons:
• greater flexibility in hours worked: thus hours can be reduced;
• reduction in real wages because of wages not keeping up with inflation;
• many workers receiving part of their income in the form of profit sharing: when profits fall, employees’ income automatically falls;
• a general reduction in unionisation in the private sector;
• in firms where workers are still unionised, unions and management increasingly seeing themselves to be on the ‘same side’: thus unions more willing to explore flexibility;
• less support from state if people are unemployed;
• greater flexibility from the use of temporary or agency staff: these can be reduced in a recession, thus helping to protect the jobs of established workers.
The following podcast looks at this growing flexibility and why it has helped to restrict the rise in unemployment.
Podcast
The real economy: Labour market BBC Today Programme, Evan Davis (24/8/11)
Articles
Agencies placing more in new jobs Western Mail (4/8/11)
Staff appointments increase at subdued pace in July, according to latest Report on Jobs The Recruitment & Employment Federation, News Release (4/8/11)
Manufacturing week: How we got here The Telegraph, Roland Gribben (27/8/11)
Jobless figures show the real risk of creating a lost generation London Evening Standard, Jonathan Portes, Director, National Institute of Economic and Social Research (17/8/11)
Flexible working: is more legislation needed? Personnel Today, Laura Chamberlain (1/9/11)
Recruitment agencies ‘play a big part’ in flexible working The Sales Director, John Oak (10/8/11)
Questions
- Find out what has happened to real GDP, employment and unemployment over the past four years. (Try searching Reference Tables for GDP and Labour Market Statistics on the National Statistics site at http://www.ons.gov.uk/ons/datasets-and-tables/index.html.)
- Distinguish between ‘insiders’ and ‘outsiders’ in the labour market? How has the relationship between the two groups changed in recent years?
- Distinguish between functional, numerical and financial flexibility of firms? (See Box 9.8 in Economics (7th ed), Web Case 6.2 in Essentials of Economics (5th ed), section 18.7 in Economics for Business (5th ed) or section 8.5 in Economics and the Business Environment (3rd ed).)
- Examine the effects of wage rises being less than the rate of inflation on the profit-maximising number of full-time equivalent people employed. How is this influenced by the rate of increase in the price of other inputs and the ability of the firm to raise prices in line with inflation?
- Should firms be required by law to allow workers to demand flexible working conditions? What forms might such flexibility take?
Approximately 1.6 million past and present female employees of Walmart have had their sex discrimination case dismissed by the US Supreme Court. This case began almost 10 years ago with claims by 5 female workers that they were paid less than their male counterparts and had been passed over for promotion. Despite statistical evidence suggesting a case of sexual discrimination, it was ruled that Walmart was not discriminating against women, as promotion decisions were made by individual managers, hence there was no common element between the plaintiffs. Justice Antonin Scalia said that a common element was ‘entirely absent here’.
Discrimination of any kind will have an impact on the demand curve for labour (or the marginal revenue product curve). As such, the equilibrium wage rate will also be affected: if a firm believes that women are less productive than their male counterparts, the MRP curve will shift inwards, pushing down their wage. The key to this case was that there were so many plaintiffs and so it was practically impossible to determine whether or not pay differentials and promotions were based on legitimate grounds. The following articles consider the case against Walmart.
Supreme Court decision in Walmart class-action claim brings praise, anger FoxNews (20/6/11)
Walmart wins class action ruling Financial Times, Barney Jopson (20/6/11)
Wal-Mart women denied discrimination class action BBC News (20/6/11)
Walmart sex discrimination class action rejected Guardian, Dominic Rushe (20/6/11)
Questions
- Why might a firm engage in discrimination?
- Use a diagram to illustrate the impact of discrimination against women by a firm on the marginal revenue product curve for women.
- Following discrimination against women and in favour of men, what happens to the men’s marginal product curve?
- Given your answer to the above 2 questions, what would you expect to happen to the equilibrium number of male and female workers and the male and female wage rate?
- Are there any adverse effects to a firm of engaging in discrimination of any kind?
Taxes are a key element in redistributive policies: taxes on the rich can be spent on benefits to the poor. The more progressive the taxes (i.e. the more steeply they rise with rising incomes), the bigger will be the redistributive effect and hence the more equal will post-tax incomes be.
But high and steeply progressive taxes can act as a disincentive to work longer, or to go for promotion or to move to a better paid job. High corporate taxes and income taxes can act as disincentive to inward investment and may encourage a ‘brain drain’ and capital flight with people and capital leaving the country for lower tax regimes abroad.
Raising taxes has two effects. First there is the substitution effect: people may work less and substitute it with leisure – after all, work is now less rewarding. People may also substitute working abroad for working at home. But the second effect works in the opposite direction. This is the income effect. As taxes are raised and people’s take-home pay is thereby reduced, they may feel the need to work longer hours or try harder for promotion in order to make up the lost income and maintain their living standards. Thus the effect of higher taxes is not clear-cut. It is an empirical question of which of the two effects is the stronger.
One important determinant of the effects of different tax rates is their relative position compared with other countries. Another is the international mobility of labour and capital. The greater the mobility, the greater the elasticity of supply with respect to changes in tax rates.
The following report and articles look at relative tax rates between different countries and the effects on output and factor movements
Articles
Wide tax gaps among countries, UHY study finds UHY International, Press Release (10/6/11)
Britain’s most talent workers flee to avoid high tax rates The Telegraph, Myra Butterworth (13/6/11)
UK tax rate ‘one of the highest’ Belfast Telegraph (13/6/11)
Data
Tax Rates Around the World – Comparison UHY Worldwide-tax.com
Effects of taxes and benefits on household income National Statistics
(see especially Data: The effects of taxes and benefits on household income, 2009/10)
Questions
- Why may relative income tax rates between countries give only a partial picture of the international competitiveness of these countries? What else would need to be taken into account?
- Does making taxes more steeply progressive necessarily act as a disincentive to output? Explain.
- What factors are likely to determine the relative size of the income and substitution effects of tax changes?
- How progressive are income taxes in the UK compared with other countries? Give examples.
- What externalities (positive and negative) might result from steeply progressive income tax rates?
- What determines the international elasticity of supply of labour?
- What is the Laffer curve? How will the shape of the Laffer curve be affected by the international mobility of labour and international tax rates?
Inequality is growing in most countries. This can be illustrated by examining what has been happening to countries’ Gini coefficient. The Gini coefficient measures income inequality, where 0.00 represents perfect equality, with everyone in the country earning the same, and 1.00 represent perfect inequality, with one person earning all the country’s income. (Note that sometimes it is expressed as the ‘Gini index’, with 100 representing perfect inequality). In virtually all countries, the Gini coefficient has been rising. In the OECD countries it has risen by an average of 0.3% per annum over the past 25 years. The OECD average is now 0.31.
But despite the fact that the Gini coefficient has been rising, its value differs markedly from one country to another, as does its rate of change. For example, Finland’s Gini coefficient, at 0.26, is below the average, but it has been rising by 1.2% per annum. By contrast, Turkey’s Gini coefficient, at 0.41, is above the average and yet has been falling by 0.3% per annum.
The most unequal of the developed countries is the USA. According to OECD data, its Gini coefficient is 0.38, well above the values in the UK (0.34), Japan (0.33), Germany (0.30) France (0.29) and Denmark (0.26). What is more, inequality in the USA has been increasing by an average of 0.5% per annum since the mid 1980s.
According to the United Nations’ Human Development Report 2010, the USA’s Gini coefficient is even higher, at 0.41 (see Table 3 of the report). But this is still below that of Russia, with a figure of 0.44, a figure that has markedly worsened over time, along with those of other former Soviet countries. According to the report (page 72):
The worsening is especially marked in countries that were part of the former Soviet Union – which still have relatively low Gini coefficients because they started with low inequality. Transition has eroded employment guarantees and ended extensive state employment. Before the fall of the Berlin Wall, 9 of 10 people in socialist countries were employed by the state, compared with 2 of 10 in Organisation for Economic Co-operation and Development economies. While the privileged elite (the nomenklatura) often attained higher material well-being, the measured differences in income were narrow.
The Gini coefficient for Russia is the same as the average of the 39 developing countries with the lowest level of human development &nbash; and developing countries are generally much less equal than developed ones. Of course, some developing countries have an even higher Gini coefficient: for Angola the figure is 0.59; for Haiti it is 0.60.
The following three webcasts look at aspects of the growing inequality in Russia.
Webcasts
Gap between rich and poor widens in Russia BBC News, Jamie Robertson (29/5/11)
Corruption slows Russian modernisation BBC News, Emma Simpson (29/5/11)
Corruption and poverty in Russia’s far east Al Jazeera (28/2/11)
Articles
Russia’s rich double their wealth, but poor were better off in 1990s Guardian, Tom Parfitt (11/4/11)
Russia’s growing wealth gap BBC News, Jamie Robertson (28/5/11)
A Country of Beggars and Choosers Russia Profile, Svetlana Kononova (16/5/11)
Rich and poor, growing apart The Economist (3/5/11)
Data
Distribution of family income – Gini Index CIA World Factbook (ranked by country in desending order)
Society at a Glance 2011 – OECD Social Indicators OECD: see particularly the Excel file 6. Equity Indicators: Income inequality (click on No if prompted about a linked workbook)
Russia Distribution of family income – Gini index Index Mundi
Chart of the week: inflation stoking inequality in China and India Financial Times, Andrew Whiffin (24/5/11)
List of countries by income equality Wikipedia
Reports
Growing Income Inequality in OECD Countries: What Drives it and How Can Policy Tackle it? OECD Forum on Tackling Inequality (2/5/11)
Human Development Report 2010 United Nations Development Programme
Questions
- Explain what is meant by the Gini coefficient. How does it relate to the Lorenz curve? What does a figure of 0.31 mean?
- Why has income inequality been growing in most countries of the world? Has the process of globalisation dampened or exacerbated this trend?
- What specific factors in Russia can explain the growing inequality?
- How is privatisation likely to affect income distribution??
- Why is it difficult to quantify the extent of inequality in Russia?
- What maxim of taxation has been used in setting income tax rates in Russia?
- What role does corruption play in determining the degree of inequality in Russia?
- What policy measures, if any, could realistically be adopted in Russia to reduce inequality? What constraints are there on adopting such policies?