13 October 2020

The public love it, so what’s wrong with the idea of a maximum wage?

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Last week, the High Pay Centre and Autonomy released a report calling for the introduction of a national maximum wage.

It received favourable coverage in the left-wing press (e.g. here and here), but the Daily Mail seemed surprisingly sympathetic too. As is nearly always the case with crude anti-liberal, anti-capitalist policies, the public already loves it: in an accompanying Survation poll, an absolute majority of respondents (54%) express support for the policy, while fewer than one in three (29%) actively disagree. The same survey shows that if the level of the statutory maximum wage were democratically decided, it would be set at £100,000 per annum.

What would be the impact of such a policy?

We cannot know exactly, because we would struggle to find a real-world example of it in a comparable country. But we could think of it as, effectively, a 100% marginal tax rate on incomes above £100,000. We could then look at the empirical literature on how responsive top earners are to tax incentives, and extrapolate from that.

We know from previous studies that the behaviour of top earners is quite sensitive to tax changes. Last year, the Institute for Fiscal Studies (IFS) tried to model the impact of a proposal to increase the tax burden on the top 5% of earners. In this case, the proposal was to lower the threshold for the 45% additional rate of income tax from £150,000 to £80,000 per annum, and to introduce an ‘additional additional rate’ of 50% for incomes above £125,000.

If nobody changed their behaviour, such a policy would increase tax revenue by just over £9bn per annum. But people would, of course, change their behaviour. Some top earners would switch to less demanding positions, some would retire earlier, some would reduce working hours, some would engage in more proactive tax planning (i.e. legal tax avoidance), some would simply emigrate, and so on.

We know for certain that responses of that kind exist. But we cannot exactly quantify them. So the IFS came up with a range of plausible outcomes rather than one definite number. It turns out that at the most optimistic end of the spectrum, behavioural changes would still knock over a third off the potential additional tax revenue, reducing it from over £9bn to under £6bn. At the most pessimistic end of the spectrum, the policy would fail to raise any additional tax revenue – it would, in fact, reduce revenue by almost £1bn. (Stop smirking, Dr Laffer.)

If a tax rate of 50% can be predicted to trigger such strong behavioural responses, you can guess how much damage an implicit rate of 100% would do.

There is at least one good reason to suspect that we are much closer to the pessimistic end of the spectrum. The University of Warwick recently released a study which looked at the demographic composition of top earners in the UK, and how it has changed over the past two decades. They find that migrants are heavily overrepresented at the top end of the income distribution, showing the extent to which Britain has become a magnet for global top talent. Around the middle of the income distribution, about one in seven people are foreign-born. But at the 98th percentile of the distribution, the share of foreign-born people is as high as one in five, and among the top 1%, it is one in four. At the very, very top (the upper 0.1%), it is more like one in three.

Why does this matter? Because it is one thing to say that there will not be a mass exodus of London-born bankers to Zurich, given non-economic factors like the language barrier. But it would be self-evidently absurd to suggest that a London-based banker, who came here from Zurich in the first place, would never consider moving back (or, for that matter, elsewhere).

It gets worse. Although a statutory maximum wage would act like a 100% top tax rate, it would not literally be a 100% tax rate. There would be no “tax revenue” as such, instead, companies would be able to retain some of the money they would otherwise have to spend on the salaries of their most highly paid employees. By also hiking the minimum wage, the High Pay Centre and Autonomy want to oblige companies to then redirect that retained money to boost the salaries of their lowest-paid staff members.

This is as if the government tried to boost the brewing industry by capping the price of wine – reasoning that wine buffs will turn to beer instead – whilst also simultaneously introducing a minimum price for beer.

It is very unlikely that such a measure would have the desired effect. Yes, if the price cap means that wine buffs now retain some extra money, they could, in principle, spend that money on beer. But there is no guarantee that they would do so, because they could also spend it on literally anything other than beer (e.g. mid-range wines, whiskey, gin…). Given that the minimum price has, in this scenario, simultaneously made beer more expensive, they will probably buy less of it.

The Autonomy/High Pay Centre report is based on the age-old fallacy that high pay is the cause of low pay, that some people earn “too little” because others earn “too much”. I am not surprised that it is popular, because this is the sort of crude zero-sum thinking which underpins our anti-capitalist zeitgeist. But it is wrong.

The market for top talent and the market for low-skilled labour are simply separate markets, and you cannot help low earners with knee-jerk eat-the-rich policies.

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Kristian Niemietz is Head of Political Economy at the Institute of Economic Affairs.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.