“Tax the rich!” “The rich should pay their fair share!” – these kind of sentiments are ten a penny in political debates these days. Taxation is a hot topic on both sides of the Atlantic again, with emotions raging high. It is therefore important to ask ourselves: How high should the tax burden be for the top earners?
In Britain, the 50p income tax rate introduced by Gordon Brown was reduced to 45% by David Cameron. In the US, the Republicans cut the top federal tax rate from 39.6% to 37% last year. In a new book, economists Emmanuel Saez and Gabriel Zucman are now advocating raising it to 60%.
The discussion usually revolves around income tax, but – as we at Epicenter show in a report released today – payroll, consumption and social insurance taxes are key components of high earners’ tax burden. In the UK, for instance, when we account for National Insurance paid by both the employer and the employee, as well as VAT and other consumption taxes, we arrive at a total marginal tax rate of 59%.
For our report we’ve put together a unique comparison of effective marginal tax rates in all OECD and EU countries. Accounting for all relevant taxes, Britain ranks 16th out of 41 countries, and its 59% top effective rate is above the international average of 56%. The idea that the UK is a low-tax economy is a myth unsubstantiated by the numbers. Many other European countries, such as Germany, Italy, or Spain have lower taxes on high incomes than Britain.
The top spot is occupied by Sweden, where high-income earners pay a staggering 76% of any additional income in taxes. High income, payroll and consumption taxes all contribute. However, the country’s Social Democrat-led government has decided to cut the top income tax rate next year. Sweden’s unfavourable international ranking is one of the factors driving the reform.
Our report underlines that politicians need to look beyond the income tax when evaluating the tax burden on wages. Hungary has a flat income tax of 15% and might therefore seem like a Central European tax haven. However, the country collects substantial social security contributions from both employer and employee, and imposes the highest VAT in the world, at 27%. Altogether, that implies an effective top marginal tax rate of 57%, slightly above the European average.
Countries should be cautious about placing excessive tax burdens on high-income earners. High marginal tax rates make it less worthwhile to increase one’s income by getting a degree or relocating to another city, while rewarding tax avoidance and evasion.
Eventually, there comes a point where increasing taxes further will not even raise any revenue, as illustrated by the famous Laffer curve, which shows the relationship between the tax rate and revenues. Under reasonable assumptions about how taxpayers respond to tax rate changes, many European countries are close to the tax revenue peak. Some have even surpassed it. Indeed, Sweden’s Ministry of Finance has stated that the country’s announced tax cut will probably pay for itself, since the lower rates will give high-earners more of an incentive to work harder and longer hours – thus increasing both incomes and tax revenues.
In the UK, this trend might be heading for a different direction. As a part of their “fair taxation system”, the Labour Party has pledged “no rises in income tax for those earning below £80,000 a year”. If, as rumoured, Jeremy Corbyn were to reintroduce the 50p top tax rate, high income earners would stand to pay an effective top marginal tax rate of 63%. That would put Britain 11th in our ranking of highest tax rates, slightly ahead of Norway and Greece.
With a looming general election, there should be an open debate about the merits of a simple and transparent tax system that rewards hard work, instead of punishing success. Part of this conversation should be an awareness of the unintended consequences of high marginal tax rates for top income earners.
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