UK continues to dig a bigger economic hole

In a sign of the times, the government in the United Kingdom is talking about increasing the top tax rate from 40% to 50% to fund part of their burgeoning budget deficit. A few points about this they may have forgotten:

  1. High income earners are likely to be more responsive to an increase in tax rates (at the margin) – as a result, by increasing tax rates at the top, we are pushing our most talented workers out of the labour force,
  2. The deadweight loss of taxation increases at a faster than linear rate – implying that for each 1% of tax we add we get a greater level of lost surplus than for the previous 1%.
  3. Highly skilled labour is more mobile – as a result, a lift in tax rates for the highly skilled will lead to them moving overseas. When the UK does this it is a good thing for countries like Aussie and NZ – but not for the UK.
  4. Highly skilled labour is able to “move income about” more easily. For example, if the corporate tax rate remains well below 50%, highly skilled individuals may find ways to set up companies and shift part of their income into the corporate tax bracket (Note this relies on being able to include a lot of spending as a business expense methinks). When this occurs corporate tax take will rise, but the increase in income tax revenue will be much weaker than expected.
  5. An income tax is also a “tax on business” – the relative split depends on the “incidence of tax”. As a result, a lift in the top tax bracket implies that there will be more pressure on firms that hire skilled labour – not really the best move when these industries are already credit constrained …
  6. By increasing the tax on income we will drive down the incentive to invest.
  7. Skilled and unskilled workers are complements – by reducing the incentive to hire skilled workers, you also reduce the incentive to hire unskilled workers. As a result this will drive down demand for unskilled workers, lowering wages and increasing unemployment.

Thank goodness economic policy in New Zealand makes more sense 😉

The Times joins in the fun.  And the Guardian illustrates that it doesn’t understand point 7 (among other points).

33 replies
  1. Miguel Sanchez
    Miguel Sanchez says:

    The UK economy is absolutely poked. They have hollowed out every other industry in favour of financial services and housing-related consumption. And now they’re doing their best to gut those sectors as well.

    And yet we’re the ones at risk of a rating downgrade?? If the UK and US are AAA then we need a new category for New Zealand – AAAAA perhaps.

  2. Miguel Sanchez
    Miguel Sanchez says:

    True – I’m thinking specifically of Standard & Poors (hence AAA rather than Aaa).

  3. SimonD
    SimonD says:

    Care to educate me a bit more on point 7 ? I don’t immediately see why they are correlated.

  4. Matt Nolan
    Matt Nolan says:

    @SimonD

    If skilled and unskilled labour are complements, then having a skilled worker working increases the production associated with the unskilled worker – economists say that a skilled worker increases the “marginal (additional) product) of the unskilled worker.

    As wages are set to equate marginal products, the more skilled workers in jobs, the higher the wages of unskilled workers will be.

  5. SharonV
    SharonV says:

    guys the 50% kicks in for earnings over £150,000 (NZ$400K) It’s is a way of capping the excessive salaries of ‘highly skilled’??? bankers etc – and to be honest not many will be earning that these days. It was a token gesture to show voters that they are closing the door on excess (after it has bolted).

  6. Matt Nolan
    Matt Nolan says:

    @SharonV

    “It’s is a way of capping the excessive salaries of ‘highly skilled’??? bankers”

    How the hang does that work – I didn’t realise that government set wages?

    At best this policy influences very few decisions – but the problem is, the decisions it will influence will be important ones about investment and the training of high value skills.

  7. Miguel Sanchez
    Miguel Sanchez says:

    “and to be honest not many will be earning that these days”

    You may be surprised – of those in the City who are earning anything at all right now, a lot of them will be in that bracket.

  8. SimonD
    SimonD says:

    I work in the city, most people I work with are on over that. The chatter around the water cooler is it’s time to pack the bags for Switzerland.

    To be honest though I don’t buy it, these guys are hot headed and the lure of the city will keep them where they are.

  9. SharonV
    SharonV says:

    Brown did state that he was going to cap what he regards as excessive renumeration – the connection being that high risk taking behaviour has damaged not only the industry but economy in general. There is no doubt that many these people didn’t have the brains to figure out they were crapping in their own nest, but the blood letting is unfair to all highly skilled/highly paid. As for the watercooler discusions – I could understand them moving to China if they could stomach the cultural change (no point going to Switzerland though???). I think most will stay here and either accept lower wages or start businesses. The glory days are over.

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