Should the top-rate tax be less than 40 per cent?

Britain will soon be a leaking ship – it’ll lose £1 billion per year by 2015, if George Osborne stubbornly sticks to the 50 per cent top tax rate. As other countries have moved to attract the wealthy, the UK has actually taken a step backwards, according to a new report. And there are losses that are harder to quantify – dampers on productivity and entrepreneurship, and deterrents to high earners from coming here. So what’s the optimum tax rate? Less than 40 per cent, says the Centre for Economics and Business Research.

The 50 per cent rate for people earning over £150,000, introduced by Alistair Darling, was meant to fatten Britain’s coffers by up to £3 billion. Instead, it’s destined to lose money. The report from the CEBR neatly sums up what’s wrong, and could go even more wrong, if Osborne clings to this politically-pleasing-but-fiscally-foolhardy tax regime.

1. The UK is plunging in tax competitiveness

All over the world, nations are using income tax as a tool to attract high-income individuals, slashing top rates and the like. This means the revenue-maximising rate of income tax is falling globally, as the wealthy move money to friendlier tax regimes. While it’s hard to compare income-tax structures across countries, given their complex nature, the global revenue-optimising rate of corporation tax has fallen to 26 per cent, from 34 per cent in the 1980s.

Meanwhile Britain has gone the other way – our tax structure has been made more punitive. The results are only too real – Twitter relocated its international HQ to Ireland partly because of the lower corporation tax rates there, for instance. The UK now has one of the least competitive tax environments in the world. Since 1997, we have dropped from 4th place to 95th in the World Economic Forum’s tax competitiveness ratings.

2. For the rich, taxes are a voluntary contribution

With the new science of ‘wealth management’, there are now convenient and legal ways for high earners to arrange their finances so they effectively decide how much tax they pay. A ‘tax-yah’ – spending a mid-career tax year abroad so one can claim non-residency to Britain – is now de rigueur among the rich.

The wealthy can also: move from income investments to investments that are subject to capital-gains tax; transfer income-producing investments to a spouse; set themselves up as a company; engage in ‘salary sacrifice’ such as opting for enhanced benefits at work rather than a pay rise. Venture capital trusts, offshore bonds, enterprise investment schemes – all these financial products allow individuals to stash their income overseas.

3. Millionaires are legging it

Just 44 per cent of millionaires are committed to staying in the UK, while nearly 8 per cent are actually planning to leave, according to a June survey by Skandia. High taxation was the most frequently cited reason for leaving.

High taxes also discourage new talent from moving to the UK. As Lord Bilimoria, chairman of the UK-India Business Council, put it:

‘Not only is excessive tax a burdien on business, a disincentive to entrepreneurship and a burden on the consumer, but it is a disincentive for overseas talent. We are driving people away.’

Data by the OECD suggests a strong link between high levels of personal tax and average hours worked per person. The higher the income tax, the lower the productivity growth. There’s also evidence higher taxes reduces entrepreneurial activity.

5. It’s costly to chase taxes

Resistance to paying tax is leading to new collection costs – last autumn, Danny Alexander committed £900 million to help fight tax evasion, in an effort to sniff out £7 billion of unpaid tax. Despite this, the ‘tax gap’ – the amount of tax uncollected – remains huge.

So, in an ideal world, what should the top rate of tax be, to maximise revenue for the government? A 2009 report by the Institute for Fiscal Studies suggests that even a 45 per cent ratefor those earning above £150,000 is unlikely to raise additional revenue – the IFS estimates the maximising rate is closer to 41 per cent.

And that’s before you account for higher rates of VAT and National Income Contributions over the past year. The CEBR says these lower the revenue-maximising rate by another two points to around 39 per cent. ‘Combined with increased labour and capital mobility, this means the revenue maximising top rate of income tax is likely to be less than 40per cent,’ it concludes.