50% income tax is a mistake

by Ed Bowsher on 04 December 2009  |  5 comments
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The government shouldn't introduce a 50% tax rate.

If you read my blog post this morning about bankers' bonuses, you might think I was a market-hating leftie. But that's not the case. In broad terms, I'm a fan of free markets. They create the most wealth and give more freedom of choice to individuals. 

If you want to have a really vibrant free market economy, it's dangerous to let the tax take rise too high - especially taxes on income. So I think the government's plan to raise the top rate of income tax to 50% is a mistake. 

You may have forgotten the details: Alistair Darling plans to raise the top rate of tax to 50% for those who earn more than £150,000 next April. And people who earn more than £100,000 will lose their personal tax allowance. According to Treasury estimates, these two changes will raise £3.2 billion for the government. But I'm not convinced. 

I think a 50% tax rate will mean that high-earners have less of an incentive to work hard and make money. I also fear that it will damage the City. There have already been reports of hedge funds leaving for Switzerland and elsewhere, and I fear that trend will pick up speed in April. That's bad news for everyone in Britain - hedge fund managers spend lots of money and help to drive the economy in London. They even pay some tax. 

As high-earners work less hard, they'll earn less money and create fewer jobs for other people. And that will hit tax revenue. So I suspect that the 50% rate won't raise as much cash as the Treasury hopes. 

Don't get me wrong, the government's deficit is way too high, so taxes will have to go up over the next few years. It's just that a 50% tax rate will do a lot of damage and won't generate much revenue in return. 

I think that the government would do better to focus on property taxes. The great thing about property taxes is that they don't discourage hard work. They're also hard to avoid. True, they might encourage hedge fund managers to exit London, but the UK has relatively low property taxes when compared to many countries, so we might see a smaller exodus than that triggered by an income tax hike. 

Now my hunch is that the Chancellor doesn't read my blog. But in the unlikely event that he does, it would be great if he could use next week's pre-budget report as an opportunity to reverse his policy on the 50% rate. 

What about bonuses? 

So if I'm opposed to a 50% tax rate, how can I support a bank windfall tax? Won't a windfall tax just be a punishment for hard work and enterprise? How can I claim to be a supporter of the free market when I'm advocating a one-off retrospective tax? 

Here's how: if the government hadn't rescued the financial system, the investment banks wouldn't be making big profits. The likes of Goldman Sachs have been especially fortunate as they've been able to clean up without much competition. The banks have made big money thanks to sheer good luck. A government-engineered windfall if you like. It's perfectly reasonable for the government to get some of that windfall.