Shouldn’t the rich contribute more?

Richest 1% pay 29% income tax. How much more can we expect the rich to contribute?

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Shouldn’t the rich contribute more?

How much the rich contribute

Rich people already contribute more. How much more? Here are some rough statistics of how much tax is contributed according to income bands (from 2012, United Kingdom)…

distribution-of-income-and-tax-across-income-groups
https://theuxbridgegraduate.files.wordpress.com/2012/08/distribution-of-income-and-tax-across-income-groups.png[1]

Some take away points:

  • Top 1% contribute more than a quarter of all income tax
  • Top 10% contribute more than half of all income tax
  • Bottom 50% contribute only a tenth of all income tax

I have met many active Socialists who maintain that the rich should be taxed even more. To this I ask the question: What are the consequences of doing so?

What happens when you tax the rich more

The thing to remember is, rich people are mobile. They have the resources to up-and-leave if the conditions do not suit them. When rich people leave, the phenomenon is called capital flight. They will take their income with them, so the UK completely loses their income tax contributions. They will take their existing wealth with them, so they don’t spend in the UK economy. They will take their businesses with them, so the UK loses jobs. They will take their resourcefulness with them, so the UK loses their social contributions. The effect of capital flight is not only less tax for the treasury, but also lost social opportunity, lost jobs, and less investment in the economy.

Socialists can and do argue that increasing tax on the rich will not drive ALL rich people away. That is true – it is always a matter of degree. When you tax the rich a little more, maybe some of the rich will flee, but not all. But the more you tax the rich, the more rich people will flee the country.

In economics, there is a concept called “diminishing returns”. It describes how doubling the effort does not double the output. For every 1% increase in tax, the increase in tax intake is less than the previous 1% increase in tax. Increasing the highest level tax rate from 45% to 50% produces less increase in tax intake than increasing the tax rate from 40% to 45%. This is because the higher the tax rate, the harder business and individuals will work to try to avoid or even evade tax, so it will be much harder to convert the numerical increase in tax rates into an actual increase in tax returns. Thus the higher you try to raise the highest level tax rates, the more it will cost to implement it.

At some point, increasing the tax rate on the richest will result in less increase in tax intake than the losses caused by capital flight. How much more tax can you extract from the rich, before you start losing more than you gain? Given that the richest 1% already contribute almost three times as much as the poorest 50% of the population, how do you know you’re not already losing tax intake from increasing tax rates?

Flat tax vs rich tax – which is fairer?

Imagine the extreme end of taxation fairness: that everybody is taxed at a 20%, regardless of income levels. Even with such a flat tax, the rich will still contribute significantly more than the poor. After all, 20% of £20k (£4,000) is a lot less than 20% of £150k (£30,000). Not only can we all agree that such a system incentivises people to try to earn more, it is arguable that this system is the fairest of all: if you earn five times more than the average person, you pay five times as much tax.

Now imagine the extreme end of socialism: Nobody earning under £40k is taxed, but any earnings over £40k is taxed completely, so that nobody earns over £40k. It’s not hard to understand that very few indeed would bother trying to increase their income or their productivity beyond the £40k that their hard work can generate. So if someone had an earning potential of £500 a day, they’d have very little reason to work more than 16 weeks a year, if all the earnings on any of that additional work would be taken away. So it’s not too hard to see that taxing the earnings of the rich to the highest possible level actually results in an incredibly low intake of tax from high earners.

Obviously, most socialists would want something in between the above two extremes, a compromise between putting the bigger tax burden on the rich and incentivising people to earn more. Where this point is, is the matter of dispute.

Perhaps, instead of increasing the tax on the rich, we should take the poorest out of income tax altogether? After all, according to the 2012 data, if we stop taxing the poorest 47% of taxpayers, you only lose 9% of all income tax.

Sources:
[1]https://theuxbridgegraduate.wordpress.com/2012/08/27/should-income-tax-be-flat/
[2]http://webarchive.nationalarchives.gov.uk/20140206181159/http://www.hmrc.gov.uk/budget2012/excheq-income-tax-2042.pdf

Author: Hoong-Wai

I am a sinner. I care about people, and truth, and justice. I have an interest in dancing, economics, engineering, philosophy, and science.

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