Taxing Times

‘Higher-rate taxpayers will just move to tax havens when the 50 per cent rate is introduced in April 2010’

Economy Marketplace UK Politics

On the intrepid assumption that any forecast from the government will prove reliable, public expenditure in the 2010/11 financial year will be 48.1 per cent of GDP. When Labour came to power in 1997/8 the comparable figure was 38.2 per cent. So the state’s share of the economy has risen by about one-tenth of national output under Labour. But the gang of politicians allegedly “managing our economy” has found it easier to spend than to tax. Whereas tax was just under 35 per cent of GDP in 1997/8, it is expected to be 34 per cent of GDP in 2010/11. 

Why has it been so difficult to raise taxes? Part of the explanation is the impact of the recession on the wealthy. High income-earners, company profits and capital gains make a disproportionately large contribution to tax revenues and the downturn has hit them particularly hard. But that has not stopped Gordon Brown and Alistair Darling from trying to extract even more money from them. Under Treasury’s plans, the increase in the top rate of income tax to 50 per cent from April 2010 is expected to increase tax revenues by £1.1 billion in 2010/11 and £1.8 billion in 2011/12. 

Several experts on tax systems have asked whether, ultimately, the increase in the top tax rate will generate any additional revenue. The point is that taxpayers adjust their behaviour in response to increases in taxes. Over time, these adjustments reduce or eliminate any rise in tax receipts. Most obviously, rich people can move themselves, and the profitable companies employing them, elsewhere. Several hedge fund managers have stated that, because of the 2009 Budget and the 50 per cent tax rate, they will leave the UK and set up in more tax-friendly nations. But even before the 2009 Budget, some companies had announced they were relocating from London to lower-tax jurisdictions, such as Ireland and Bermuda. 

The low-tax nations are small or even tiny, in terms of population and total national output, compared with high-tax nations, such as Germany, France, Italy and the UK. By contrast, tax havens are minuscule, while low-company-tax states have populations beneath that of the average European state. 

A cynic might say that, in a world where capital and labour can easily traverse borders, the small nations have been crafty. They have carved out a niche in tax avoidance. There is an obvious economic logic in what they have done. If a particular taxpayer shifts to a tax haven and pays, say, 80 per cent less tax in total, the remaining 20 per cent is worthwhile extra revenue to a tax haven with a population less than one-half of one per cent of a typical large European state. Tax havens keep their populations lightly taxed by attracting the wealthy, since a high-net-worth incomer pays a tax bill well above that of their own average citizen. 

The existence of tax havens, and even of low-tax medium-sized nations, confronts the big nations with a dilemma. Politicians — particularly on the Left — want to enjoy the praise of being kind and cuddly when they increase expenditure on health, education and pensions. However, the extra expenditure on the various social goodies is financed not by them as individuals, but by taxpayers as a body, including high-income taxpayers. The mobility of the high-income taxpayers constrains politicians’ ability to capture the esteem they had hoped for from wearing social consciences on their sleeves. Brown, Darling and the like loathe Monaco and the Isle of Man, because such places prevent the British public from recognising their greatness as human beings. 

The larger issue is, “Why does the government need to spend almost 50 per cent of national income at all?” Defenders of a large state sector may argue that the heavy tax burdens of the large European nations have been responsible for the provision of health and education services, and an extensive welfare state, which have promoted social justice. But — if we compare the UK, Germany, France and so on with the Channel Islands, the Isle of Man, Switzerland and Ireland — this argument is clearly nonsense. 

The tax havens and small nations have much lower ratios of government spending on health, education and welfare to national income than the large nations, but are their populations unhealthy, badly educated and to a significant extent socially deprived? No. In general, they have better health and education and a lower incidence of poverty. The truth is that Brown and Darling’s redistributive socialism, and the large public sector and punitive top tax rates associated with it, deliver neither economic efficiency nor social justice. They are damaging and obsolete in the 21st century, when people have ample freedom to move themselves, their possessions and their ideas across frontiers.