Income Tax Policy: A Revelation
Nothing is certain except death and taxes. Once a new tax is introduced it becomes a devil of a job to unwind it. Cutting tax rates is a very emotive issue in every country.
Cutting income tax rates for the "well off" is an even more emotive issue, and a policy issue usually associated with the political right. To anyone who has no involvement with either the very rich or the very poor, that probably makes sense: I mean, who other than the rich, or the champions of the rich, would want to cut income tax?
It reminds me, somewhat obliquely, of Mohammed Ali Jinnah, the founder of the state of Pakistan, who argued at the time of Indian partition in 1947 that the country's Muslims needed a state of their own. He got his wish, but he himself was not what one would call an orthodox Muslim. He lived most of his life in the West, wore Western clothes and was partial to a glass of whiskey. The political elites often think they know what is best for us.
Higher tax rates for higher earners is an almost universal mantra, deemed necessary so that the rich can be seen to be paying their fair share. But what do the less well-off think of that?
Last week I took part in a day's charity volunteering work, on behalf of the MyBnk charity. The objective of MyBnk is to provide education on money and finance to school children and young adults. I helped deliver a class on managing money and taxes at the School of Hard Knocks, a youth group based in West Ham Rugby Club. This is a charity that provides an 8-week employment course for 17-23 year-olds who have been referred by the job center, generally if they are long-term unemployed or experiencing difficulty passing interviews. There were about 20 in the group I addressed, some of whom had never had a job since leaving school.
I was impressed with their desire to learn, their energy and their keenness to engage with me, and their general knowledge of the economy. When it came to the section on income tax, we presented some slides illustrating how income tax impacts the net take-home pay for someone on 15,000 per year, 35,000 per year and 150,000 per year. The first two cases pay a marginal rate of 25 percent, excluding payroll taxes, and the third case pays a marginal rate of 50 percent.
Did the group think this was fair? To a man, and woman, they said no. The most common refrain was "that's not fair".
But for me the revelation was the impact on their aspiration. They could not see why anyone would want to work hard, and aim for a high salary, if they then simply handed over half of it to the state. For a student of finance such as me, accustomed to hearing politicians of almost every hue state their acceptance of higher tax rates for higher earners, this was a revelation. No one likes the idea of high tax rates, even those that aren't earning anything. Certainly a salary of 35,000 was well within the capability of everyone in the group I addressed, if they embarked on a career in a field they had aptitude for and maintained it for several years. But when they became aware of the government's share of their earnings, they were instantly deflated.
One of the arguments for a "flat tax" is that it actually raises the state's tax take because it reduces evasion and also incentives people to work harder to raise their income. Having seen first-hand how a high tax rate reduces aspiration even among low earners, I was left in no doubt that the same would apply to income tax rates. After unemployment, the most urgent priority for any government looking to raise an economy out of recession is to simplify the tax system so that it becomes less of a drag on aspiration, and less of a hindrance to the desire to work hard to better one's own quality of life.
Professor Moorad Choudhry is at the Department of Mathematical Sciences, Brunel University and author of The Principles of Banking (John Wiley & Sons Ltd 2012).