Friday, 10 February 2017

Economic Myths: Means-testing means smaller government and lower tax rates.

The lefties love means testing, because they love having lots of rules on who is deserving and who isn't, and lots of public sector meddlers to administer it all. They don't care about higher tax rates on higher earners, in fact they welcome them, and refuse to accept the concept of the Laffer Curve. Fair enough, at least they are coherent.

What winds me up no end is when Conservative voters pretty much agree with them, ostensibly because means-testing means smaller government and lower tax rates.

This is clearly arrant nonsense. Just as I was drafting this post in my mind, MBK conveniently sent me an article from the FT which gives some illustrations.

Bearing in mind that we can view the income tax-free personal allowance as a kind of universal benefit or a tax rebate, what happens if this is withdrawn from people whose earnings are above an arbitrary threshold..?

Among higher earners, arguably the most egregious quirk in the tax system is the tapering of the tax-free personal allowance on annual income above £100,000. For every £2 earned above this threshold, £1 of relief is taken away. Income earned in 2015-16 between £100,000 and £121,200 will therefore effectively face an additional tax rate of 20 per cent.

Combined with the higher income tax rate of 40 per cent levied on income above £42,385, “it isn’t anything more or less than an effective marginal income tax rate of 60 per cent,” says Paul Johnson, director of the IFS.

Patricia Mock, a tax director at Deloitte, says the 60 per cent rate — which has never been officially recognised as such — affects ever more taxpayers as wage inflation takes a higher proportion of salaries above £100,000. Official figures show the number affected rose from 588,000 in 2010-11 to a projected 791,000 in 2014-15.

Yup, the end result is that more people are paying more tax and suffering higher marginal tax rates. A sensibly advised high earner will do his best to avoid the 60% band and will shuffle his income around to either remain just under it, or right through it and out the other side, so HMRC has to employ more inspectors to monitor compliance etc.

Why do Conservative voters go along with this?

I accept that some people will say "Come off it, people earning £100,000-plus are doing all right for themselves, they can afford it" (and clearly they can), but the general principle applies all the way down the income scale. As we well know, the marginal rate on the first £20,000 is effectively 80% - 90% if you take into account foregone benefits, they are the ones I really feel sorry for.


Lola said...

That's on of the chief reasons why I favour LVT/CI. Massive simplification and the impossibility of governments from after its introduction of playing these games. LVT/CI kills all that meddling opportunity stone dead.

Bayard said...

"Why do Conservatives go along with this?"

Probably because it is yet another stealth tax. They can boast about the top rate being "only 40%" and thus keep the hissing to a minimum, whilst enjoying 20% more feathers.

Mark Wadsworth said...

L, exactly.

B, I meant "Conservative voters", not the politicians.

Bayard said...

Ok, delete the second sentence then.

James Higham said...

And if over 80%, that's in Soviet Union tax territory.

Curmudgeon said...

And means testing creates a massive moral hazard as it encourages people to be feckless and spend all their money rather than providing for themselves.

Mark Wadsworth said...

JH, yes. Overall rate on normal employee is 50% of his income. Everybody else pays more, except landlords.

C, an excellent point. UK governments always wail on about "encouraging people to save" but in practice they are doing the opposite.

The only exception is pensions saving which gets kids glove treatment, but as we know, all the tax benefits are soaked up in fees and commissions so you end up little better off than if you'd saved up yourself.