IFS: effects of top tax rate hike ‘uncertain’

23 Aug 17

Raising the top rate of income tax to 50% could raise up to £2bn more for the Treasury but could also cost more than double that depending on how high earners react, according to Institute for Fiscal Studies analysis.

The IFS yesterday released a review of the short-lived 50% top rate of tax, which operated in the UK between April 2010 and March 2013.

Researchers argued that implications for the UK’s tax revenue are shrouded in uncertainty because of the way high-earning individuals reacted.

The independent think-tank noted that the 2010 change was telegraphed, giving people time to use measures to reduce their taxable income.

In 2013, HMRC estimated that the 50% rate would probably raise no more than a 45% rate because of the actions of those on the highest wages. This prompted the move to reduce the top rate back down to 45%.

IFS researchers said HMRC’s 2013 assumption was a “reasonable central estimate” but added “our analysis also shows that it is plausible that such a policy [50% top rate] could raise or cost £1-2bn a year in revenues”.

The analysis estimated that the higher end of costs to the Treasury could be £4.4bn.

The main issue in calculating the effects on tax revenue of this policy is the so-called forestalling factor, whereby taxpayers bring forward income to avoid the pre-announced tax rise.

The IFS said forecasting tax revenue also depends on the extent to which revenues from other taxes, such as VAT or capital gains tax will be affected by behavioural responses.

“Available data do not allow such impacts to be fully estimated”, the IFS said.

Analysis by the institute suggests there was “significant” forestalling ahead of the policy’s implementation but this could not fully explain all of the reductions in income seen among the affected group.

The report states: “Instead, it appears that the changes in incentives caused by the 50% tax rate led to these individuals reducing their incomes in a way that would have affected tax revenues on an ongoing basis if the rate had been retained.”

In conclusion, the report states policymakers will need to “reconcile themselves to uncertainty” about the revenue effects of changing the top rates of income tax.

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