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Ontario NDP Leader Andrea Horwath speaks at the Ontario NDP convention at the Hamilton Convention Centre in Hamilton, Ontario, Saturday, April 14, 2012. (SHERYL NADLER/THE CANADIAN PRESS/SHERYL NADLER/THE CANADIAN PRESS)
Ontario NDP Leader Andrea Horwath speaks at the Ontario NDP convention at the Hamilton Convention Centre in Hamilton, Ontario, Saturday, April 14, 2012. (SHERYL NADLER/THE CANADIAN PRESS/SHERYL NADLER/THE CANADIAN PRESS)

Neil Reynolds

Taxing the rich: Not as easy as it sounds Add to ...

Announced in 2008 and implemented in fiscal 2010-2011, the British government imposed a substantially higher marginal tax rate on the country’s top 1 per cent of income earners, raising the rate from 40 per cent to 50 per cent, and simultaneously revoking the personal exemption traditionally granted to all taxpayers.

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The London-based Institute for Fiscal Studies, an independent research organization, calculated that the higher rate was originally expected to transfer £3-billion ($4.7-billion) from the top 1 per cent to the bottom 99 per cent. It didn’t come close.

When George Osborne, the Conservative Chancellor of the Exchequer, revoked the 50-per-cent tax rate last month in his third budget in two years, he reported that the Treasury had broken even in the experiment – or had almost broken even. Apparently the Treasury lost £3-billion in this transaction, on the one hand, and gained £2.9-billion on the other.

“No chancellor can justify a tax rate that collects next to nothing,” Mr. Osborne told the BBC. “It’s as simple as that.”

He called the previous Labour government’s “bash the rich” experiment a failure, a triumph of spin over substance. He said people with taxable incomes of more than £150,000 produced essentially the same tax revenue with a marginal tax rate of 40 per cent as they produced with a marginal rate of 50 per cent.

Ontario’s Liberal Premier, Dalton McGuinty, might want to reflect on the British experience as he ponders NDP Leader Andrea Horwath’s offer to swap New Democrat votes for a higher marginal tax rate for Ontarians with taxable incomes greater than $500,000.

Assuming that Mr. McGuinty agreed to this trade, the province’s highest marginal rate on personal income would rise, federal and provincial rates combined, from 46.4 per cent to 49.4 per cent – meaning that this rate would theoretically net $247,000 in revenue, a tax increase for the top 1 per cent of at least $15,000.

Ms. Horwath’s proposal, however, raises the question: Will the 1 per cent pay, or will that group find ways not to pay? The British experience suggests that, when marginal tax rates hit 50 per cent, people find ways not to pay.

The Institute for Fiscal Studies notes that, without “behavioural adaptation,” the 50-per-cent marginal rate in Britain would theoretically have produced an extra £6.8-billion in revenue. The Labour government had assumed, up front, that people would find ways to avoid paying half of it. But people found ways to avoid all, or almost all, of it.

In an assessment of Labour’s high marginal rate, IFS economists Paul Johnson, Mike Brewer and James Browne concluded that high-income earners used legal means to reduce their taxable income. They increased pension contributions. They delayed receipt of income. They converted income to capital gains (taxed at 28 per cent). They split incomes with spouses. They reduced taxable income by working less, by retiring early – and by moving to countries with lower tax rates.

Further, because they had a full year’s warning, they were able to forestall the tax increase – by moving next-year income into last-year tax return. British taxpayers caught by the £150,000 threshold reported an average increase in taxable income of 14 per cent in 2009-2010; and an average decline of 25 per cent in 2010-2011. They reported an average increase of dividend income of 78 per cent in 2009-2010; an average decline of 73 per cent in 2010-2011.

Britain’s 50-per-cent marginal rate fell on more people than Ms. Horwath’s 50-per-cent marginal rate would apply in Ontario. The very rich are more able to avoid tax increases than the merely rich – who, in turn, are more able to avoid tax increases than the almost rich. If you want to increase tax revenue from the rich, you first need to create more of them.

As an alternative to very high tax rates, the IFS economists conclude, it’s probably better to make the top tax bracket more inclusive – and then to lower the rate for all high-income earners.

A lot of people paying 40 per cent more or less willingly, will pay more than a small number of people paying 50 per cent more or less involuntarily. For many relatively affluent taxpayers, however, this big-tent approach comes a bit close for comfort, signifying that they are – from the perspective of cash-strapped governments at least – richer than they think.

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