Opinion & Commentary
Populism is driving US and UK Tax Policies
The level at which a country sets its top marginal rate of personal income tax says a lot about its priorities. The higher the rate and the steeper the scale, the greater the emphasis on redistribution and the welfare state; the lower the rate and the flatter the scale, the greater the emphasis on efficiency, enterprise and meritocracy. That is why the promised hikes in the top rates of the US and the UK are more significant than the relatively small amounts of money they will raise.
The UK government’s proposal to raise the top rate from 40 to 45 per cent after the next election reverses a decades-long trend away from punitive marginal rates, which reached 83 per cent in the 1970s. Although the reduction to 40 per cent was all the work of the Thatcher government, Blair recognised that his government’s acceptance of it epitomised the ‘new’ in New Labour and for ten years steadfastly refused to reverse it, despite pressure on him to do so.
In the US, the context of President-elect Obama’s intention to lift the top federal rate from 35 to just under 40 per cent is different, but the implications are equally significant. Since the top federal rate was slashed from 70 to 28 per cent (in combination with base broadening measures) under the Reagan administration in the 1980s, there has been a tug of war between Democrats wanting to increase it and Republicans wanting to hold it down. Clinton increased it; Bush cut it back to 35 per cent; and now Obama plans to restore it to the Clinton level.
The British and American moves will leave their top rates well below the confiscatory levels of thirty years ago, but should still set alarm bells ringing. Reagan and Thatcher started a worldwide trend towards lower marginal rates of income tax. Obama and Brown may now be starting a trend in the opposite direction. Their actions will help set the scene for the major tax review currently under way in Australia. The Rudd government has already quietly backed away from the ‘aspirational’ income tax scale of 15/30/40 per cent that Labor adopted in last year’s election campaign to demonstrate its claimed commitment to economic conservatism and the enterprise culture.
Policies on taxation of high incomes can be populist or principled. Populist policies appeal to notions of envy and resentment, while principled policies appeal to more positive notions of incentive, reward for effort and risk and a fair go for everyone, even the rich. The intellectual case for lower and flatter (if not flat) income tax scales rests on these principles. There is also the practical point that high rates on high earners raise little revenue because high earners are a small minority and their behavioural responses limit the revenue yield. The intellectual and practical case was won in the 1980s but is threatened by the current outbreak of policy populism in response to the global financial crisis.
If they go no further, the proposed increases in the US and the UK may be viewed as symbolic acts, like the increase in luxury car tax in the last Australian budget. Even symbolic acts, however, can be harmful. And it is a particularly cynical and short-sighted use of the democratic process for a government to turn anyone’s after-tax income into a political plaything.
The question of where the top marginal rate should be set cannot be divorced from the requirements of responsible fiscal management. The underlying fiscal positions of both the US and the UK are truly awful. But if their leaders really believe that higher taxes must eventually be part of the solution they should be honest and courageous enough to warn of tax increases across the board and not pretend that the rich can bear the entire burden while the middle class is sheltered.
Australia’s top marginal rate peaked at 66.7 per cent in the 1970s. It has since been reduced five times to its current level of 46.5 per cent. There is no macroeconomic management argument for increasing it. If principle wins the day in the current major review of the tax system, it is destined to come down further.
Robert Carling is a senior fellow at the Centre for Independent Studies.
