A 50 per cent top rate makes sense

My column last week for The CEO Magazine reiterates a point made previously at Troppo: the weight of research shows decisively that high marginal tax rates have little effect on the efforts of most high-income earners.

Sample quote:

“These research results line up with what we all see each day. Does anyone really believe that if you slug all those Macquarie bankers 50% instead of 48, they’ll suddenly start arriving in the office at 8.55am and leaving at 5.25pm? Nope. They’ll still be streaming through the lobby at 7.15am tomorrow, coffees in hand, ready to work as hard as they did yesterday.”

This was Nick Gruen’s conclusion in his influential CEDA paper Tax Cuts for Growth, which in 2006 seems to have pretty much established that extra tax on high incomes would not devastate the Australian economy.

The paper also pointed out that given how much the rewards of the economy were shifting towards the top end of the income scale, increasing taxes there would raise a decent amount of dough.

If anything, the past decade has reinforced those conclusions. If you really think Australia needs to address its Budget deficit, then higher marginal tax rates for the biggest earners make a good deal of sense.

So now that Bill Shorten is suggesting exactly that, it’s worth revisiting what Nick had to say. It all still applies.

Read the whole thing.

David on Twitter: @shorewalker1

About David Walker

David Walker runs publishing consultancy Shorewalker DMS (shorewalker.net). David has previously edited the award-winning INTHEBLACK business magazine, been chief operating officer of online publisher WorkDay Media, held policy and communications roles at the Committee for Economic Development of Australia and the Business Council of Australia, and run the website for online finance start-up eChoice. He has written professionally on economics, business and public policy since 1987 and spent three years in the Canberra Press Gallery for News Limited and The Age.
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19 Responses to A 50 per cent top rate makes sense

  1. Tony Tea says:

    I agree that your tax numbers are dubious regarding incentive; I mean 48 to 50 is bugger all in the scheme of things. But what about, say, 32 to 53? And where do you draw the line regarding overall increases or decreases? Or, for that matter, what is a good/fair/effective/whatever line at which anyone should be taxed?

    • David Walker says:

      Hi Tony. What we’re talking about here is labour supply elasticities, and Nick’s paper gives some indications about this in appendix 3. Take a look at the graph there, which gives some idea of where the line might be drawn.

      For the higher-earning half of the income distribution, supply is really very inelastic, meaning people don’t change their work effort much at all in response to changes in income. A rise in the current 32.5 per cent marginal rate, though, would capture anyone earning more than $37,000 – quite low on the income distribution – and would be much more likely to have an effect on the labour supply.

      However, that’s not really the case we’re addressing here. When I talk about high income earners, I’m talking at least about people earning six digits. And Shorten is talking about the top marginal rate, which cuts in at $180,000 a year.

      On top of that, a couple of riders, which are mentioned in the piece at The CEO Magazine:

      * At least two groups are much more sensitive to changes in income even well up the income distribution – married women and sole parents.

      * As I point out in the TCM piece, we can use data analysis to see the practical benefits of such measures – but that doesn’t show that a 50 per cent top marginal tax rate is fair. It’s possible to make the case that a 50 per cent top rate would be effective in budgetary terms yet still not be fair. (Hardly anyone makes that case, but I suspect some people nevertheless feel it to be true.)

      What we were trying to do in 2006, and what I’m trying to do again now, is simply remind everyone about the lack of empirical support for statements like “a 50 per cent top rate would turn lots of people off work”. Most people who currently pay the top rate would change their work patterns barely at all.

      • Moz of Yarramulla says:

        You could probably talk to both the sole parents who have taxable incomes more than $180k and ask them directly whether they’d change their work habits if tax rates changed. No need for statistical analysis :)

        I think it’s also important to track gross income and make an attempt at untangling the more common tax avoidance measures (the lawful version, I think, cf evasion). Didn’t Kerry Packer famously have a taxable income of $1 every year?

        From hanging around with the wrong crowd, I think it would also be handy to look at under-18’s and people in full time education, because there are a number of those who have taxable incomes just shy of the $90k surcharge level who could stand a bit of investigation (it seems a common pattern is to pay them that much as a way of increasing ‘family’ income from a family (part) owned or controlled company… but if the tax office decided that, say, them paying their after-tax money to their parents counted as rental income on the family home… things would be very exciting, tax-wise).

  2. Anthony Park says:

    Hi David,

    I want to point out that in academia other factors e.g. prestige or publishing a high impact paper drives long work hours.

    Amongst my small business friends, they work super long hours, take home less than their top one or two employees. The hope is that at some point they get bought out by a bigger company.

    However, quite a few of my higher salaried friends who work in finance etc get shares as part of their package. David, at what tax level do you think workers start taking more of their renumeration as shares, superannuation etc?

    • David Walker says:

      “At what tax level do you think workers start taking more of their renumeration as shares, superannuation etc?”

      There may be data somewhere on this but I don’t have it. The shares pose valuation problems too. I once did a start-up where I initially drew one-third of my pay in share options, but I mentally valued them as zero. I slept better that way.

      On the other hand, I’m now sitting here thinking about the economic implications of a society where everyone works for the small possibility of a huge capital gain. It’s a really interesting exercise, and more than just theoretical.

      I’m just not sure I know how to describe the potential labour supply elasticities in that world.

      • Moz of Yarramulla says:

        One consequence in software is a lowering of median income relative to average, especially in the US where that gap is already larger than most civilised countries. From personal experience there are a lot of people sucked into over-valuing options or unvested shares, as well as some who simply take a bad gamble because that’s the only option available. An unsurprisingly number of the big buyouts also involve the “sweat equity” partners getting very little because it turns out that the buy-out is timed for just before their shares vest or other similar tricks.

        I think it does feed into the “entrepreneurial culture” that’s being imposed on us, because the jump from “I get paid whatever TaskRabbit leaves from the lowest bid” to “I might get more if these shares are ever worth anything” is small. But it’s also a handy way to eliminate minimum wage and other protections afforded to the upper end of the working class – here, have one single share, now you’re a shareholder and those rules don’t apply. The common alternative is the brutal Uber thing of “laws? Your laws mean nothing to us” which we’re also seeing more of. To the point where Deliveroo advertise as their novel selling point “we obey the law”.

  3. hc says:

    This seems like a version of the fallacious argument that “all demands are price inelastic”. The evidence on labour supply elasticities that I have seen (e.g. the Treasury survey paper) is very mixed and inconclusive. The reason about being careful about high-income earners is that it matters a lot if income tax hikes reduce effort since, by definition, you lose a lot of output.

    Mirrlees in his original paper on optimal income tax focused on such issues. Better to have higher average tax rates – including on low and middle-income earners – and low marginal tax rates on higher income earners. If you lose some low-income earners you don’t lose much output. They go on the dole and it does not cost much in terms of foregone output. It matters much more if high-income workers face disincentives since they fund the bulk of the redistributive transfers.

    Mirrlees hated the politics of all this but that is where economic logic steered him.

  4. David Walker says:

    Harry, thanks for your comment. I absolutely agree that high income earners’ labour response matters. And if we get better evidence for a different conclusion, I’ll change my mind. At some point, I’m not smart enough or well-trained enough to do anything else. But please believe me when I say I certainly don’t believe that “all demands are price inelastic”; I tend to believe the opposite most of the time.

    Nick’s paper does find strong labour supply elasticity for a couple of groups at high incomes. It also points out that the elasticities are much stronger further down the income ladder. And it fits with a lot of overseas work which has found similar results. This was a real surprise to me when I started reading the literature – so much so that I asked Nick whether I was reading it right. That was where the CEDA paper came from.

    I understand Mirrlees’ logic. But if data like the HILDA data that Nick made use of is right, there seem to be other factors in play on this issue. If there’s data that tells a much different story, though, please point me to it.

    Meanwhile, another way of thinking about this whole issue may be that the increasing bias towards skill in labour demand has been producing changes to relative incomes at the top end far greater than anything the tax system has been able to do. If high income earners were ever going to change their labour response, that should have done the trick. But high-end labour supply has been pretty stable – possibly because these people were already working pretty hard 25 years ago, and they still need time to sleep, eat, and say hello to their families at least once a month.

    I could be wrong about all this, so feel free to educate me further. I mean that seriously. Quite apart from anything else, any admirer of Burton Malkiel is a friend of mine.

    P.S. Are you referring to Treasury’s 2007 Dandie and Mercante review paper, or something else?

  5. conrad says:

    The alternative to people working less because of high tax rates is that people will have to work more, both in the short term when they actually have the ability to influence how much they will work (e.g., to pay off loans etc.), and in the long term (to get enough to retire). I’m not lucky enough to be in the 180K+ bracket, but I’m not exactly poor, and if I had to pay more in tax I’d certainly be in the working longer in the long term category. When I see these elasticity of demand scenarios, these longer term changes are almost never talked about.

  6. Paul Frijters says:

    agreed that the economics makes sense, but that wont matter much politically. Taxation is foremost a political battlefield. Who is on your side?

  7. I am and will always be Not Trampis says:

    David, Most high income earners have very good lawyers and accountants and thus will not pay 50%!
    Not only that their advice is tax deductible!

    • David Walker says:

      I hear this a bit, and it clearly has some truth to it. On the other hand, it would seem on its face to be true to some extent no matter what the top marginal rate is.

      If it’s true, the question then is: how does that extent change with a changing top marginal rate? Does the effect you’ve described change much between, say, 45 per cent and 50 per cent?

      For instance, you might believe that most people paying the top marginal rate will always find a way to avoid paying half of what they owe on ever dollar over $180,000. Or you might think that at 45 per cent most will pay three-quarters of what they owe on ever dollar over $180,000, and at 50 per cent that same group will pay half. The two stories have quite different revenue results.

      In other words: if we’re raising $10 billion with a top marginal rate of 48 per cent, and we move that rate to 50 per cent, how much revenue do you think we’ll then raise, and why?

  8. john Walker says:

    Is there really no way of improving-increasing the (taxable, non cross-subsidy) incomes, and numbers of, people in the middle?

  9. john Walker says:

    I guess there must be a point where a top tax rate would have an impact, would it be : 55%, 75% or what?

    • David Walker says:

      John, I’m not sure, but in pure revenue-raising terms you might be pretty nervous about pushing the top marginal rate too far north of 55 per cent. There’s not that much data at those income levels. But Nick may have more to say.

      At some point, of course, high income earners start leaving the country. (In the economic language which I learned from Nick, the labour supply effects spread from the intensive margin to the extensive margin.) I’ll have more about this in another post.

      • David thanks,
        On the other side , I suppose that if some ( possibly quite a lot?)of those high earners for example a few uni CEOs and the like left the country ,we might be better off?

        • “The remuneration paid by Macquarie Group to its 12-member executive team — more than $120m last year — is more than twice its expected $50m tax bill stemming from controversial new levy.”

          Would we be worse off as a nation if some of those guys stopped working?

        • Moz of Yarramulla says:

          Damn, mere moments ago I was looking at a “which entrepreneurs are valuable” article and now I can’t find it. The thesis was that there’s a fairly constant level of innovation in business over a whole society, the question is whether it’s directed to new products or new ways to game the system. Macquarie Bank are an excellent example of the latter, being extremely good at finding and making new opportunities for rent-seeking.

        • john Walker says:

          Dear Moz
          This aging brain sympathises :-)

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