Taxing the 5%

The shadow chancellor has said that the Labour Party would finance its policies by increasing income tax on the top 5%, were it to win the election. So how do the numbers stack up?

According to the ever useful oddschecker.com, you can get 17:1 on Labour forming the next government. Thus, it might seem that what John McDonnell, Shadow Chancellor, says about future tax policy is unlikely to become reality after 8 June. However, it is worth remembering that following the last election, Mr Osborne ‘borrowed’ several policies from the Labour manifesto, including a crackdown on non-doms and the introduction of a sharply increasing minimum wage (an indirect form of tax on employers).

Labour’s tax plans, as revealed so far, are that those earning £80,000 and above would pay more income tax, although how much more has not (yet) been specified. This is a jump from the £70,000 threshold which John McDonnell had previously suggested would catch the top 5% of taxpayers. The actual numbers, courtesy of HMRC, are revealing:

• The HMRC data say that in 2014/15 a total income (not just earnings) of £71,700 was required to hit the 95th Alas, this is the latest HMRC data, published two months ago.

• The most recent Annual Survey of Hours and Earnings (ASHE) data from the ONS show that the top 5% of earners saw income rise by 2.5% in 2015/16 (against a median increase of 2.2%). For 2016/17, the earnings change is likely to be very similar – the median year-on-year figure was 2.3% in February. Add say 7.5% to the HMRC figure to cover three years and the 2017/18 95% threshold comes out at £77,200 in round numbers. If you assume that any McDonnell income tax changes take effect from 2018/19, then £80,000 looks very close to the likely top 5% threshold.

• Although the HMRC data includes the 95% threshold, their analysis sticks with round numbers for totalling income tax receipts, making it impossible to accurately assess how much the top 5% paid to the Exchequer. However, we can get quite close as one of HMRC’s round numbers is £70,000.

• In 2014/15, 30.7m income taxpayers supplied £167bn to the Exchequer. That was about 28% of total Exchequer income, underlining why a promise to freeze income tax rates is a folly in most economists’ eyes. The 1.61m (5.24%) with income of £70,000 and above handed over £80.19bn – 48% of the total income tax paid. So, in politically smoothed shorthand, the top 5% already pay half of all income tax.

• It is at this point that the maths starts to get questionable. We do not know how much more tax Labour would want to raise or how much they would spend. The two numbers are not the same, as McDonnell has made clear he would increase borrowing to fund capital expenditure. What we can say is that adding a tenth to the income tax bill of the top 5% could raise about £9bn by 2018/19, not a huge amount when public sector current expenditure for that year is forecast by the OBR (on today’s policies) to be £730.9bn and total managed expenditure, which includes capital expenditure, £817.2bn. The same £9bn could be raised by adding 2p to basic rate or 1% to the employee and employer Class 1 NIC rates.

• In practice a tax change at the top end will be accompanied by significant behavioural effects and may not deliver the anticipated cash flows to the Exchequer. The introduction (and subsequent reduction) in the additional rate income tax and dividend tax changes have highlighted this distorting effect.

The top 5% of taxpayers are the people most likely to be able to manipulate how and when (or even if) they receive their income. Again, the dividend changes provide an example: HMRC estimate that the pre-announcement of the dividend reform cost the Exchequer £0.8bn, of which £110m went to just 100 individuals, drawing an average pre-emptive dividend of £30m.

“Taxing the rich” appears to work on the same principle as the wisdom of robbing banks – that’s where the money is. However, as with bank robbery, knowing where the money is will usually be very much easier than extracting it.