In praise of progressive taxation

What is taxation for? That may seem a very big and obvious question to ask, even a naive one, particularly in Tax Journal. From the time of the medieval kings, indeed before, taxes have been used to pay for the state’s spending obligations; initially, mainly wars, but in modern times usually welfare and public services.

 

We sometimes forget, however, that the purpose of taxation is also to redistribute income, a task it does rather well. There has been a lot of talk recently about a ‘Robin Hood tax’, a tax on financial transactions intended to raise billions from banks and other financial institutions (and, in practice, pension funds and private investors).

 

The entire tax system has strong Robin Hood characteristics, though. The hero of Sherwood Forest would be proud of a system which takes from the rich and gives to the poor so effectively. Progressive taxation is a great modern invention and it works very well in Britain.

 

I was struck by this when reading a recent report from the Institute for Fiscal Studies. Living standards, poverty and inequality in the UK: 2017 was, as always, a model of thoroughness from the IFS. Among its several conclusions was one that, however many times you say it, many people find difficult to accept.

 

This is that inequality across the bulk of Britain’s population, measured by the so-called 90:10 ratio (incomes at the 90th percentile versus incomes at the 10th), is lower now than it was at the end of the Thatcher government, now nearly three decades ago. At worst, according to another measure, the Gini coefficient, inequality is similar now to the levels of 25 years ago.

 

According to the report, incomes at the 10th percentile have grown by 7.7% since 2007/08, while those at the 50th percentile have risen by 3.7%. Those at the 90th percentile, meanwhile, have dropped by 0.6%. The drop in inequality in recent years is enough to take it below those late Thatcher period levels. The Gini coefficient is flatter than the 90:10 ratio because of the rise in incomes for the top 1%.

 

The idea of falling or flat inequality is one, as I say, that many people find hard to grasp. There are good reasons for this. The Sunday Times ‘rich list’ is an annual celebration of Britain’s wealthiest, and the latest edition suggests that they have been doing rather well as the impact of the financial crisis fades. As a society we are programmed, if not to celebrate, then at least to notice, the mega rich. The British are reserved about talking about money, except when it comes to those at the top and, perhaps, BBC presenters and stars.

 

Rich lists, of course, measure wealth, not income, and there is always confusion between the two. When the talk is of income, as in the case of the BBC presenters or footballers, the figures are always for gross, pre-tax salaries. The role of the tax system in evening out incomes is usually ignored.

 

That role, the role of progressive taxation, is significant, as HMRC’s figures clearly demonstrate. If we take the top 1% of earners, HMRC’s tax liabilities and distribution tables show that their share of pre-tax incomes was 11% in 1999/2000, rising to a modern day peak of 13.9% in 2009/10, and is estimated to be 12% this year, 2017/18. The post-tax numbers are clearly lower: an 8.8% share in 1999/2000, peaking at 11.2% in 2009/10 but falling back to 8.9% this year. The comparison of 1999/2000 and 2017/18 is particularly interesting. While the pre-tax income share has grown by a full percentage point between the two periods, the post-tax income share is up by just 0.1 points.

 

The numbers are, if anything, even more telling slightly lower down the income distribution. So, for the top 5%, the pre-tax numbers are a 23.3% income share in 1999/2000, rising to 26.4% in 2009/10 and falling back to 24.2% in 2017/18. Post-tax, however, the figures are respectively 19.9%, 22.4% and 19.6%, so the post-tax share of the top 5% is down.

 

That is also true of the top 10%, their post-tax income share having fallen from 29.3% in 1999/2000 to 28.5% this year, despite a small rise in their pre-tax share, and an even more significant drop since the financial crisis.

 

Behind all these figures, of course, is a rise in the share of income tax paid by those at the top. For the top 1%, that share has risen from 21.3% in 1999/2000 to an estimated 27.7% this year. For the top 5%, the rise is from 39.6% to 48.1% now. The top 10% of income taxpayers accounted for a fraction more than half of all revenues from income tax in 1999/2000, at 50.3%. Now it is up by nearly nine percentage points to 59.2%.

 

There are two things that arise from this. One is that the mechanism for squeezing more tax out of those at the top of the income scale has been subtle and clever. Yes, we have seen the introduction of a 45% (briefly 50%) additional rate of tax. Mainly, though it has been achieved by delivering the benefits of higher personal tax allowances to those further down the income distribution. If that subtlety was replaced by the bludgeon of big tax hikes for the well-off, as some would want, you would worry about future revenues.

 

Already, as the figures show, Britain is worryingly dependent on a minority of taxpayers. The IFS and others have pointed out that anything that risks the continued presence of these taxpayers in Britain could have serious impact on the public finances, which is why the Brexit process has to be handled with care. Progressive taxation works, as the numbers clearly demonstrate, but don’t push it too far.