NCPA - National Center for Policy Analysis

Why the Higher Rate of Income Tax Yielded so Little

March 27, 2012

Britain's 50 percent personal income tax reaped little revenue, according to an analysis by tax-office officials.  The study is based on a single year's tax returns, but is nonetheless compelling, says The Economist.

  • It shows that the combined incomes of the taxpayers liable to pay the 50 percent rate (i.e., those with earnings above £150,000, or $238,000) fell by a quarter, from £116 billion ($185 billion) to £87 billion ($139 billion), in 2010-2011, the first year in which the tax applied.
  • This sharp drop means either that the well-paid did a lot less work in Britain or that they shielded their income from the higher tax rate.

A closer look suggests the latter.

  • The tax wonks find that up to £18 billion ($29 billion) of income was brought forward to the previous tax year to avoid the top rate.
  • Much of this "forestalling" came in the form of higher dividend income, which surged in 2009-2010 before plummeting a year later, as owner-directors of companies altered the timing of their own payouts.
  • There was a similar spike in employment income in 2009-2010, which is put down to the early exercise of share options to avoid the new tax.

The forestalling made it tricky for the tax officials to estimate what the take from the 50 percent rate would be in a "normal" year.  The study puts the figure at around £1 billion ($1.6 billion) "at most," far less than the hoped-for £2.5 billion ($4 billion).

The Treasury estimates a £100 million ($160 billion) revenue loss from cutting the top rate of tax to 45 percent, based in part on the analysis of 2009-2010 tax receipts.  The results suggest that the tax take from incomes over £150,000 is little different whether you set the tax rate at 45 percent or 50 percent.  Setting the rate much higher than 45 percent is pointless; beyond 50 percent it is self-defeating.  The additional revenue loss of abolishing the higher rate altogether is estimated at a few hundred million pounds.

Source: "Falling Flat: Why the Higher Rate of Income Tax Yielded so Little," The Economist, March 24, 2012.

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