Thursday, 22 March 2012

Laffer Curve Fun, with a side serving of nepotism

HM Revenue & Customs has finally come up with a sixty-page report explaining why total revenues will not fall if the 50% income tax rate is reduced to 45%, here's the chart showing possible Laffer Curves from page 51:(image pinched from The Guardian, that's a good article if you ignore the leftie spin).

Fair enough, but what is this TIE of which they speak? It's short for 'Taxable income elasticity', see page 14:

The measure of the overall responsiveness of total taxable incomes to changes in marginal tax rates is the "taxable income elasticity" (TIE). This estimates the percentage change in total taxable incomes in response to a one per cent change in the net-of-tax rate (the proportion of each additional pound earned received by the individual after tax, also known as the marginal retention rate), and therefore captures all the behavioural responses described in Chapter 2.

Chapter 2 isn't much use either, but basically TIE is some sort of estimate of the price-elasticity of supply of labour. So if TIE is low at 0.35, people don't drop out the (taxpaying) workforce in response to lower post-tax incomes, and the increase in tax revenues by nudging the rate up to 50% outweighs the effect of the smaller tax base. If TIE is high, at 0.55, then once you get to an income tax rate of 43%, so many people drop out of the (taxpaying) workforce that total revenues start to fall if you nudge the rate any higher.

But HMRC cheerfully admit that they have no idea what the average TIE of higher earners is, so the whole thing is fairly useless, except to illustrate the point that a reasonable man concludes that while there must be a revenue-maximising income tax rate:

a) Whatever the true TIE is, the revenue-maximising tax rate could be anywhere within a very wide range (between 43% and 57%, going by the chart) and caution dictates we ought to go for the lowest figure in that range (43%).

b) We do not want to be anywhere near the revenue-maximising income tax rate anyway, we would rather be at the economy-maximising income tax rate, which happens to be zero per cent.

For your side-serving of nepotism, see City AM.


Lola said...

Your point (b) - eggsaktly.

Physiocrat said...

Looks like a 1950s wallpaper pattern to me.