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Fiscal Drag Means The Top Tax Band Is Over The Laffer Curve Peak

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OK, you can argue against this idea if you’re one of the fools who thinks that there is no such thing as the Laffer Curve. You can also argue against it if you think – again wrongly but not necessarily foolishly – that we’re nowhere near that peak.

But imagine that you’re a Tory Chancellor. OK, you could still be a fool, that’s true. Imagine also that you’re a Tory Chancellor who believes what Tory Chancellors insisted upon a decade ago. OK, that too could be evidence of foolishness. But go on, just imagine.

More people than ever face paying the 45pc rate of income tax on the top band of their earnings following a decade-long threshold freeze.

Some 440,000 are forecast to lose 45p for every £1 they earn over £150,000 this financial year – 10pc more than paid in 2018-19, official figures published yesterday revealed.

The £150,000 additional rate threshold – the point at which the top 45pc rate kicks in – has not changed since it was first introduced in 2010-11, despite steady inflation and wage rises. More have been caught as a result through what is known as “fiscal drag”.

That means that the top tax band is now over the Laffer Curve peak.

No, really.

Think back to what was actually being said back in 2010 etc. Brown had raised the top tax rate to 50% as a poison pill for any incoming Tory. I think I’m right in saying that it didn’t even come into effect until after the likely election date.

So, the argument from Osborne etc was that 50% was over the Laffer Peak. They might well be right too – that Diamond and Saez paper tells us that in a system with allowances that peak is 54%. But that’s taxes upon income, not income taxes, so we must include employers’ and employees’ NI to get to the full rate. Yes, their paper really does say this.

Sp, 50% income tax only is too high. 45% income tax only might be fractionally on the high side but it’s closer to the peak at least.

However, the peak is created by the interaction of the income and substitution effects. We know that these weigh differently upon decision making dependent upon income levels. Low paid piece workers are definitely more influenced by the income effect. As we’ve seen with doctors’ pensions those on three and five times median wage definitely react to the substitution effect.

Hmm, OK. So, the Laffer Curve peak in terms of income is going to rise with inflation and also more general wage increases.

Cool. The insistence in 2010 was that 45% at £150k was the peak of the Laffer Curve. Given inflation and general wage increases since then this must mean that it’s above that peak.

Now, whether we believe this or not depends upon whether we believe Osborne’s insistences back then. But those insistences were viable at least.

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