How should we tax income?
Earlier this week, I had a lively economic debate over dinner with two young Right-wing friends.
They are both broadly supportive of the Laffer curve which suggests that, above a certain percentage rate, tax on income produces a lower yield and they believe that in many Western economies we are already beyond that rate so consequently government should reduce tax rates and this would increase tax revenues.
At the theoretical level, I am always suspicious of neat relationships in the real world suggested by academic economists. I remember the Phillips curve for instance. Furthermore proponents of the Laffer curve differ wildly on the tax rate beyond which the tax yield falls with estimates varying from around 35% to 70%.
I am highly sceptical of the utility of the Laffer curve. It presupposes that very high earners are incentivised by higher take-home pay and that they would not work for salaries where most of the marginal increase in income is taken by tax. I suspect that, beyond a certain of level income, increases in take-home pay are not that important and that such high earners like excessive gross salaries – regardless of the marginal rate of tax – because it is a symbol of their status and power.
Clearly, however, high marginal rates of tax are likely to stimulate tax evasion and I just wish that we would put as much effort into combating tax evasion – by individuals and corporations – as we should do in combating benefit fraud.
My friends are also in favour of a flat rate income tax rather than a progressive rate tax regime. Unless we had a much narrower distribution of incomes, I would be opposed to a flat tax on social equity grounds. Flat tax is regressive. Those with lower incomes tend to pay a higher proportion of their income in total taxes than the affluent do. It should be the reverse.