Their fair share?

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U.K. Sets Off Tax Bomb. It Goes Pfft.

Therese Raphael writes editorials on European politics and economics for Bloomberg View. She was editorial page editor of the Wall Street Journal Europe.
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Never have so many argued for so long about so little.

In telling the House of Commons last week that lowering the top U.K. tax rate to 45 percent from 50 percent raised an additional 8 billion pounds ($11.38 billion), Chancellor of the Exchequer George Osborne reprised a long-running argument over the top marginal rate. He couldn't resist gloating. The data, he crowed, "completely" refuted his Labour Party opponents' prediction that cutting the rate would cost the Treasury 3 billion pounds and be a boon to millionaires.

Labour wasn't buying Osborne's Conservative interpretation. Labour's shadow chancellor, John McDonnell, asserted that the added income resulted from rich people rearranging their financial affairs. Game still on.

Labour ran its last campaign on a platform that included a return to the 50-percent top rate, well above the OECD average of around 42 percent. That didn't turn out very well for Labour, but don't underestimate the support among U.K. voters for what by American standards are high tax rates.

A 2014 YouGov poll found that while most Americans believe it's their moral right to keep the money they earn, Britons are likely to stress a duty to contribute to public services. Democrats in the U.S. align closely with British Conservatives on tax: About 55 percent say the duty to contribute to public services is the stronger moral argument. That drops to 24 percent when you poll U.S. Republicans, and shoots to 71 percent for U.K. Labour voters.

This division is reflected in overall tax burdens: Where the U.S. tax take is 25.4 percent of gross domestic product, Britain's is 32.9 percent. Americans, as John Kenneth Galbraith once noted, may have revolted against taxation without representation, but they have never been very fond of taxation with representation either.

The 50-percent rate for those with incomes over 150,000 pounds (about $213,000) was announced in Labour's 2009 budget and implemented the next year. The move was first defended as a temporary measure to increase Treasury receipts. But Labour didn't get close to even the modest windfall it predicted. In fact, people at that level of income did a very rational thing: They arranged to pay as much as possible before the tax rate rose.

Reported incomes among those earning 150,000 pounds or more increased by 14 percent in 2009-2010, when taxpayers had been warned of the impending tax hike, and fell 25 percent the following tax year when it first came into effect. Dividend income grew 78 percent before the 50 percent rate came into effect and then fell 73 percent just after. A comprehensive report by Britain's tax authority, Her Majesty's Revenue and Customs, concluded:

Between £16 billion and £18 billion of income is estimated to have been brought forward to 2009-10 to avoid the additional rate of tax. This behavioral response is entirely legitimate, and difficult to prevent using anti-avoidance legislation.

Nor did the fairness argument for 50 percent hold much sway.  Labour could never quite answer why, if 50 percent is a fairer tax than 45 percent, they weren't advocating a return to 60 percent or 70 percent.

It's too early to say whether Osborne's 8-billion-pound bonanza is more than simply an avoidance-strategy windfall. Whether the rate is 45 percent or 50 percent, "This is only affecting 1 percent of people so you wouldn't expect it to make much difference," says James Browne of the Institute of Fiscal Studies in London. "It would be hardly noticeable in terms of GDP."

As much as I would like to find some, the British experience doesn't offer compelling evidence so far that fiddling with tax rates at this level makes a meaningful economic difference. The prevalence of behavioral responses at the high end of earnings does, however, recommend broadening the tax base and closing loopholes.

That isn't to say that marginal tax rates are irrelevant. The fact that top-earning British taxpayers shifted their income and the timing of reporting around to avoid an extra five percentage points suggests that this group is sensitive to even relatively small changes.

Many warned that there would be an exodus of high-skilled (and highly paid) labor. It didn't happen, but it wasn't pure scaremongering either. I knew people who seriously considered leaving. It may be that the 50-percent rate wasn't in place long enough to have impact; the government had explicitly said it was a temporary measure.

Leaving homes, schools and communities takes quite a big push. My closest friend during high school was a girl whose family had moved from Sweden, fed up with the country's exorbitant tax rates in the 1970s. They resettled on the East Coast of the U.S. and built a successful business. It was Sweden's loss and America's gain. Evidence on the international migration of top soccer stars in Europe has shown income tax rates to be a major factor. It has also played a role in the major influx of French nationals to Britain after the government of Francois Hollande imposed a 75 percent rate. But there are many reasons high-skilled labour remains in Britain despite relatively hefty rates of taxation.

I suspect that Britain has reached a place, perhaps only temporarily, where social justice concerns cohabit acceptably with revenue optimization. It's higher than Americans would tolerate and lower than some Britons would like. That will not settle the argument though, because it's not really about income or the economy. It's about the push-me, pull-you that is at the heart of the British electorate, between Anglo-Saxon notions of economic freedom and a social consciousness that is more continental European. Finger-pointing and accusations aside, Britain has so far managed to have it both ways.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Therese Raphael at traphael4@bloomberg.net

To contact the editor responsible for this story:
Jonathan Landman at jlandman4@bloomberg.net