The 38 per cent rule: There’s a limit to how much the state can tax the people
Ed Miliband’s proposal to tax non-doms more harshly may be good, populist politics. But does it make economic sense? At most, the yield will be around £1bn, even if people do not alter their behaviour in response to the change in policy. The actual amount generated could even be negative if enough non-doms leave the country. Most commentators recognise this.
The history of tax wheezes dreamt up by governments is a litany of the eventual tax take falling short of its anticipated level because of changes in behaviour. In 1795, Britain was engaged in a titanic struggle for survival against revolutionary France. The sheer scale of the war put the public finances under unprecedented strain. The then Prime Minister, William Pitt, invented the Powder Tax. Anyone wishing to buy powder for his wig had to register and pay a tax of a guinea (£1.05), a non-trivial amount in those days. Wigs rapidly went out of fashion, and the tax yielded very little. The diehards who persisted with wigs became known as “guinea pigs”, the origin of the modern phrase.
There does seem to be a limit to the amount of tax which British governments are able to raise. Fifty years ago, a new Labour government, headed by Harold Wilson, had just come to power, determined to transform the British economy. In the financial year 1964-65, the total amount of tax and National Insurance payments raised came to 36.2 per cent of GDP. In the final year of office of this highly interventionist government, 1969-70, this figure had risen. It had increased to the dizzy height of 37.4 per cent. A government which by today’s standards was radical and left wing felt able to put taxes up by all of 1 per cent of GDP.
The 1969-70 level is almost the highest ever recorded over the past five decades in the UK, being fractionally higher in the recession of the early 1980s at 37.6 per cent. Gordon Brown controlled domestic policy in Britain from 1997 onwards. The tax manual doubled in size thanks to the huge number of new schemes Brown introduced. But when he was booted out by the electorate just after the end of the tax year 2009-10, tax and social security receipts were only 34.5 per cent of GDP.
Elected authorities at all levels in the UK seem to be reluctant to increase tax beyond a certain point. The Scottish Executive has long had the power to raise the basic rate of income tax by up to 3p in the pound. But despite the fact that the body has always been controlled by parties of the Left – Labour and the SNP – neither has used the power. Local authorities can hold referenda to put up council tax, but they don’t.
The 38 per cent threshold is not an immutable physical law. But no UK government of any political persuasion in the past 50 years has been either willing or able to raise more tax than this as a percentage of GDP. This sets clear limits to the ambitions of any government during the next Parliament.
[custom id=”1″]