Wednesday, February 22, 2012

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Why High Tax Rates Fail

economic commentary by Reb Akiva @ Mystical Paths

Telegraph UK: The Treasury received £10.35 billion in income tax payments from those paying by self-assessment last month, a drop of £509 million compared with January 2011.

It is the first year following the introduction of the 50% rate which had been expected to boost tax revenues from self-assessment by more than £1 billion.

A Treasury source said the relatively poor revenues from self-assessment returns was partly down to highly-paid individuals arranging their affairs to avoid paying the 50% rate.

While there are plenty who believe you can simply tax people as much as you want, economic research and actual experience repeatedly shows that when tax rates exceed a certain level, money received by taxing actually FALLS.  So while a government may get more money when increasing taxes from 20% to 30%, when that same tax goes higher than 40% the actual money received becomes less.  And the higher it goes, the less it becomes.

Why?  It’s never worth cheating on your taxes when they’re 10%, but when they’re 50% it’s another story.  Cheating also means working the system per every rule.  I’m not going to hire an expensive accountant to save me 1% when I’m being taxed 10%.  But I’m certainly going to hire that accountant and tax lawyer to save me 10% when I’m being taxed 50%.

Also, if the government is going to take half my money, why bother?  Say I’m a corporate vice president.  If I work 60 hours a week I may be up for a bonus of $500,000 at the end of the year.  If I’m taxed at 25%, that’s the price I pay for the wonderful opportunity.  If I’m taxed at 50%…I may as well work the regular 40 hours a week and go for the smaller bonus (which will be taxed at a lower rate).

Not to be forgotten is the black market or grey market.  As with tax cheating, it’s not worth it at low rates.  But at high rates I’m willing to do some deals under the table, since the profit (50%) is major.

And lastly, in a global marketplace the costs of shifting some or all of my business to lower tax areas becomes worthwhile when the rates exceed the cost of the move.

The result of all of these combined is a FALL in taxes revenue when rates go too high.  For England it appears 50% is too high.

This is one reason why President Reagan’s administration was able to lower tax rates from 70% to 31% for the highest earners in the US in the 1980’s and get a major INCREASE in tax revenue. 

Got that?  Lower taxes, increase tax revenue.  Counter intuitive but true.

It’s also shown in communist and socialist situations where the government effectively pushes taxes over 70% and/or actually confiscates resources that people basically give up. Nobody is willing to work hard and generate major economic activity just to watch it all be taken away.  This is what happened in the past in Russia, and what’s happening today in Venezuela.

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