The most controversial announcement in George Osborne’s Budget was the cut in the top rate of income tax from 50 per cent to 45 per cent from next year. The opposition party’s response was directed toward this single measure, although it accounted for a mere £50m of estimated lost revenue in its first year. Mr Osborne must have calculated that the economic gain would outweigh the political pain.

He was supported in his economic case by an impressive new study by HM Revenue & Customs, based on the actual tax returns of the 300,000 people with incomes above £150,000, which puts them into the highest tax bracket. They comprise about one per cent of UK taxpayers and account for about 30 per cent of income tax revenues. Studies from other countries have shown that higher earners are more likely to change their behaviour in response to tax changes than lower earners. This was indeed borne out in the UK with the potential yield from the 50 per cent tax payers decreased by more than 80 per cent through legal behavioural changes. These ranged from bringing forward income via dividends to working less and emigrating. The Swiss Federal Migration Office reported a 29 per cent increase in Britons given long-term work permits in 2010 compared with the previous year. While this is only one example, the HMRC estimates are consistent with other academic studies (such as the Mirrlees review), which show that such a high marginal rate is a highly distortionary and ineffective form of taxation. Continue reading »