Higher Tax Rates – a Poison Pill for Government Finances?

John Redwood and the Adam Smith Institute may have inadvertently exposed a poison pill left by the outgoing Labour Government.

I completely agree with the contention that in the medium to long term higher tax rates reduce revenue. The ASI obtain this conclusion from the analysis of Capital Gains Tax Rates and revenues over the past fifty years. However, looking at the ASI’s graph on page 3, suggests something important for short-term tax policy as well.

For instance, in 1986, the year before tax rates rose from 20% to 28%, revenue rose 96%. In 2002, the year before tax rates dropped from 20% to 15%, tax revenue dropped 26%.

The expectation of a change in tax rates is highly significant on short–term revenue as people optimise the year in which they declare the capital gains

The UK had just the same effect with income tax in March. The deficit for the last financial year was £11bn lower than forecast in the last budget, (due to higher tax receipts from top earners than expected), and over £20bn lower than forecast last autumn.

In the budget I would therefore expect an adjustment for lower than expected tax revenues from higher rate tax payers in next month’s budget of at least £10bn.