"The idea of increasing the top marginal tax rate in Australia is unlikely to raise any revenue, and may actually decrease government revenue due to a shrinking in the tax base, as high-income people reduce their labour supply, investment, innovation and tax compliance," said John Humphreys, the deputy director of the Australian Taxpayers Alliance and an economics lecturer at the University of Queensland.
In dynamic tax theory, the revenue-maximising tax rate can be measured using the formula t* = 1 / (1+a.e). The "a" variable is the measure of income dispersion calculated by a = (z*-z) / z which can be easily calculated based on ATO statistics and is close to two in Australia. The more contentious "e" is the elasticity of taxable income which can be estimated by looking at the international literatures.
"Based on mainstream estimates of the high-income elasticity of taxable income, it is fairly straight forward to calculate the tax rate that will raise the maximum amount of revenue, and in Australia that is about 45%. If tax is increased beyond that level, then it is unlikely to raise revenue, and may actually cause a drop in revenue. The current top marginal tax rate is 47% if we include the falsely named Medicare Levy, and a proposal to increase that rate further to 49% makes absolutely no economic or fiscal sense."
The modeling by Humphreys is due to be published in Policy Journal in the coming months, and will include costings of various tax reforms that show marginal changes in the top marginal tax rate (in either direction) have very little impact on revenue because of the behavioural responses.
"The literature on the elasticity of taxable income is quite clear that high-income people have a greater capacity to change jobs or working practices, to change investment and innovation decisions, to afford tax accountants to help them minimize tax, to move countries, and sometimes to take advantage of tax evasion schemes. Even estimates from pro-tax advocates at Harvard suggest an elasticity of at least 0.6 and the recent experience in the UK also suggests an elasticity of 0.6 for high-income earners.
"The experience in the UK was particularly noteworthy. When the UK government increased the top marginal income tax rate from 40% to 50% the British Treasury estimated that the tax increased raised nearly no additional revenue. When the top marginal tax rate was dropped to 45% the revenue from high-income earners increased substantially. The UK Treasury now estimates their revenue-maximising top marginal tax rate at about 48%.
"There is no logical argument for increasing marginal tax rates about the revenue-maximising level, and indeed there is no good argument for having tax rates anywhere near the revenue-maximising level since those taxes raise very little money but cause significant economic damage.
"The proposed increase in the top marginal tax rate in Australia cannot be justified by normal economic analysis. It is a measure that will reduce investment and innovation, it will ironically lead to lower levels of private charity, and it will raise no revenue for the government. The only reason for such a tax increase is to make the political point of deliberately hurting successful people out of spite or jealousy."
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