Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

The British government announced last week that it was reducing the top income tax rate to 45 percent from 50 percent, effective April 1, 2013. The top rate was raised to 50 percent from 40 percent two years ago, but failed to raise nearly as much revenue as expected. The experience may shed some light on the possible effects of raising the top rate in the United States.

Today's Economist Perspectives from expert contributors.

In November 2008, the Labor government announced plans to raise the top rate to 45 percent beginning in April 2011 from 40 percent, where it had been for 20 years. In its 2009 budget, the government announced an increase in the top rate to 50 percent, effective April 6, 2010.

The higher rate affected taxpayers with incomes above £150,000 (about $238,000), which is roughly the top 1 percent, or about 300,000 individuals. The increase was expected to yield about £2.5 billion a year of net additional revenue and raise the share of total income taxes paid by the top 1 percent to 27.7 percent from 25 percent.



The original revenue estimate included an assumption that about two-thirds of the gross revenue yield would be lost because of behavioral effects. That is, the amount of revenue that would be collected with no change in behavior, like reducing hours worked or engaging in additional tax avoidance, would be two-thirds larger.

Her Majesty’s Treasury, Britain

In May 2010, there was a general election in Britain, and a coalition government led by the Conservative Party took control. In its 2011 budget, the government announced that the Treasury would study the impact of the new higher tax rate before recommending changes, and that study was published last week.

The study concluded that the behavioral effect of raising the top rate was much more powerful than anticipated. Two factors in particular had a large effect on revenues.

There was a timing effect. People moved income that they anticipated receiving forward so it would be taxed before the new higher rate took effect. They also postponed the receipt of income into the future in anticipation of a change in the tax rate after the election of a new government.

Also, because the British top rate had increased above that in all other major countries except Japan, many Britons relocated in reaction. For example, 1,379 people in high-income occupations moved to Switzerland in 2010, a 29 percent increase over the previous year.

Keep in mind that while the United States taxes its citizens and resident aliens wherever they live, the British are taxed only in the country where they are living.

Taking account of the much greater behavioral impact from the higher top rate than anticipated, Treasury economists concluded that the cost of reducing the top rate to 45 percent from 50 percent was negligible in terms of revenue – about £100 million a year.

Her Majesty’s Treasury, Britain

Note that the behavioral response is positive when rates are reduced. All the effects that reduce revenue when tax rates are raised are reversed, thus recouping revenue lost from the rate reduction. British Treasury economists estimate that 97 percent of the static revenue loss will be recouped. In short, this appears to be a case in which a tax cut literally pays for itself.

It’s important to remember that this experience may be exceptional. In particular, because of the importance of income-shifting, the short-term effect of tax-rate changes may have been much larger than the long-term effect, exaggerating the behavioral response.

We saw this in the United States in 1992, when many taxpayers anticipated an increase in rates by the Clinton administration and brought forward income from 1993. For example, on Dec. 2, 1992, The New York Times reported that senior executives of Disney sold $200 million in stock, citing “the strong likelihood of impending tax legislation” for their actions.

However, in the longer term, the 1993 tax increase in the United States, which raised the top rate to 39.6 percent from 31 percent, did raise substantial additional revenue. It’s possible that had the higher British tax rate been allowed to continue, it, too, would have raised more revenue than the estimates shown in the table.

It is difficult to say to what extent the recent British experience is relevant to the United States. The Congressional Budget Office projects that raising the top income tax rate to 39.6 percent from 35 percent, and other tax increases scheduled to take effect on Jan. 1 under current law, will raise federal revenues as a share of the gross domestic product to 20 percent over the next five years from 17.7 percent if current tax cuts are extended.

But a March 20 analysis from Congress’s Joint Committee on Taxation estimates that implementation of the so-called Buffett rule, which would require those making $1 million or more a year to pay an effective federal income tax rate of at least 30 percent, would raise only $46.7 billion over the next 10 years. That’s a drop in the bucket compared with the $41.2 trillion in federal revenues expected to be collected under current law.

It may well be that raising the top income tax rate is not the best way to raise additional revenue from the wealthy, although recent estimates show that the revenue-maximizing top rate in the United States might be as high as 83 percent. Limiting tax deductions for the wealthy might be more effective.

Whatever we do, we should try to learn as much as possible from the experience of other nations. The research in the British Treasury study would be a good place to start.