Does international labour mobility make it impossible to tax the rich?
By Shariq Varawalla, Westminster School
Empirically in the UK, the top 1% of earners had a share of 29.8% of the total tax paid to government last year (HMRC, 2014). This on first impression would suggest that the talented high earners of the UK pay their tax. The OECD found that a high burden of taxation was on “mobile high-skilled workers” in developed economies and also suggested that this group of workers was more responsive to changes in the income tax rate compared to other groups. It warns that the international mobility of these workers was a concern for governments as they added “significant value to an economy”. They even went on to explore the merits of possible tax concessions to this group (OECD, 2011). The non- UK domicile tax laws are an example of such concession where non-UK income and capital gains are not liable to taxation in the UK for the non-domiciles (HMRC, 2013). This essay explores the extent to which talent is mobile, the effect of taxation on labour markets and migrants’ rational decision- making process.
The effect of taxation on labour markets can be analysed using fundamental economic model of supply and demand. Markets will tend to equilibrium where supply equals demand; this is the intersection of the supply and demand of a good. An increase in the level for example of income tax will cause a leftwards shift of the supply curve for labour. This would cause equilibrium wage rate to rise and quantity to fall. There is much debate in the world of economics about the exact effect of income tax on labour markets (Phillips, 2008) with very extensive literature on the subject. A higher tax rate reduces the reward for working. This results in the substitution effect as labourers have an incentive to partake in more leisure at the expense of work i.e. the opportunity cost of leisure reduces. This also has an impact on entrepreneurship where there is a reduced incentive to start a business in a high tax jurisdiction. The second opposing effect of an increase in income tax is the income effect. A higher tax rate decreases the disposable income of workers, hence the marginal incentive to work longer hours increases. But the evidence for high earners suggests that the substitution effect is larger than the income effect (HMRC, 2012) hence net effect of an increase in income tax is negative. High- skilled international mobility makes the world’s talent less likely to work in a country with high or increasing income taxes. Migration could result in reduced labour market participation, such that talent itself is as labour in high demand and low supply. This results in inelastic supply as well as inelastic demand (Fabbri, et al., 2002) with consequential substantial effects on wage rates.
The mathematical calculation of the effect on government tax revenue involves the use of “taxable income elasticity” (TIE). It is a measure of the responsiveness of total taxable income to changes in the marginal tax rates. If TIE is large enough, it is possible that an increase in the marginal tax rate would result in a decrease in tax revenues. This is not necessarily suggesting total incomes are falling; more that total taxable incomes are falling. This signifies an increase in both tax evasion, which is illegal, and planning and minimization, which is perfectly legal but not necessarily moral. Many estimates of TIE have been made perhaps the most applicable is the Brewer, Saez and Shephard calculation of 0.46 for the top 1% income group (HMRC, 2012). This means a 1% fall in the net-of-tax rate1, taxable income would fall by 0.46%. (IFS, 2009). This value suggests that government increasing the tax rate in the UK would actually decrease tax revenue. The fact that the UK taxation system is progressive and has various benefit concessions means that there is no single TIE value for individuals, thus limiting the accuracy of the mathematical calculation on the effect on tax revenue on a population basis.
When the maximum 50% tax rate was introduced on earnings over £150,000 in Britain, which was previously 40% in April 2010 the hypothesis is that highly skilled workers would be deterred from migrating to the UK. Empirically this was not the case, as in Q1 2010 3,680 workers (Home Office, 2013) classed as PBS Tier 1, which is the bracket for entrepreneurs, investors and ‘exceptional talent’. In Q2 2010, the first quarter where the new higher rate for the top income bracket was created, 3,960 PBS tier 1 immigrants were allowed into the UK (Home Office, 2013). This modest increase in immigrants into the UK would suggest that increase income tax does not actually result in talent not entering a country. There are lots of other factors at play as 2010 was a volatile economic period but what the data does show is that the increase of the tax rate from 40% to 50% did not deter immigration of high skilled workers into the UK. The raw data can be misleading though as many employers apply tax equalisation that neutralises the impact on employees moving between countries. Ultimately, the higher tax rate and the increased National Insurance contributions did increase the cost to employers for having highly paid and skilled professional in the UK.
By further examining the rise of the top income tax rate in 2010 by Alistair Darling the then Chancellor it is possible to examine the cost-benefit analysis of the migration of talent. The UK has a progressive income taxation system; this means that the higher one’s earnings are the more as a proportion of income one has to pay. It works on an incremental basis; there are tax brackets, which are the cutoff values for taxable income after which a higher rate must be paid. For example, a childless adult between the ages of 21 to 65 working in the UK with an income of £250,000 in the pre tax increase year of 2009/10 would have been liable to pay £89,932 whilst in the financial year 2010/11 the amount would increase for the same pay to £102,520 (listentotaxman, 2013). It is important to note that only 41% of the £250,000 would have been paid in tax not the full 50% due to the progressive system. Therefore, the net loss in disposable income is £12,588. For a rational individual therefore to migrate internationally the benefit of moving must outweigh the cost. If the assumption is made that the individual has already made an optimal decision such that no job with a higher net benefit i.e. wage plus other benefits of work minus the negatives of work namely the leisure forgone then the worker has to migrate in order to maintain his disposable income. The worker can only expect a wage of up to £250,000 abroad as any higher he would have chosen to move to that country in the first place. Hence for the worker to move the cost of time finding a job of that same pay, the cost of actually moving and other costs like that of social ties being broken for example children having to move school all have to sum in monetary terms to less than £12,588 for the individual to move. The level of mobility therefore is dependent on the costs involved in international migration. If the costs are low then talent is very internationally mobile making it very hard for governments to raise income tax, as this will result in a mass exodus of talent, which is also called ‘brain drain’. Considerable ex-patriot infrastructure ranging from international schools, foreign language hospitals and gated communities do reduce these costs. But these costs will never be zero hence there will always be a value which government can increase income tax to such that the rational worker will not migrate. Hence, it can never be impossible to tax a rich worker, though for the entrepreneur that is a separate question.
Cases like Depardieu-gate in France and of Eduardo Saverin in the US are high-profile examples of individuals fleeing their country in order to avoid the high income tax rates. The statistics do suggest that talent is increasingly fleeing high taxation systems. In Q1 of 2014, 1,001 Americans renounced their US citizenship (Gersham, 2014): this was the highest quarterly number on record. However, two points are raised by this. Firstly, the US policy of taxing worldwide income may be considered unfair considering many systems only tax domestic income, hence international mobility of talent definitely makes it impossible to excessively tax the rich. Secondly, what the data does not show is that some are now arguing that the criteria for immigrating to a country is not only the tax rate; there is a “new rule of capital – money will move to where it’s treated best” (Frank, 2012). Technological advancements have meant the rich can manage global investments and businesses from any location, as long as they don’t have to pay tax on worldwide income they are not liable to pay tax on these incomes to the country they live in. Consequently, social considerations are taken into account like quality of life as well as of course the climate! The rich cannot maintain the kind of enriching lifestyle they receive in London or New York in many of the traditional tax havens hence US nationals are reported to now be moving to large European countries like Britain and Switzerland despite them not having the lowest tax rates (Lesperance, 2012). The effect on business confidence and entrepreneurial spirit may be greater than the actual financial cost of the tax to individuals. Francois Hollande’s 75% top tax bracket is a symbolic gesture to the super-rich that France is not open to business. The tax lawyer Michel Collet said “Talent and skills go where they are welcome”, the surge in French nationals seeking homes in London2 and Belgium that was seen post the 2012 election demonstrates that talent will move to escape aggressively taxing countries (Chassany & Simmons, 2012). The theory supports this that a higher tax rate makes internationally mobile labour more likely to migrate in anticipation of lower disposable income.
Competitive taxation policy is when governments lower taxes in order to attract the FDI or at least prevent the outflow of resources: this includes attracting high skilled workers into a country. Especially for small countries, there is sound economic evidence to suggest this boosts economic growth and actually increases tax revenue (Brill & Hassett, 2007). Some of these countries are described as tax havens but larger countries like Ireland have also implemented such policy. However, if the Laffer curve is considered then multiple countries competitively cutting taxes to below the optimal tax rate will result in government revenue falling (Kleven, et al., 2009) . Nonetheless, there will always be countries where it is economically viable to carry out competitive taxation policy hence talent will always have the option to move to such places. Full tax harmonization, a world where tax rates are identical around the world, is a utopic vision but events like the 2013 G8 summit show that world sentiment is changing and so a crack down on tax evasion and avoidance has begun. The G8 final declaration was, “Tax authorities across the world should automatically share information to fight the scourge of tax evasion”. For the UK in particular, 10 British Dependencies including Jersey and the Cayman Islands were signed up to international tax-related information sharing convention (M.V., 2013). Considering a lot of tax avoidance happens due to the cloud of secrecy around the financial arrangements these measures should help. Should tax rates around the world begin to converge the fiscal incentive to migrate will decrease such that the migration of talent will be less responsive to a change in tax in one country.
Clearly it is not impossible to tax the rich, but they will always tax minimise such that loopholes and havens will be sought and exploited. However, initiatives like the increased tax cooperation and information sharing amongst the G8 countries are reducing this. The fact that high skilled labour is mobile means that they will always have the option to move from high tax to low tax countries. Irrespective of the economic arguments regarding the optimal taxation level, governments will find it very difficult to raise taxes beyond a certain level without the flight of its most productive human capital, as we have seen more recently in France. However, the strong attractions of living in global cities like London and New York will mean that highly skilled labour will despite higher taxes still choose to live and be taxed in these cities. For entrepreneurs the need for linkages to venture capital, stable political and legal environments and talent will mean that within reason, irrespective of tax they will choose to locate their businesses where it makes the most commercial sense. The caricature of the capitalist class spending their lives on yachts in tax havens just does not hold. Thus barring penal and excessive taxation, highly skilled international talent will not seek to locate itself purely on tax considerations and we can conclude that this group of people can be taxed sufficiently contrary to public opinion around the world.
1 One minus the marginal tax rate
2 30% increase in interest in wealthy boroughs in 2013 according to estate agents Knight Frank LLP