The 50p tax nonsense – we need a new economic paradigm

There has been much coverage by the media of a letter to the FT by 20 high-profile economists urging the government to drop the 50p tax rate which applies to incomes over £150,000 and is paid by around 310,000 people.  The economists say the higher rate is doing “lasting damage” to the UK economy, makes the UK less competitive and should be dropped to stimulate growth.   Their thesis is that economic growth depends in large part on the efforts of a small group of high earners and also that these high earners are an entirely mercenary bunch.

Well, shock, horror!  But, before rushing to abolish the higher rate, ask yourself how much – if at all – mainstream economists understand the workings of the economy.  After all those who, like these, belong to the mainstream neoclassical school and who comprise the great majority of economists in government, in banking and in academia failed to see the credit crunch coming and, now that it’s here, quite obviously have no idea what to do about it.  They would like the public to see them as social scientists with the emphasis on the science bit, whereas in reality they are not scientists at all but the high priests of a cargo cult pushing a self-interested party line.   This letter is part of a campaign being run by PR firm Westbourne and some at least of those involved are very high earners.

(For the avoidance of doubt let me say I have a great deal of time for the minority of economists who genuinely try to follow the evidence and don’t insist in reducing complicated humans to “homo economicus“, a coldly rational calculating machine).

Also, ask yourself if you think there is any evidence that people behave in an entirely mercenary way.  Yes, people are influenced by material considerations but most of us have a life as well.  The officially sanctioned fantasy that people are entirely rational calculating machines is part of the failed paradigm that led to the crash.

The evidence that a 50p rate drives talented people away and/or damages industry is remarkable slight although these claims are often made.  Richard Murphy of Tax Research UK says there is no evidence of people relocating in significant numbers.  We had vastly higher marginal tax rates in the 50s, 60s and 70s yet by many measures the economy performed better than it has subsequently.  Of course, this doesn’t mean that marginal rates don’t matter but it does suggest that they are not crucial, at least not within broad limits and that the economy can do perfectly fine as long as other factors are not pulling it down.

In reality few high earners would succeed in isolation, unsupported by the wider community.  Many, perhaps most, of them are bankers, lawyers, accountants and perform service functions for the wider economy; they could not survive without it.  Some of that comes via being physically present in a country that provides a good legal and administrative framework but the City also depends to a high degree on huge implicit and explicit taxpayer subsidies without which much of it would not be viable.

And, if these 20 economists’ view is right, we should expect to find a superabundance of angel investors looking for promising startups, a ready flow of capital to SMEs wanting to expand and so on.  After all, we have more wealthy people with surplus funds to invest than ever before yet this just isn’t happening.  Capital for smaller businesses, whether new or established, is notoriously hard to find and expensive when found.  How can this be?

Perhaps the right wing’s favourite economist, Adam Smith, can help.  In Wealth of Nations he writes:

When a landlord, anuitant [i.e. someone with investment income] or monied man, has a greater revenue than what he judges sufficient to maintain his own family, he employs either the whole or a part of the surplus in maintaining one or more menial servants.  Increase this surplus and he will naturally increase the number of those servants.

Or, as we might say today, wealth tends to be spent on conspicuous consumption – which is why prestige houses and top jewellers are doing rather well.  Smith goes on to note that when an “independent workman” has a surplus:

… he naturally employs one or more journeymen with the surplus, in order to make a profit by their work.

In other words, then as now small business was the engine of employment and growth.  Look after the wealthy and luxury goods markets will boom as civil disruption and riots increase, look after Main Street and the economy will recover.

The conclusion has to be that we need to change the ruling economic paradigm if we are ever to get out of this depression.  If we carry on with the old paradigm things will only get worse.

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