Moral focus sacrifices real debate

This is Monday’s Perspective column from Fund Strategy.

The political debate about income tax must be one of the most peculiar intellectual clashes of these peculiar times. It boils down to the rich debating the rich about how much tax should be paid by the rich.

It is hard to put a starting point on the latest clash, but the strongest candidate is August 14. On that date Warren Buffett, a billionaire investor, placed an opinion piece in the New York Times that argued the “mega-rich” should pay higher taxes. He proposed that those households earning more than $1m (£635,000) a year in taxable income should pay more immediately.

Buffett’s statement preceded – or more likely triggered – similar calls among many of Europe’s super-rich over the following weeks. On August 23, a group of 16 wealthy executives and investors signed a similar statement in Nouvel Observateur, a French weekly magazine. Soon afterwards a group of rich Germans reiterated a call they had first made back in 2009 to pay higher taxes. Luca di Montezemolo, the chairman of Ferrari, told the La Repubblica newspaper that it was right he should pay more tax because he is wealthy.

It took longer for the debate to take off in Britain. The tone was slightly different. On September 7, the Financial Times (FT) published a letter from a group of 20 economists in which they claimed the “50% rate of income tax is doing lasting damage to the British economy”. The thrust of their argument was that such a high rate of tax on the rich represented a punishment on wealth creation.

Among those opposing the call for a tax decrease were Chris Huhne, a Liberal Democrat cabinet minister, and Ed Balls, the shadow chancellor. The thrust of their arguments was that in these tough times such a move would be perceived as unfair.

Indeed it is striking how little of the international debate about tax rates refers to economics. Buffett’s original comment in the New York Times did not make an economic case for higher taxes.

Instead it implicitly assumed that the matter was one of fairness. Many other proponents of higher taxes on the super-rich have followed in his wake while opponents have often denounced such proposals as “class warfare”.

The FT letter was unusual in focusing on the economic dimension of the discussion, yet its arguments were weak. It noted that Britain has slipped from second to fourth as a destination for inward investment without proving that high personal taxes were the cause.

The rest of the letter essentially asserted that higher taxes make Britain less competitive internationally and a less attractive place to do business.

But the historical data on top tax rates on personal income does not reveal any correlation with economic growth. In America, for example, the highest tax rate reached 94% in 1944 and stayed at more than 90% until the early 1960s. Yet these were years of exceptionally strong growth. The comparison with today if anything suggests an inverse correlation between tax rates and economic expansion.

In Britain the top tax band was at 83% from 1974-79 before staying at 60% from 1979-88. Therefore, during most of Margaret Thatcher’s tenure as prime minister, from 1979-90, the top tax rate was much higher than the current level.

No doubt many economists would counter that it is simplistic to focus on the highest band of income tax. There are other forms of taxation that need to be taken into account including corporation tax and VAT. It is also possible for high rate taxpayers to find legal ways to minimise their tax bill.

Such objections only strengthen the argument that high income tax rates on the rich have little impact on economic growth. Whatever the highest notional rate it is certain that the advisers to the wealthy will find creative ways to avoid much of it.

The real message being pushed by advocates of high taxes is moral rather than economic. Again the clue is to be found in Buffett’s New York Times article. In both the first and last sentences of the piece he refers to the notion of “shared sacrifice”. It is clear that his main point is to persuade everyone in society, not just the rich, to accept reductions in their living standards.

Buffett’s argument is really a form of what used to be called “noblesse oblige”: the idea that with wealth or power comes responsibility. His argument is essentially that the rich should make sacrifices to set an example for the rest of society.

In fact Buffett was playing a bizarre double act with President Barack Obama. The billionaire’s reference to American leaders calling for shared sacrifice followed pleas by Obama using that term.

A month after the article was published the president referred to Buffett when he proposed a new minimum tax rate for those making more than $1m a year.

The arguments in Britain by Huhne, Balls and others defending the 50% tax rate follow similar lines. They do not argue that higher taxes make sense on economic grounds but that it would look bad to raise them when so many people are suffering from economic hardship.

Calls for sacrifice by and from the rich are motivated by an acute fear of social fragmentation. They are a desperate attempt to strengthen social solidarity when it appears to be under extreme stress.

Any discussion of how best to tackle the difficult economic challenges facing America and Europe is conspicuously absent from the debate.