Damien Grant: Taxing the rich is popular but imprudent

In 2008, the cost to the economy of each dollar raised at the rate of 39c was more than the tax collected. Photo / Thinkstock

Back in 1999 Helen Clark and Dr (now Sir) Michael Cullen raised the top rate of marginal tax from 33c to 39c for those earning over $60,000.

This was politically popular with people who earned less than $60,000 and the army of indolent people who thrived under the fifth Labour Government. The idea was to raise more money from the wealthy. It failed.

Government revenue did rise, from 31 per cent of GDP in 1999 to a high water mark of 34.5 per cent in 2006 but this extra tax was not paid by the rich, it was paid by the middle class, workers in PAYE jobs who lacked the ability or creativity of the wealthy and self-employed to do what any self-respecting plumber does - evade tax.

Readers of a certain vintage may remember Reagan-era economist Alfred Laffer, who gave his name to the Laffer curve, the idea that increasing the rate you taxed someone caused them to work less. A zero rate of tax would raise no revenue and at the other extreme if you taxed all of someone's income no one would work and thus no tax would be collected.

There is an optimal rate of tax; if it were increased or decreased, total tax revenue would fall.

Earlier this month the Treasury published a study by economists Iris Claus, John Creedy and Josh Teng, who looked into the effects of the increase in the top rate of tax to 39 per cent in 2000 and its return to 33 per cent in 2008. The share of tax paid by top income earners did not increase once the top rate of marginal tax was raised. More importantly, the cost to the economy of each dollar raised at the rate of 39c was more than the tax collected. Total tax revenue rose as middle-income earners moved into the top tax bracket because of inflation.

When the top tax rate decreased to 33 per cent, the level of tax paid by the top 10 per cent remained the same.

Here is the ugly truth about tax: the middle class pay it. The rich do pay a lot of tax but beyond a certain level tax is voluntary. The creative minds employed by tax evaders are well resourced and paid.

What the Treasury paper does not investigate is why the rich did not pay more, perhaps because unfounded speculation is best left to newspaper commentators than peer-reviewed Treasury papers. So I will tell you.

Some reworked their taxable income into trusts where the tax rate was lower. Among them were Christchurch surgeons Penny and Hooper, who were prosecuted by the IRD for tax avoidance. Others decided it was easier to work less. Those with real money sent that money overseas, creating jobs in places such as Uruguay. Taxing the rich is popular politics but poor economics.