Can you hike income tax without hurting the economy?

Increasing income tax rates for the rich could help reduce levels of inequality in developed countries, without hurting economic growth, new research from the International Monetary Fund suggests.

Debates on how to address inequality can be fierce and passionate, and the subject of taxes often takes centre stage.   

The right of the political spectrum is traditionally opposed to high tax rates, the left supports them. But it’s important to try and strip out the politics from such a discussion, however difficult that might be.   

Global inequality

As income levels in China and India catch up with more advanced economies, global income inequality has declined over recent decades. Yet the inequality within countries, particularly more advanced economies, has jumped.

In its new fiscal report, the IMF says the top 10% hold, on average, half of the wealth in countries within the Organisation for Economic Co-operation and Development (OECD).

The IMF reckons governments can reduce this inequality by increasing income tax for the top 1%, without this having a negative impact on economic growth.

Whilst higher tax rates bring in more revenue to the government, many argue that lower tax rates are better as they stimulate spending in the economy. Higher rate taxpayers, whether individuals or businesses may also be compelled to relocate if the tax bill becomes too high.

Progressive tax theory

These ideas fall into the theory of progressive income tax, where those with higher incomes are charged higher tax rates than those on lower wages. Many countries, including the UK, adopt this tax structure, but there’s been a fundamental change over the last few decades.

Following a big shift in the 1980s and 90s, the average top income tax rate for developed countries in the OECD fell from over 60% to 35% in 2015. In the UK the top tax rate for individuals currently stands at 45%.

The progressive tax system is an important tool in addressing income inequality, the IMF argues, alongside efficient spending on education and health.

Clearly, the IMF touched a nerve with its fiscal report, as the US accused the Washington-based group of wanting US tax reforms to fail. The US administration has announced a tax reform that will include slashing corporate and individual tax rates if it’s enacted.

Be clever with your money

The findings of the IMF report hold little sway when it comes to setting fiscal policy in the UK, but with Brexit negotiations ongoing, the Budget next month, and Central Banks under the spotlight, it’s important you’re prepared – it’s your future, after all.

It won’t come as a surprise that a rise in taxes will reduce the amount you take home each month. That will be hard to hear for those that are already feeling the squeeze of inflation against stagnant wage growth on the weekly shop.

A tighter budget could endanger any public propensity to save. Even if the Bank of England does hike interest rates in November, a low interest rate environment favours borrowers and spenders, over savers.

Financial security could take a hit, when the powers that be are already scolding Brits for being an ageing nation that isn’t saving enough.

But preparing for the future is important, especially when geopolitical noise abounds and Brexit negotiations are, to be generous, challenging.

Financial education

This backdrop makes financial education even more important, especially as Brits are known for being more prudish about money than our antics in the bedroom.

No matter the tax system, this isn’t an environment for savers. Money sat in cash savings accounts is at best gathering dust, or at worst losing purchasing power over time as inflation eats into the negligible returns on offer.

If you’re saving for a future that’s a couple of years away, you should consider investing to try and protect and grow your money. With interest rates so low, you’re not going to find many opportunities to offset inflation in a cash account.

When you do invest, make sure you maximise your returns by investing in a stocks and shares ISA. You can put up to £20,000 in an ISA and all your income and growth in the value of your investments will do so tax-free.

Unfortunately, I don’t have a crystal ball and I can’t tell you with any certainty what will happen to global financial and savings landscape as the UK negotiates its exit from the European Union and geopolitical tensions continue to rumble.

What I will urge you to do is take advantage of the tax benefits available to you today to try and build a more financially secure future for you and your family.