IMF: higher taxes for rich will cut inequality without hitting growth

11 Oct

Higher income tax rates for the rich would help reduce inequality without having an adverse impact on growth, the International Monetary Fund has said.

In an analysis certain to be seized on by Labour as backing for its tax strategy, the IMF used its influential half-yearly fiscal monitor to attack the rationale for the reductions in tax for the highest earners in recent decades.

The IMF said tax theory suggested there should be “significantly higher” tax rates for those on higher incomes but the argument against doing so was that hitting the rich would be bad for growth.

“Empirical results do not support this argument, at least for levels of progressivity that are not excessive,” the IMF said, adding that different types of wealth taxes might also be considered.

The fiscal monitor does not mention any country by name, but the thrust of the report suggests it has doubts about the pro-rich tax plan proposed by Donald Trump for the US.

By contrast, its finding that tax systems have failed to keep pace with an ever-widening gap between those on the highest incomes and those struggling with stagnant wages had echoes of Jeremy Corbyn’s 2017 Labour manifesto.

Labour proposed a new 45% tax band on those earning more than £80,000 and a 50% rate for those on more than £123,000.

Corbyn and the shadow chancellor, John McDonnell, said the proposed changes were needed to arrest rising income inequality – a line of argument supported by the IMF study.

The fiscal monitor said most advanced economies in the west had experienced a sizeable increase in income inequality in the past three decades, driven primarily by the growing income of the top 1%.

Traditionally, governments have sought to make their societies less unequal by levying higher income tax rates on the rich and using the proceeds to help those less well off either directly or through public services.

But it found that income tax systems had become markedly less progressive in the 1980s and 1990s and had remained stable since then, even though growing inequality raised the need for a more progressive approach.

In an IMF blog, the head of the IMF’s fiscal affairs unit, Vitor Gaspar, said the average top income tax rate for the rich country members of the Organisation for Economic Cooperation and Development had fallen from 62% in 1981 to 35% in 2015.

“In addition, tax systems are less progressive than indicated by the statutory rates, because wealthy individuals have more access to tax relief,” Gaspar said in the blog co-written with Mercedes Garcia-Escribano. “Importantly, we find that some advanced economies can increase progressivity without hampering growth, as long as progressivity is not excessive.”

IMF research found that between 1985 and 1995, redistribution through the tax system had offset 60% of the increase in inequality caused by market forces. But between 1995 and 2010, income tax systems failed to respond to the continuing increase in inequality.

It also said inequality should be tackled by giving a more pro-poor slant to public spending.

“Despite progress, gaps in access to quality education and healthcare services between different income groups in the population remain in many countries,” Gaspar and Garcia-Escribano said, adding that in rich countries men with university education lived up to 14 years longer than those with secondary education or less.

“Better public spending can help, for instance, by reallocating education or health spending from the rich to the poor while keeping total public education or health spending unchanged,” they added.

In its separate global financial stability review, the IMF said it would take several years for central banks to return interest rates to more normal levels due to the risk of aborting recovery.

But the report also highlighted the risk that prolonged monetary support could lead to the buildup of further financial excesses. Too much money was chasing too few assets offering a yield, the IMF said.

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