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Growth is about so much more than just the top rate of tax | Will Hutton

The notion that so-called ‘wealth-generators’ must be treated differently from the rest of us is nonsense that has gone on for too long

The great delusion of the age is that society must be endlessly grateful to the wealthy. They owe nothing to society. Rather, society owes everything to them as “wealth generators” because society contributes nothing to their success. The mores and values that inform the rest of human interaction – reciprocity, proportional distribution of pain and reward, trust and social obligation – must be suspended for them. If we want to enjoy the benefits of a dynamic capitalism we must recognise that the rich are different – and not self-defeatingly tax them. American neo-conservatives and their Republican outriders have worked tirelessly for 50 years to promote this hocus pocus, which offends not only the first principles of humanity, but of what we know about capitalism.

Successful capitalism is an incredibly difficult phenomenon to create and sustain. It depends on entrepreneurial flair, yes, but also on ideas, institutions and processes ranging from great universities to innovative financial organisations that do not always appear spontaneously by the operation of free markets. They sometimes have to be designed by public action. Great businesses and wealth flower in strong societies that equip their entrepreneurs to prosper. The framework which supports this costs money, and it is proper that the rich should contribute proportionally.

But this means “Big Government”, complain American neo-conservatives, so that these unexceptional, commonsensical propositions become transmuted into an alleged dimunition of individual freedom – culminating in the Tea Party movement and the breakdown of US politics. Blessed is a weak society and strangulated state but with lots of lowly taxed, rich individuals. Except that in a generation’s time everyone will be poorer.

Last week Britain had its own mini tea-party moment – an extraordinary letter signed by some 20 economists who claimed to take the politics out of the debate about the top rate of income tax. Britain needed a growth strategy, they argued, and what was holding back inward direct investment, risk-taking and entrepreneurial zeal generally was Labour’s increase in the top rate of income tax to 50 pence in the pound for those earning over £ 150,000, an increase that the coalition government had not reversed – but it should, they argued.

It was over-exaggerated, politicised hype. Of course punitive, confiscatory tax rates are real deterrents to enterprise, but a 50% top tax rate hardly qualifies. Instead the writers embrace a notion of economic rationality that thinks it can identify predictable and measurable increases in effort and entrepreneurial zeal for comparable cuts in income tax in a linear relationship.

But human motivation, especially for business builders and entrepreneurs, is infinitely more subtle. They are driven by a matrix of motivations. And, like everybody else, they are embedded in family and friendships that are rooted in place. The few good studies we have show, for example, that significant differences in top income tax do not cause people to migrate across US states – an easier task than coming in or out of Britain. Nor are the differences matched by significant differential growth performance.

Equally, the assertion that top tax payers contribute so much revenue that they must be prevented from becoming a dying species is to mix up apples and pears. What has been driving the increases in revenue from the top 1% of tax payers is the monumental rise in income inequality over the last 25 years – a rise that has not been associated with improved economic performance. Rather, there has been an arms race driving ever higher executive pay, certainly bringing some upward bias to tax revenues, but it should hardly be confused as the ” incentive” of lower tax on the rich. But the letter signatories were careless of this evidence – and much other evidence besides. For example, their assertion that other major economies “had got back to pre-recession output levels” while Britain, soaking the rich, had not, was plain wrong. All the six top high-income countries – the US, Germany, Japan, France, Italy and the UK – reported output in the second quarter of 2011 below the respective peaks of 2008. None has fully recovered. The US and Germany have fared least badly – but their rates of top income tax vary considerably. A linear correlation between taxing the rich and growth does not exist.

The letter, for all its pretensions to be about “non-political” economics, was instead a surrender to the Tea Party world view. Pfizer did not recently close its operation in Sandwich, Kent, because of the 50% income tax rate: rather, massively concerned about its business model, it has concentrated research in those parts of the world where it judges that there is a strong ecology supporting the pharmaceutical industry. Equally Telefónica, locating its digital business in London last week, came because it liked Britain’s openness and the ecosystem supporting its digital operation. The top rate of tax did not challenge this judgment.

So why have 20 economists thus risked their standing? Part of the answer is that economics itself has been so captured by the neo-conservative right that many of its practitioners can no longer think straight. And for any variety of personal and political reasons, there is virility in associating oneself with a primitive, hunter-gatherer view of capitalism. To do better, to challenge the current orthodoxies, requires originality and hard work. Much easier to play to the gallery with a substandard letter to the FT.

That is not to argue that the rich like paying tax. They don’t. But a growing number, such as former M&S boss Sir Stuart Rose, urging the government not to heed the economists’ call, recognise that the rich are part of society too. For perhaps the worst consequence of the letter is that it diverts discussion from what really drives dynamic capitalism – the revolutionary urge to innovate and the deep plumbing of its institutions which aid or abet that effort. Where this is not happening, it needs to be corrected by an enterprising state – an argument I and two colleagues set out in a paper “Making the UK a global innovation hub” for the newly formed Big Innovation Centre on www.biginnovationcentre.

The top rate of tax can’t alone be at the heart of a growth strategy. Britain needs more demand, stronger banks, better capitalism and sounder institutional structures to help us capitalise upon the coming wave of scientific and technological possibility. Get all that right, and growth and investment will follow. Wealth generation is about very much more than pampering the rich. © 2011 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds