Responses to changes in marginal tax rates for high earners

The research will examine the scale and nature of behavioural responses to changes in marginal tax rates among higher income individuals. Using a recently developed technique the researchers will examine the extent of individuals bunching their incomes around points at which marginal tax rates rise (i.e. whether there are a higher number of individuals with incomes around these levels than at slightly higher or lower levels) – the more responsive individuals are to tax rates, the more they will bunch around points where the marginal tax rate changes. The research will also examine how the income share of the richest 1% of individuals changed when the 50% income tax rate was introduced in 2010.

As revenue is raised from expenditure and corporate income taxes as well as personal income taxes, an understanding of the type of response (e.g. whether it is a real reduction in effort and output or an increase in avoidance or evasion) is necessary for the calculation of revenue changes. A key response is likely to be changes in contributions to private pensions, which are tax-deductible, but income from private pensions is taxable (albeit usually at a lower marginal rate) in retirement. The researchers aim to show how the extent of income-shifting affects our estimates of revenue-maximising tax rates.

The findings from this research are of clear relevance to policy-making and public debate. It will provide new evidence about how high income individuals respond to changes in their tax rates, allowing assessment of the revenue yield from tax changes (like the new 50% rate and the freezing of the higher-rate threshold) and the associated welfare costs.