IMF: Tax hikes need not harm growth

Person filling out French tax form Image copyright AFP

The International Monetary Fund says that some rich countries could raise top rates of income tax without harming economic performance.

A new report from the IMF looks at what governments can do about inequality.

It also says that income from capital needs to be taxed adequately.

The IMF argues that government spending and tax policies play an important role in determining the level of inequality, which it says has increased in most developed economies in recent decades.

The report says that in those countries, what it calls "redistributive fiscal policies" - tax and spending - can make a substantial difference. On average, it says, they reduce inequality by about a third. Spending policies include payments to people on lower incomes and the provision of services such as health and education.

Personal income tax has become less progressive in the 1980s and 1990s - that is to say, the tax rate as income rises does not increase as much as it used to do. Or to put it another way, the extent to which higher earners pay more tax has declined.

The average top rate for the rich countries fell from 62% (in 1981) to 35% in 2015.

Inevitable inequality

The report argues that tax on personal income is probably even less progressive than the tax rates suggest, because wealthier individuals have more resources to plan their tax affairs and more incentive to do it.

The IMF asks whether the decline in higher tax rates is due to concerns about economic growth. It is, after all, an often expressed concern that higher tax rates might sap the incentive to work and invest.

The report says there is no strong empirical evidence that progressive tax policies since the early 1980s have been harmful for growth. It does not, however, rule out the possibility that extremely high rates approaching 100% in the UK and Sweden in the 1970s might have a negative impact.

Some degree of inequality is inevitable in a market economy, the report acknowledges, as result of differences in talent, effort and luck.

But it says that excessive disparities in income "can erode social cohesion, lead to political polarisation and lower economic growth". It also accepts that there is no easy answer to the question: when does inequality become excessive?

Trends over recent decades have been varied. The report says income inequality has decreased if you take the entire global population, owing to strong income growth in some large emerging economies. The obvious examples are China and India.

But within the rich nations, the general pattern has been widening disparities in the period the analysis examines: the 30 years up to 2015.

The analysis suggests that tax and spending policies do make a substantial difference. But the impact has declined over the period examined.

The report says that income from capital needs to be taxed adequately to maintain the progressive nature of the tax system, because it is distributed more unequally than income from work.

In terms of how much inequality is reduced by taxes and spending, the UK is close to average for the developed economies.