The Laffer Curve: A Natural Experiment
As a doctor and a researcher the ARC WM Director relies on money raised by taxation. The more tax the chancellor collects, the better for the ARC WM Director! But hang on, if the tax rate goes to high, then the tax take will decline. The function that describes the relationship between tax rate and tax take is called the Laffer curve.
While most people accept the general principle (no tax, no take; 100% tax, little or no take) there is little evidence on the tax rate at which the tax take peaks.
Until now. A natural experiment has been carried out on specialists in the NHS. In order to understand this experiment it is necessary to also know about a curious feature, perhaps better termed an anomaly, in the UK tax system. The tax policy is curious because the tax rate jumps from 40% to 60% between the thresholds of £100,000 and £120,000, before then dropping back to 40%. It just so happens that £100,000 corresponds to the basic salary for a specialist in the NHS. This is serendipitous because the government has been offering doctors extra weekend work to manage surging demand. Would a marginal tax rate of 60% dissuade doctors from taking up the offer? The answer is yes. A large proportion of doctors have declined this invitation, on the basis that the reward, given this high tax rate, is not worth the effort. This is in contrast to previous incentive schemes to manage waiting list backlogs.
So here you have the answer, the Laffer curve peaks at around 40% tax rate! Okay, this is just one segment of the workforce, in one particular country, at one threshold, and it applies at the weekend. The ARC WM Director would continue to work at a higher marginal tax rate, but please don’t tell anyone! The ARC WM Director loves his job, which he can do in social hours, while hospital specialists do not like being away from their families over the weekend. Obviously, a lot more information is needed. But the above evidence shows that care is needed when applying tax rates above a 40% threshold.
Readers from abroad might wonder why the tax rate should be 60% between earnings of £100,000 and £120,000 per annum, while it is 40% either side of this zone. The reason is that the tax free allowance is tapered off over this interval.
Richard Lilford, ARC WM Director
- Armstrong S. Cuts to Pension Tax Relief Deepen Retention Crisis for Senior Doctors. BMJ. 2019; 364: I206.