Higher income tax rates for the rich would help reduce inequality without having an adverse impact on growth, the International Monetary Fund has said.
The Washington-based IMF used its influential half-yearly fiscal monitor to demolish the argument that economic growth would suffer if governments in advanced Western countries forced the top 1% of earners to pay more tax.
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.
But the influential global institution said: “Empirical results do not support this argument, at least for levels of progressivity that are not excessive.” The IMF added that different types of wealth taxes might also be considered.
Labour seized on the report, calling for higher taxes on the rich, citing the IMF’s intervention as evidence of the need for a fairer tax system.
In its election 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.
John McDonnell, the shadow chancellor, said: “The IMF support the argument we made in the General Election for a fairer tax system. There is no evidence to support those who scaremonger about the effects of making the rich pay fairer tax.”
He added: “ Not only have the Tories slashed the top rate of tax, they still plan billions in tax giveaways to the super rich and big corporations over this parliament.”
Despite claims from ministers that Labour’s tax plans would be both politically and economically damaging, McDonnell believes higher taxes for the rich would be both workable and popular.
“With every day that passes the case for a change of direction at the Treasury grows. Instead of engaging in infighting in his own party the chancellor should listen to Labour’s calls for fairer taxes and increased investment, so we will build an economy for the many not the few.”
Theresa May has repeatedly attacked Labour’s approach as extreme, claiming in prime minister’s questions on Wednesday that Corbyn and McDonnell are on “planet Venezuela”.
But the prime minister conceded at a fringe meeting at her party’s conference in Manchester that public opinion appears to be more favourable to some of Labour’s economic ideas than Conservative strategists had assumed in the run-up to June’s general election.
“We thought there was a political consensus,” she said. “Jeremy Corbyn changed that”.
With Philip Hammond due to deliver his budget next month, it is unclear whether the government will press ahead with promised tax cuts for higher earners, including plans to increase the higher rate threshold for income tax to £50,000.
The fiscal monitor does not mention any country by name and does not specify at what level governments should set the new higher rate for top earners. But the report stressed that cutting tax for the top 1% had gone too far - a strong hint that the IMF has doubts about the pro-rich tax plan proposed by Donald Trump for the US.
Instead, the IMF said higher tax for the rich was necessary to arrest rising income inequality – the argument used by McDonnell and the Labour leader Jeremy Corbyn.
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.
A Treasury spokesperson said: “A fair tax system is a critical part of our plan to build a fairer society. Today, the richest 1% pay over a quarter of all income tax while 4 million of the lower earners have been taken out of income tax altogether.”
