The Obama factor in Labour's budget

Most of the commentariat are busily discussing the supposed "death of New Labour" and trying to come up with reasons why Peter Mandelson and co sanctioned the introduction of the 50% top rate if income tax.

They've overlooked an important point: Labour was only able to do this because the election of Barack Obama gave us cover. Here's what I wrote on 5th November 2008 (the day after his win):

Obama has stated that he thinks a person on an income of $250k is rich (this is about £158k at current rates). He intends to raise the top federal tax rates to to 36% and 39.6% (from the current 33% and 35%). Remember that Americans pay state income tax in addition to federal income tax. The American state that mirrors Britain's economy most is New York State. There, the state income tax if your income range is between $100,001 and $500,000, is 7.375%. If your income range is $500,001 and over, your tax rate is 7.7%. People living in New York City pay city income tax too of between 2.9% and 3.6%.

That means that the top marginal rate of tax for high earners in New York City (London's great rival) will go up from the current 46.3% to 50.9% under Obama. Compare that to the 41% levied in the UK. It gives cover for the Labour govt to raise N.I. by a mere 1% over the upper earnings limit (to take the marginal rate to 42%), should they wish. Especially as the Irish have introduced an income levy of 1% (and 2% for earnings over €100000) to take top rate to 43%. Alistair Darling has ruled out tax increases for now. But what has happened in the USA gives us room for manoeuvre if we need it.

People always overlook the fact that you may want to do something, but are constrained by your neighbours and can only take action when they move. This applies to tax more than anything. It explains why there is a lot of corporate tax competition within the EU, with every EU nation's corp tax rate coming down including Germany's - in the UK corp tax is 28% compared to 33% in 1997. But in the USA, even under Bush, the corporate tax rate remained 35%. That's because the US federal government is able to impose a blanket rate (the state corporate tax rates are offset against the federal ones). The EU imposes no such blanket rate, and hence this opens things up for the states to compete on corporate tax, the opening salvo of which was fired by Ireland in the early 1990's. The American states compete on income tax rather than corporate tax.

All movements in matters of taxation have to be relative to that of your main rival. London's main rival is New York in high paid individuals and the financial services industry. In the USA, Obama has also helpfully capped the earnings of people in bailed out firms at $75000 (£51724 at current exchange rates). Many bankers will prefer to remain in the UK and bite the bullet of the 50% tax than move to the USA. I expect the Labour government is also calculating that their move on income tax will give cover to the other EU nations should they need to raise taxes (and many will not want to do this, but will need to do so due to the exceptional circumstances we are living in). Many of the high paid of the UK have been threatening to go to Switzerland. But the Swiss are in trouble with their banking system, which will probably need to be bailed out by the Swiss government - and they will likely have to pay for it by, you guessed it, tax rises.

As for the "death of New Labour" - what is happening is no different to the evolution that took place in our sister party the US Democrats, from Bill Clinton to Obama. We sustained the "Bill Clinton" bit a little longer than they did - but then they had to endure the extreme-right wing Bush in the interim, which provoked a bigger backlash. One of the what-ifs of history is what would have happened had Al Gore been elected in 2000. The forces bearing on the Labour government would have been quite different. Oh well.