David R. Henderson  

Marginal Tax Rates: Singing Taxman to My Class

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UPDATE BELOW:

Often, when I teach my classes about marginal tax rates, I give them a little history about such rates. They're shocked when I tell them that the top U.S. federal marginal tax rate on individual income in the 1950s and early 1960s was 91 percent. Then I tell that that Great Britain was even more extreme. Before Maggie Thatcher became Prime Minister, the top rate on "earned" income was 83% and the top rate on "unearned income" (dividends and interest) was 98%. (Tim Worstall informs me that the top rate on capital gains was 30% and so a lot of people figured out how to convert other income into capital gains income.) A few years earlier, the top rate on "unearned income" had been 95%.

Then I sing part of a song that even many of my 30-something students have heard:

Let me tell you how it will be
There's one for you, nineteen for me
'Cause I'm the taxman, yeah, I'm the taxman

Should five per cent appear too small
Be thankful I don't take it all
'Cause I'm the taxman, yeah I'm the taxman


I tell my students that that song is "The Taxman," by the Beatles.

"Who wrote that song?" I ask. Few know, so I tell them that George Harrison wrote it. "When did he write it?" I ask. No one knows this, so I tell them "1965 or 1966." "Why is that date significant?" I ask. No one in class knows and so I tell them. "If the taxman takes 19, leaving one," I ask, "what is the marginal tax rate?" That they get: someone says 95%. "Bingo," I say.

Then I say:
Think about the Beatles' earnings. Late 1963 was when they first started making real money. Then in 1964, they hit it big. Presumably they didn't spend it all but started investing, figuring that they would get interest and dividends on their investments. They probably did. But those returns would be taxed at the 95% rate. When would they start noticing this? Probably some time in 1965. Thus the 1966 song. George Harrison was pissed off at "the taxman."

This was all speculation on my part. What wasn't speculation was the information about marginal tax rates, about who wrote the song, and about approximately when he wrote the song.

I never bothered checking the web. This morning, while writing this post, I did check. And I was right. See here. One new thing I learned was this:

The backing vocals' references to "Mr Wilson" and "Mr Heath," suggested by Lennon, refer to Harold Wilson and Edward Heath, respectively; the former was the leader of the Labour Party and the latter was the leader of the Conservative Party, the two largest parties in British politics.

Of course, I knew who Wilson and Heath were, but I had never noticed the backing vocals saying their names.

UPDATE
Tim Worstall wrote me the following:
One way out was something not available to US citizens: to leave the country for some portion of the year. In the UK you must be resident in order to pay UK taxes. So, if you were to, say, go and live on an ashram in India for 6 months then you would not be resident in the UK in that tax year and would pay no tax in the UK. Puts a slightly different light on all that sitar playing by Harrison.

Or, if you were a member of the Stones, you could spend some time recording in the south of France and thus, with a bit of touring in the US perhaps, not be resident in the UK.

People did catch on to this pretty quickly. Indeed, the Stones are quite famous for organising themselves efficiently in this manner. It's also a reasonable explanation for the existence of Apple Records. The Beatles money went into that and then profit was taxed at corporation tax rates. But then it could indeed be invested. Only the actual amount taken out would be taxed at that 83 or 98%. Accumulation was much more lightly taxed by having an intervening corporation.


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COMMENTS (15 to date)
Jay writes:

In my classes I use a QFNL ("Question for Next Lecture"). At the end of each class I pose the question. At the beginning of the next class I ask if anyone wants to answer the QFLN. (10% of their grade is responding to a QFNL at least 2 times during the semester.)

The "Taxman" QFNL is one of my absolute favorites. I prefer to be more circumspect with the question and allow the respondent to go out and get the answer. The QFLN I pose is "Ok, we just talked about marginal tax rate. What does George Harrison have to do with this?" Every time at least one student goes and figures it out and reports back to the class. Everyone loves it.

John Hall writes:

And I'm the opposite. Always knew that they said Mr. Wilson and Mr. Heath, but never knew why.

Gene writes:

Interesting that at some point after the song was written, the UK felt that 95 percent wasn't enough and raised it to 98 percent. Boosting it that extra 3% is a revealing example of pettiness, even malice, on the part of a government--giving the knife a little extra twist, just because it could.

Eric writes:

Have there been any studies on the expatriation of capital? And the repatriation when they lowered the rate? They did lower the rate, right?

Vivian Darkbloom writes:

"(Tim Worstall informs me that the top rate on capital gains was 30% and so a lot of people figured out how to convert other income into capital gains income.)"

Yes, and Lennon and McCartney were two who figured that out. Rather than pay 98% tax on their royalties, the rights were contributed to a company "Northern Songs Ltd" and then that company was listed on the London Exchange, effectively converting "ordinary income" to capital gain income for the prior owners.

Moral: The higher the marginal income tax rate, the more creative the efforts to avoid it.

http://www.bloomberg.com/news/2013-03-22/the-beatles-v-the-taxman-a-former-manager-recalls-yesterday-.html

Daniel Kuehn writes:

Do you actually sing it?

If so, a video needs to be forthcoming. Give Bob Murphy some competition.

David R. Henderson writes:

@Eric,
Have there been any studies on the expatriation of capital? And the repatriation when they lowered the rate?
I bet there have. I just don’t know them. But see the Update above from Tim Worstall.
They did lower the rate, right?
Yes. Maggie lowered it in the early 1980s to 60% on both kinds of income (earned and unearned), if I recall correctly. Then in the late 1980s, she lowered both rates again to 40%.
@Vivian Darkbloom,
Thanks. What a great name, by the way.
@Daniel Kuehn,
Do you actually sing it?
I do.
If so, a video needs to be forthcoming.
I agree but none exists yet.
Give Bob Murphy some competition.
Actually, Bob and I have agreed that when he and are in the same city, we will have a karaoke contest. I’ve forgotten whether we have money on it or not. My gut feel is that he will win. My wife thinks I have a shot. I’m thinking of doing “Ice, Ice, Baby."

Ghost of Christmas Past writes:

Thank you for explaining, incidentally, why the different rates on "ordinary," "investment," and "capital gains" income in the US today are unjust and really constitute a scam whereby the rich pay lower marginal rates than the salaried mid-to-upper middle class. Only the rich have the luxury of choosing the form in which their income appears. High salary? Middle-class fool! High tax rate for you! Trade salary for stock... Corporation doing well, ought to pay you a dividend, but tax on dividends high? No problem, corporation will buy back some of your stock, giving you a low-taxed capital gain. Ultra-rich hedge-fund general partner with high commission income? Easy-- call your contingent income "carried interest" and you shall pay low capital-gains rates even though you risked zero actual capital!

Andrew Hofer writes:

Being a Lloyd's name also acted as a deferral and a modest shelter (converting passive income into earned income taxed at a lower rate, and taxed only after the final reckoning is done in three year). This a reason any number of celebrities, etc. got roped into signing up and creating the bubble/spiral.

Greg Delemeester writes:

David, rather than singing the song yourself you could play this version of the song (with commentary).

[broken link fixed--Please check your urls before posting your comments.--Econlib Ed.]

@Vivian Darkbloom, Thanks. What a great name, by the way.

Nabokov appreciates the compliment, I'm sure.

What I remember about London in 1974 was how dismal the lives were for ordinary people, and that the streets of London were filled with Rolls Royces. Which puzzled me until I read the explanation in Free To Choose years later; When investment income is taxed at 98%, consumption becomes verrrry attractive.

Vivian Darkbloom writes:

Regarding that Update---

It is likely that for most big name acts, the percentage of income accruing to the individual performer is relatively small. Of course, with respect to the UK and its unique residency rules, it has been fairly easy to avoid residency and hence individual taxation. Contributing rights to a corporation to avoid individual income tax rates is only half, and not the most important half, of the tax planning story for performers.

Another commenter asked about the expatriation of capital, which I think is more relevant to the point here. Absent rules to prevent it, such as the US Passive Foreign Investment Company (PFIC), Foreign Personal Holding Company (FPHC) and Controlled Foreign Corporation (CFC) under Subpart F, non-US citizen acts typically position the rights to their work and their touring companies offshore (the Netherlands/Netherlands Antilles, Ireland, etc) to which royalties are paid and taxed at very low effective rates. Major US corporations have been able, despite these rules, to do much the same by using various exceptions for "active trades and businesses".

Again, relatively high marginal tax rates drive all this...

And, a tip to would-be rock stars---tax planning is important, but the more important key to one's earning capacity is to own the rights to the songs you perform. The Beatles may have eventually worked out the tax problems, but they made some very bad business decisions along the way.

So, my advice to Henderson: Don't do "Ice, Ice, Baby"; copyright and perform your own music and lyrics.

Vivian Darkbloom writes:

Patrick Sullivan,

Let's leave *him* out of it.

The next thing you know, people will be confusing me with Vivian Bloodmark. In fact, it has already happened.

David R. Henderson writes:

@Ghost of Christmas Past,
You’re welcome.
@Vivian Darkbloom,
So, my advice to Henderson: Don't do "Ice, Ice, Baby"; copyright and perform your own music and lyrics.
Not good advice.

MG writes:

"One way out was something not available to US citizens: to leave the country for some portion of the year."

This is still sadly true, and true not only with respect to the UK, but with almost any other country. The US tax man will follow you and wour income anywhere. This is another factor why US citizens defacto/empirical taxation is so progressive relative to other OECD countries. Let's measure what the OECD's high earners actually pay in taxes in their own countries, nit what they are theoretically taxed at.

I would also suspect that the freedom not to report income through expatriation must "flatten" income inequality relative to the US, if income data is based on reported taxable income -- essentially reported inequality in high tax countries goes down, as income gets reported in Monaco, Singapore, the Cayman's etc.

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