At Blackpool at Party Conference, we changed the terms of trade in the tax debate. George Osborne announced the abolition of Inheritance Tax (well almost), and the Party was stunned by its own success. Suddenly Labour and Alistair Darling were scrambling to match our tax promise.
Yet for years (until the Conference), the Conservative Party had been cowed into submission by Labour on the tax issue. Labour had a very simple and effective ploy. Every time Conservatives mentioned tax cuts, Labour said “Which schools and hospitals will you close?” — and we retreated in disarray. But the question is a nonsense, and it is time to expose it.
Labour’s implicit assumption is that the economy is static. You can change one thing, but nothing else changes. So you reduce a tax rate, say from 30% to 20%, and your revenue simply goes down by a third. Or you increase income tax rates (this is a Lib-Dem favourite) on salaries over say £100,000, and simple arithmetic tells you that you have millions more to spend on education.
But the economy is not static. It is dynamic. Change a tax rate, and you change a whole raft of incentives. People do different things, and the effect is much more complicated than simple arithmetic. Let’s say you reduce income tax rates. First of all, people on higher incomes will spend less time and money on legal tax avoidance or illegal tax evasion, and perhaps more time on productive and remunerative work. People on the margins of employment will have more incentive to work, to claim less welfare and start paying tax. People in the black economy may decide that the risks are no longer worth the tax avoided, and go legit. Aspiring entrepreneurs will find capital accumulation easier, and the rewards for risk-taking greater. They will start new businesses and employ others. And critically in the face of globalisation, international investors will find Britain more attractive, and our share of FDI, already large, will tend to grow.
When Ronald Reagan argued that lower tax rates would deliver higher revenue, his opponents called it “Voodoo Economics”. Usually we say that if a deal sounds too good to be true, it probably is. New lamps for old. Higher revenues for lower tax rates. But this elegant economic theory actually works. At my Transatlantic Conference in Brussels in early October (see “International Leaders’ Summit” earlier on the blog), Dan Mitchell of the Cato Institute (www.cato.org) presented data from dozens of countries over decades, which proved beyond doubt, again and again, that the theory works in practice. Low tax rates lead to faster growth and higher revenues. In the USA under Reagan, in the UK under Lawson, in Russia and China more recently, and lately in a host of countries, especially in central Europe, low taxes and flat taxes have been proven to raise growth and raise tax revenues.
At the Conference we had Mart Larr, former Prime Minister of Estonia, who introduced flat taxes almost by mistake, but with huge success. He had read only one book on economics, which happened to be by Milton Friedman. Mart assumed that flat taxes were Western economic orthodoxy, and was taken aback when he was hailed as a pioneer of the flat tax movement. Since then some twenty countries have adopted the flat tax. Poland’s new Civic Platform government has announced it will do the same. Flat tax in conquering the world because it works. It makes people more prosperous, and provides governments with higher revenues to fund social services. Maurice McTigue, former Finance Minister of New Zealand, told us how his government was almost embarrassed by the overflowing treasury they experienced as a direct result of reducing taxes.
With countries across the world lowering taxes, it becomes imperative that we in the UK follow suit merely to stay competitive. We should turn Labour’s question around. How will they continue to fund public services unless they join the low-tax revolution?
It is time for the Tory Party to stop parroting cliché that “We will put financial stability before tax cuts”. The truth is different: we won’t achieve financial stability without tax cuts.
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