“Cuts and tax rises: there’s no other way”

This was a front-page headline in this morning’s Daily Telegraph, and it appears to quote Bank of England Governor Mervyn King.
I hate to disagree with such an authority as Mervyn King, who seems exceptionally wise and well-balanced.  His recent castigation of the government, and by implication of Gordon Brown’s economic stewardship, have been splendid to watch.
And yet he’s wrong.  Wrong to repeat the schoolboy howler that tax rises raise revenues, and can therefore help to fill the government’s deficit.
After a certain point, tax rates become counter-productive.  Companies move off-shore, or fail to invest.  Individuals have less incentive to work, more incentive to hire accountants to think of creative tax-avoidance measures.  Entrepreneurs have fewer opportunities for capital accumulation.  At the margin, it becomes less attractive for the unemployed to find work, less attractive for the employed to do overtime.
This is well-known to economists, and is expressed in the “Laffer Curve”, which shows that if you raise tax rates from very low levels, revenues initially increase.  But as rates get higher and people are less willing to pay, the curve flattens and starts to fall.  Britain is already over the hump, and any further tax rises will damage revenues.
This sounds like a neat theory, but it has been proven over and over again in dozens of countries over many decades.  When Russia reduced tax rates from 90% to 19%, revenues tripled.  Suddenly it was easier to pay the tax than to evade it.
It is time to ditch the childish delusion that high-tax countries like Britain can raise revenues, and reduce deficits, by raising tax rates.  Gordon Brown’s disastrous mis-management of the British economy has left us boxed in to a position where tax hikes will be counter-productive.  Only spending reductions can address the Labour deficit.

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