Osborne’s NICs Pledge is Spot On

This morning I Tweeted: “They say that George Osborne’s NICs pledge will cost £5bn. But it may cost nothing, if it saves jobs and promotes employment”. Let me expand on that.

For a start, why do we still talk about National Insurance Contributions?  Surely National Insurance Tax would be more accurate?

The fact is that not only the BBC, and the Guardian, and the Labour Party, but also commentators who ought to know better, make a basic error when assessing proposed tax changes.  They assume that when you change a tax rate, everything else stays constant.  So for example with the 50% income tax rate on salaries over £150k, they simply take the aggregate income of all those earning £150k+, and multiply by 10% (i.e. 50% minus 40%), and take the answer as the increase in tax revenues.  They ignore those who will move to Geneva, or fail to invest in the UK, or construct ever-more-sophisticated tax dodges, or perhaps even just retire early on the basis that work is no longer worth the effort.

Thus the new 50% tax rate may raise no new revenue at all, while at the same time jeopardising future growth, and hurting the UK’s reputation as a good place to do business.

That is why we have the notoriously, wonderfully counter-intuitive Laffer Curve.  Over and over again, across dozens of countries and over several decades, we have seen the iron rule of taxation: that unless tax rates are currently very low indeed, higher rates will reduce revenues, while lower rates will increase revenues.  Superficially ridiculous, but true.  When Ronald Reagan made this case, they called it “Voodoo Economics”.  But when he did it, it worked.

Exactly the same is true of NICs, which, as I note above, are in reality a tax like any other tax.  They are a tax on employment.  The effect of increasing taxes on employment will be to reduce employment levels from what they would otherwise have been.  This will increase the risk of redundancy for those in employment, and reduce the opportunities for the unemployed.  Higher unemployment will reduce the amount of income tax paid.  It will increase the social costs of unemployment.  The additional unemployed will spend less, and pay less VAT, than they would if they had jobs.  Reduced consumer spending will have a generally dampening effect on economic activity.

I don’t have a handy economic model into which to plug these assumptions, but it’s a fair bet that reversing Labour’s NICs increase will be cost-neutral (as would scrapping the 50% income tax rate).

So all credit to George Osborne for his NICs pledge.  I just wish that instead of saying “The lost revenue will be counterbalanced by spending cuts”, he’d come right out and say “There probably won’t be any lost revenue”.

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