It’s Spot-the-Fallacy time: last week a lead headline in the Daily Telegraph read “Taxes must rise to fund elderly care”.
I’m fairly surprised that a major right-wing newspaper would make this basic error. It makes the implicit assumption that raising tax rates will raise revenue. Yet as I wrote yesterday in my piece on the welfare cap, raising tax rates usually does not raise revenue (unless you start from a low base). At higher levels raising tax rates will actually reduce revenues — and suppress economic growth. That pattern of revenues peaking, then declining, as tax rates rise further, is embodied in the Laffer Curve.
It’s time to face the fact that raising tax rates is no longer an option. Indeed I have no doubt that removing the current 50% income tax rate (actually 60% including National Insurance) would raise revenue.
Changing tax rates causes tax-payers to modify their behaviour. At the margin, some slip into unemployment, or into the black economy. They may do less overtime, or retire earlier, or decide against starting that new business, or invest offshore, or hire smarter accountants. (In particular, as I have written recently, the proposed 30% emissions reduction target by 2020 — which will involve higher carbon taxes — will drive energy-intensive businesses offshore and so reduce economic activity — and tax revenues — in the UK).
It’s time, once and for all, to recognise this reality. So I appeal to George Osborne: please recognise the Laffer Curve, and build it into your thinking.
But you need to go further, George. Let’s have an independent study looking at each type of tax — income tax, capital gains tax, VAT, National Insurance, carbon taxes — and for each tax, make a best estimate of the point at which the Laffer curve peaks.
When Denis Healey was Chancellor, he threatened to “squeeze the rich until the pips squeaked”. Clearly he was not familiar with the Laffer concept, and while his threat may have been good politics (short-term), it was nonsense as an economic policy. What we need to do, now and for all time, is to resolve never, ever to pitch tax rates higher than the Laffer maximum. Lower would be good, but higher is self-destructive.
That’s the way to maximise both revenues and growth. I’d like to see George Osborne formalise it as a public statement of policy.