An Appeal to George Osborne

The Laffer Curve represents the rate of taxation at which maximal revenue is generated. This is the curve as used by Laffer, but the curve need not be symmetrical nor peak at 50% in practice.

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.

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2 Responses to An Appeal to George Osborne

  1. Maxwell says:

    it is time for the government to hire a professional “Chancellor”, and not rely on amatuer operatives like Osbourne. An ex chief accountant at some multi-national company or something like that. ( Not Fred Goodwin ! ).

    Would you start a business and then get some former Hooray Henry, to run the accounts. I don’t think so. So why the UK Government always does this. Brown knew NOTHING about accountancy. Osbourne isn’t much better.

  2. Peter Hulme Cross says:

    It may already be a bit late for that, Roger..

    • the Adam Smith Institute says its studies show that 500 top managers of some 80 hedge funds have left the country

    • the Swiss Funds Association reports that 20 to 25 hedge funds have left the UK for Switzerland in the past year

    • a Lloyds TSB poll of almost 1,000 people with savings or investments in excess of £250,000 found that 36 per cent say they want to emigrate, and 14 per cent are likely to leave within two years.

    The government recognises that small and medium-size businesses (SMEs) are important job creators. So one goal of government policy is to encourage their establishment and growth. Never mind that..

    • higher tax rates act as a disincentive to risk-taking

    • increased VAT drains purchasing power that might have been directed to small businesses

    • the Treasury’s promise to send a horde of tax collectors to teach SMEs how to organise their data might not add to the lure of entrepreneurship

    • entrepreneurs are at risk of ex post seizure of their profits by a Treasury that refuses to draw a sharp and visible line between illegal tax evasion and perfectly legal tax avoidance

    There is more of course…

    making war while cutting military spending.

    trying to become more competitive in world markets while driving up the cost of energy in pursuit of unattainable green objectives….

    but I think that is enough to be going on with!

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