What do John F Kennedy, Ronald Reagan and Margaret Thatcher have in common? All three lowered tax rates and increased tax receipts. The explanation is simple: when tax rates are raised the state receives more initially, but when the rates become too high the receipts diminish as people and businesses simply stop working or avoid tax. There is plenty of evidence that we are in the latter phase today.
Professor Arthur Laffer, whose birthday it is today, famously explained the phenomenon to Donald Rumsfeld and Dick Cheney (then Ford/Nixon officials) on the back of an envelope back in 1974. Laffer was modest enough to admit that what since then has been dubbed the Laffer Curve was not invented by him. The North African historian Ibn Khaldun described it in 1377 in his book Prolegomena. David Hume and Adam Smith mentioned it too.
Long academic palavers have tried to ascertain what the revenue maximising tax rate is. Estimates vary widely though many end up in the 25 – 30% bracket. For example in Hong Kong the corporate tax rate is 16.5 % - and Hong Kong is certainly not short of a penny.
Many countries have lowered their tax rates between 1979 and now, usually based in part on the Laffer curve. In the spring of this year a great number of UK economists and politicians such as John Redwood used it to argue against a proposed increase of capital gains tax to up to 50%. Their campaign ensured that CGT only went up to 28%.
A few years ago I stalked a number of politicians at the Conservative Party Conference with questions about the Laffer effect. In a Telegraph debate (Tebbit and Heffer against D'Ancona and Villiers) Theresa Villiers pointed out that the Laffer curve is a curve, and that tax receipts go up for a while when tax rates are increased before the Laffer effect kicks in and marginal receipts diminish. She apparently thought that UK tax rates were still sufficiently low to increase receipts with rate rises – which they were already patently not at the time. George Osborne was still in his “we are not going to make promises about unfunded tax cuts” - phase. And at a Reform fringe meeting Philip Hammond said that Laffer was too difficult to explain to the public at large. I suppose all those utterances have to be seen in their context at the time.
If the truth of the Laffer curve is so blindingly obvious, why is it not applied more often? In the short term tax cuts would make tax receipts go down – as the economy would not start growing at a faster pace instantaneously. A bit difficult to risk in the dire economic situation we are in thanks to Labour. For the left – as illustrated by John Kenneth Galbraith's utterances - tax cuts are unsellable as it looks as if “the rich are let off lightly”. They still prefer everybody on foot rather than some on foot and some on a bicycle. And for all politicians perception takes precedence over economic reality. For example: how could they possibly explain cutting taxes for high earning bankers in today's lynch-mob climate?
The case for tax rate cuts to increase revenue has not been made by this government. Neither was it made during the election campaign – and some have attributed the less than complete election victory to this omission. A very large number of companies moved abroad as a result of Labour's tax rises. The exodus continues. Also, new ventures are deterred from setting up shop in over-taxed Britain.
It is a choice. Are we happy with an economy growing at a laughable 1 or 2% pace (yesterday some in the media thought that such poor growth forecasts for Europe were a Great Triumph!), or do we want a better future for our children? Happy birthday, Arthur Laffer!
PS: you can meet Arthur Laffer at the Taxpayers' Alliance's Gala Dinner in early September.
