Osborne should announce an investigation of the dynamic effects of tax cuts in the budget

By Paul Goodman
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Perhaps George Osborne will scrap the 50p budget in the budget, or cut it to 45p, or do nothing at all.  This morning's claims about his plans are more likely to come from the Liberal Democrats, in one of the further public negotiations that convey a loss of control by the Chancellor. You can find them in the Guardian and the Financial Times.

But amist the froth are to be found two solid nuggets of fact.  The Guardian reports:

"A preliminary study conducted by Customs & Excise for the Treasury, due to be published next week, is expected to show that the 50p rate – introduced by Labour in 2010-11 for those earning more than £150,000 a year – is bringing in hundreds of millions, rather than billions, of pounds. An earlier Treasury study assumed it would raise £2.6bn."

- And the F.T says -

"However, he is expected during the Budget to unveil figures from the tax authorities showing it has raised less than £1bn, far below the £2.5bn previously estimated. These will add to pressure from UK business leaders and his own MPs to scrap the tax."

This re-raises the question of at what level tax rates lose revenue rather than raise it (Fraser Nelson believes that the 50p rate has cost the Treasury takings already), and therefore whether lower rates would raise revenue rather than lose it.

As I have pointed out before, Osborne gave the following answer in part of a question-and-answer session in 2006:

"William Norton: "Do you support the call from the TaxPayers' Alliance to establish a Dynamic Analysis Division within HM Treasury to investigate the positive effect on incentives and growth of a reduction in the tax burden ?"

"George Osborne: The TaxPayers' Alliance are right to highlight the issue of the dynamic effects of tax cuts. The current Treasury model assumes that any change in the level of taxation will lead to an exactly equivalent change in revenue. They fail to take into account the broader economic consequences of tax changes. It is difficult to know exactly what those dynamic effects are – how big they are, and when they impact on tax revenues. So I welcome the TaxPayers’ Alliance’s interesting idea, and I look forward to hearing Gordon Brown's reply."

Osborne was correct in last year's budget to nudge the Treasury in the direction of investigating the effects of rates on revenues.  He did so by establishing the HMRC investigation into the 50p rate from which the F.T and Guardian quote this morning.  It looks as though this has found exactly the justification for axeing the rate that I argued it would at the time.

He now had the chance to move further - by arguing in his budget speech that the HMRC probe was so useful that he is extending it to examine the effects of other tax rates on revenues.  The Liberal Democrats could not reasonably oppose a study.

And if it turns out to confirm that tax cuts have dynamic effects on revenues - which most Conservatives believe is so in at least some cases - the Chancellor will have the political cover to cut rates that he seems to believes he needs.