Let’s raise taxes

There I was, thinking these words would never cross my lips. Yet on this subject I agree with the chancellor, which is another thing I thought I’d never say.

When in a hole, keep digging

Clearly, the giant hole created in public finances has to be filled, and promiscuous borrowing creates a bottomless pit by filling with one hand while digging deeper with the other.

Where that nice young man Rishi Sunak and I diverge is on how taxes must be raised. In fact, judging by his announcement yesterday, we may even define higher taxes differently.

Mr Sunak, who for some unfathomable reasons and on no apparent evidence is widely seen as the saviour of Britain, has ordered a review of capital gains tax (CGT). A review doesn’t always mean a rise, but something in the chancellor’s language suggested that in this case it might.

Experts believe he’s considering raising CGT rates to the levels of income tax, which he hopes could bring in £90 billion over five years. Therein lie our disagreements.

Mr Sunak is planning to increase tax rates; I’d like to see an increase in tax revenue. And the two aren’t at all the same thing. In fact, they are usually at odds.

Here I’m going to state some blindingly obvious things that any sensible person knows already. Moreover, I’m going to take Arthur Laffer’s name in vain without the sneering accompaniment that these days is de rigueur in some circles.

But first a historical observation. If high tax rates in general and those on assets in particular improved the health of the economy, then Harold Wilson’s tenure back in the ‘70s would have gone down in history as a period of unprecedented prosperity.

After all, he introduced a top marginal tax rate of 83 per cent on earned income – and 98 per cent on the ‘unearned’ variety. Yet such economic sagacity earned Britain quite a different reputation, that of ‘the sick man of Europe’.

The matter was clarified by Arthur Laffer, an American economist endowed with that rare quality in his profession: common sense. He pointed out that a 100 per cent and zero per cent tax rates have something in common: neither will produce any tax revenue. Hence the optimum tax rate lies between those two extremes, somewhere between 15 and 20 per cent.

Lying underneath Laffer’s simple curve based on that observation is the understanding that taxation is the mightiest instrument the state has for affecting people’s economic behaviour. A man who knows he’ll get to keep 90 per cent of what he earns will work harder than one who’ll have to make do with a measly 40 per cent.

By the same token, a man who knows his investment gains will be taxed lightly will be more willing to invest than to spend. All this is basic.

Delving to an even greater depth, the state’s appetite for taxation also affects the state itself. If rapacious, that appetite is guaranteed to make the state more conceited and less accountable. For, the greater the proportion of the people’s money does the state control, the more control will it exercise over people’s lives tout court.

So yes, the Exchequer definitely needs higher tax revenues. That means it needs lower tax rates.

The best way to deliver higher tax revenues is to widen the tax base by stimulating the economy to grow and produce more people generating high taxable incomes. Similarly, the best way to get more CGT revenues is to encourage people to invest more. And extorting a smaller proportion of their profits is more likely to achieve that end.

All of this is too simple for most economists to understand. They climb on top of a mountain made up of their models, paradigms and graphs, and from that vertiginous height they laugh at Laffer.

Yet the principles he outlined are unassailable, based as they are on that most uncommon commodity, common sense. However, principles aren’t to be confused with a panacea.

The Laffer curve won’t work by itself and it won’t pay for itself. When Ronald Reagan first waved the curve as a magic wand, he used it as an election tool in his campaign for the Republican nomination. His opponent, George Bush, called it “voodoo economics”, and indeed it can be just that.

The Laffer curve, as Reagan eventually found out the hard way, can only work in the context of public thrift and general economic prudence. It will neither stimulate the economy nor increase the tax base without significant parallel reductions in public spending.

That’s where economics clashes with politics, and in that contest there can only be one winner. For, like drastically lower tax rates, sweeping reductions in public spending clash with the mentality of modern Western governments. Since such measures defeat their inner imperative of acquiring ever greater control over the people, economic sanity has to retreat, tail between its legs.

Whenever an economy is in crisis, the treatments prescribed by modern governments tend to make the disease worse. That was the case with the 1929 stock market crash that only became the Great Depression as a result of governmental meddling. And, much as I hate to play Cassandra, it’ll be the case with the measures proposed by Messrs Johnson and Sunak.

Still, I’d rather be a Cassandra than a Pollyanna – that way I’d be less likely to be disappointed than pleasantly surprised.

2 thoughts on “Let’s raise taxes”

  1. In the US, the ‘power of the purse’ belongs to the House. Tip O’Neill promised Reagan he would cut spending, and then reneged.

    1. Yes, David Stockton wrote an interesting book about this. It wasn’t just the House, if I remember correctly. The heads of various departments also fought cuts tooth and nail. Stockton was going from one to the next, doing his Oliver Twist bit and hitting his head against a brick wall.

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