Wednesday, February 13, 2008

I've been invited to become an author for Conservative Home's CentreRight blog. Sinclair's Musings will remain my home on the web for material not relevant to my work at the TaxPayers' Alliance and I will keep cross-posting my favourites from both of the other sites I write for. However, I'm looking forward to contributing to the nascent discourse at CentreRight. Here's my first post, a response to Peter Franklin:

Re: The left side of the Laffer curve

You rang.

What needs to be remembered about the Laffer Curve is that it is an abstraction of a much more complex relationship between taxes and revenues. It captures an essential truth that tax rises will not always increase revenue, and tax cuts will not always lead to a decrease. However, it necessarily omits two crucial factors: time and the specific tax that is to be cut or raised.

Economic gains from tax cuts will often be felt over the medium to long term. The European Central Bank studied the effects of growth in the state and found that a growth of 1 per cent in the size of the state led to a 0.13 per cent fall in economic growth. Other studies have found effects at a similar order of magnitude. That fall in economic growth won't mean a lot in the first year but over time becomes very significant. Brown's spending splurge since 2000 may have left Britain's GDP almost £14 billion lower.

Different taxes will have different effects on the economy. There is an ongoing debate over the kind of tax cuts most conducive to higher growth. However, the conventional view is that the effects on growth will be at their largest when they affect incentives to work and invest in the United Kingdom. Alistair Darling is retreating from taxing non-domiciles because it was expected that tax rise wouldn't increase revenue - even immediately. A dynamic model (PDF) produced for the TaxPayers' Alliance by the Centre for Economics and Business Research suggested that pre-announced, phased cuts in corporation tax to the Irish level over 14 years would boost investment by 60 per cent and GDP by 9 per cent - and pay for itself within eight years.

The evidence that tax cuts and controlling spending will have a very positive effect on growth is quite well established. Gains from increased growth quite quickly weaken and then overwhelm the effects on revenue of a tax cut. Combine that with an easing of the burden on hard pressed taxpayers and the case for restraining growth in spending in order to cut taxes and unleash the dynamic potential of a low tax economy is incredibly strong.


Gracchi said...

Good news for Centre Right!

Bretwalda Edwin-Higham said...

Second that.

Vino S said...

The Laffer curve, if i recall correctly, was allegedly written by Arthur Laffer on the back of a napkin. As such, i find it difficult to take too seriously!

Obviously, beyond a certain point, the degree of tax avoidance and evasion does mean that higher taxes won't raise more revenue. I am sure if our top tax rate for capital gains or income tax was 80% and we raised it to 85% it wouldn't make any difference to revenue.

However, at most levels of taxes, it stands to reason that an increase in the rate is likely to lead to an increase in revenue. And, at those levels, cutting taxes _cetrius paribus_ cuts revenue. I would be interested in hearing below what rate you think cutting taxes would actually start reducing revenue because it seems to me that the fans of the Laffer curve always call for tax cuts and never say what the point at which tax cuts fail to boost revenue are. For example, if income tax was 2d in the £ (as it was in 1874) then I seriously doubt a cut to 1.5d or 1d would have raised revenue!