Roger Helmer, MEP for the East Midlands (Conservative) and a TPA supporter, blogs at http://rogerhelmermep.wordpress.com/
Imagine that we had an income tax rate of 10% (wishful thinking!), and we reduced the rate to 5%. Chances are tax revenues would fall by roughly half. But what if we had a starting rate of 60% and reduced it to 30%? Your first thought might be that revenues would also halve. After all, you’ve cut the rate by half. Yet all the pragmatic experience, over and over again in many countries over several decades, suggests the opposite. Revenues might well double. It’s wholly counter-intuitive. When Reagan announced major tax reductions, commentators called it "Voodoo Economics". But Reagan was right, and the commentators were wrong. When Russia recently reduced tax rates from 80% to 16%, revenues increased by 150%.
The fact is that if people feel taxes are onerous or excessive, they find ways of avoiding or evading them. They may work less, or move investments off-shore, or hire fancy accountants, or opt for the black market. Low-income people may decide that welfare is a better deal than work. Foreign investors vote with their feet, and go elsewhere.
But reduce taxes, and the reverse happens. People in the black economy will switch to the mainstream and go legit. The marginally unemployed will look for work. Higher up the income scale, expatriated investments may come home. There’ll be less creative accounting, but more capital formation to back entrepreneurs, more inward investment, higher growth, increased prosperity. And there’ll be more revenues for government to spend on social goods. (For a more technical explanation, Google the Laffer Curve).
On May 27th, I had the privilege of co-hosting a seminar on the flat tax in the European parliament, with the European Enterprise Institute and the Adriatic Institute. In the Chair, we had Edward Lucas, a Deputy Editor of The Economist. Our two main protagonists were my old friend Dan Mitchell of the Cato Institute in Washington, a supply-side tax reform expert, who made the case for a pure flat tax, and Robert Batinovich, a successful entrepreneur and former government official, who argued for a slightly less austere version designed to answer the criticism that the pure flat tax, while it would clearly work, would tend to favour those with unearned income, and therefore be seen as favouring the rich.
Both speakers made a powerful case for lower and simpler taxes, and highlighted the dangers of the EU’s implacable hostility to what it calls "unfair tax competition". I argued that no tax competition is unfair: rather that the EU’s efforts at harmonisation are a cartel operated by governments against the interests of the people. The EU’s opposition to low tax rates could come back to haunt it in Ireland on June 12th, since fear of pressure to increase Ireland’s hugely successful 12.5% corporate tax rate is a powerful weapon for the NO campaign.
The debate was very well-attended and successful, and I was pleased that we managed to bring together such a distinguished panel. I am also delighted that back at home the Conservative Party is starting to respond to public demand for lower taxes, and to feel its way, however tentatively, towards lower and simpler taxes, if not the full nine yards of a pure flat tax. If we follow this route, then (as someone used to say) "things can only get better". I am determined to fight Labour’s great fallacy. Whenever we talk about lower tax rates, Labour politicians ask "Which schools and hospitals will you close?". But they are the ones closing hospitals. The proper question for Labour is this: "If you fail to reduce taxes, if you fail to use lower taxes to increase revenues and prosperity, what public services will you have to cut?"
Hurrah! For the first time since 1472 the political cycle has turned. Tax and spend is out, and tax cuts are back on the centrist agenda.
Yesterday, David Cameron finally summoned up the nerve to say taxpayers "can’t take any more pain", and that the economy is being frazzled by tax and spend. And today, Nick Clegg is saying much the same.
But there are of course a few details to settle. Like the one that Tory Shadow Chief Secretary Philip Hammond fell over on last night’s Newsnight – what does it actually mean to say that taxes will fall as a share of GDP over an economic cycle?
Paxman had great fun with poor Mr Hammond. What is an economic cycle? Where are we in it now? Is the current tax take too high? How low should the percentage be?
Hammond wobbled around all over the road.
Well, the economy is sometimes above trend, and sometimes below…
Yes, but where is it now?
Well, I don’t know… that’s for the statisticians to tell us…
You don’t know?
Well, ahhhhgh… Hammond’s front wheel buckled and he ended in the ditch.
What Newsnight highlighted is that much more work needs to be done on this "sharing the proceeds" stuff. As we’ve blogged many times, it’s still no more than a nifty slogan. With Hammond likely to be at HMT within two years, he needs to get some serious content.
We wonder if he has any idea what the job of Chief Secretary to the Treasury actually involves? Chiefy is the most hated member of the Cabinet. While his boss the Chancellor gets all the plaudits for cutting taxes, Chiefy is the one who has to deliver the public expenditure control that funds them. He’s the one who has to say no to all his Cabinet colleagues as they attempt to grab more and more for their own departments.
Cameron’s cabinet will be different, and they’ll all commit to slashing departmental waste on their own turf?
Where on earth have you been these last 150 years? Even poor tortured low tax Keith Joseph found himself presenting a departmental brief arguing for more industrial subsidy cash in those bleak early years of Thatcher. It’s the nature of the beast, and whatever their best intentions may have been, once spending ministers get their feet under their huge new desks, they get turned (Yes Minister, op cit).
Which is why we need clear upfront rules and quantified commitments. Hammond needs a big visible stick to beat off his colleagues. Discretion and Best Endeavours simply won’t work.
It’s time to beef up sharing the proceeds with that Third Fiscal Rule – a fixed and quantified target for cutting the share of public spending in GDP over a cycle, now with added endorsement by the OECD (see many previous blogs, eg here).
Come on Mr Cameron – you’re so nearly en route to the Promised Land. Just one more heave. Or whatever it is you do to ride a bike.
PS The real answer to Pax’s cycling questions is surely that the Treasury already publishes estimates of the cyclically adjusted fiscal deficit, and the Tories would merely be adding publication of the adjusted tax and expenditure numbers. Here’s HMT’s current chart from the Budget, showing we have been in cyclically adjusted deficit every year since 2002-03:
Of course, as we all know, the Treasury numbers are now so massively fiddled, they’re not worth the paper they’re printed on. But the methodologies used to make such adjustments are broadly understood and agreed. What’s more, George Osborne has already pledged to establish an independent fiscal monitoring office to do the calcs (modelled on the NAO). So why didn’t Mr Hammond say that? They need to be far more specific in their own thinking.
David Cameron’s pledge that the Conservatives will prioritise cutting the tax burden, in a speech this morning, is great news. It suggests that the Conservatives are taking seriously the need to the end the Great British Taxpayer Rip-off we identified in a report (PDF) last weekend:
"With the rising cost of living, taxpayers can’t take any more pain indeed they want a government that can give them the prospect of relief. And our economy can’t take any more pain without losing jobs to lower tax competitors.
£20 billion wasted on an NHS computer that still isn’t working properly.
£2.3 billion spent refurbishing the offices of MOD civil servants.
And in one year alone nearly £2 billion of tax credits lost due to fraud and error.
These are outrageous examples of a spendaholic culture in government a culture that is the public sector equivalent of the reckless, debt-fuelled spending spree that Gordon Brown’s policies have encouraged in the private sector. The level of government waste in our country today is evidence of an out-of-touch political elite who have forgotten whose money it is they’re spending. Ministers who get in their offices and think ‘great, now how can I spend lots of money.’ People who have become so accepting of government waste that they assume it’s just part of the job and that anyone who objects must be calling for "cuts.""
Political parties have to acknowledge that the time has come for reductions in the overall burden of tax. We have had revenue neutral shifts of every kind imaginable promised over the last few years and every one has either compromised Britain’s competitiveness – making us all poorer in the long run – or directly hit ordinary people struggling to pay their bills.
That bind can be broken if the Conservatives, or any other party, confront the rising tide of ineffective and often downright wasteful public spending, some of which can be seen in the report we released today on quangos (PDF).
Last month the French finance minister Christine Lagarde cheerfully announced France’s intention to push for corporate tax harmonisation when it chairs the EU for six months from July. Since then the EU Commission and pro European politicians have toned it down to make sure businessmen don’t urge for a “no” in the Irish referendum on the constitution on 12 June. I trust the Irish will not be fooled.
Tax competition is the most effective method to keep government in check. As long as there is tax competition between states or regions politicians are unable to tax and spend as if there is no tomorrow. If the tax rate is lower over the border companies flee and jobs disappear – as recently illustrated by the relocation of several very large companies to Ireland. Thanks to the Irish Republic’s corporate tax rate of 12.5 % the impetus towards a lower corporate tax rate in the UK has become unstoppable.
Tax competition is any statist’s worst nightmare. France, never having been short of statists since time immemorial, now wants the tax base harmonised across Europe. That we do not live on planet Europe but on planet Earth has passed the little European by completely. If the UK – as always – gives in, and tax base harmonisation goes ahead, a compromise will result. We will end up with a medium harsh tax base regime, likely to be worse than the one we have. And in the world competition Europe will continue to slide down the economic prosperity curve.
As Churchill said: “For a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle”.
Let’s say “no”, for once.
An interesting new paper, written by economist Keith Marsden and published by the Centre for Policy Studies, presents further evidence of how smaller governments perform better on a range of measures than do larger governments.
The paper shows how countries with low taxes and spending relative to GDP enjoy faster economic and employment growth, lower debt and higher spending growth on public services (as opposed to income transfers) but do not suffer from higher inequality or lower tertiary education rates than countries with higher tax and spending ratios.
Mr Marsden concludes:
These overall findings suggest that the analysis and prescriptions of the early supply-siders were correct. Of course, tax rates and levels, and the size and nature of government interventions, are not the only factors affecting a country’s economic performance. But this evidence rejects the widely-held view that lower taxes inevitably result in cuts in public services, or at best their slower growth, and widening income inequalities.
Although the turmoil in financial markets is preoccupying policy makers at present, they should not lose sight of the stimulus that tax cuts and the pruning of inefficient government programmes could give to sluggish economies. The need to realign some governmental priorities is also revealed.
Even if you haven’t heard of Shire Pharmaceuticals or their ADHD drug, Adderall, which they describe as the "leading brand in the US market" you should still be very concerned at the possibility they might leave Britain due to high levels of tax, as is reported in City Am. This is a FTSE100 firm, one of the biggest in the UK. High tax rates won’t raise much revenue if firms like this one leave the country.
High levels of tax have hurt our international competitiveness but, although big companies have left before, this is usually hidden by the fact that it is new investment that goes elsewhere rather than existing companies in the UK leaving. Now it is becoming more apparent than ever that Britain’s long term prosperity is being imperilled by an increasingly uncompetitive tax system.
Tax evasion is rightly a crime and honest taxpayers should not have to subsidise a criminal minority. Equally, there are sensible measures – such as simplifying the tax system – that can be taken to reduce the extent to which people can plan their way around tax (and reduce the advantages accorded to those with expensive accountants).
However, we don’t think that trying to blur the line between tax evasion (breaking the law in order to avoid paying tax) and tax avoidance (arranging your affairs, within the law, in a way that minimises your tax burden) is a good idea at all. There are a number of reasons why, in practice and economic theory, such schemes turn out poorly whether you attempt to clamp down on anti-avoidance through a grand General Anti-Avoidance Principle or by encouraging the HMRC to become extremely aggresive (as has happened in recent years).
However, the basic problem is that the people who pay the highest price are never the rich foreigners that many on the left like to set up as bogeymen. It is ordinary people. Ex-cabbies starting up a business who haven’t done anything wrong but are bankrupted for 88p, for example. This morning we found this 1909 election poster from the excellent collection at the Bodleian library which illustrates the basic problem pretty beautifully:
Dr. Terence Kealey (Vice Chancellor of Buckingham University) recently explained on Radio 4’s PM programme that Ireland is now wealthier than the UK. Indeed, Ireland’s per capita income is $38,504; the UK’s is $33,238. It is probably for the first time ever that Ireland is wealthier than the UK.
In free market circles it has become common knowledge that the Celtic Tiger was created through tax cuts and cuts in regulation. The usual counter-argument from the other side is that not the market, but EU subsidies caused the Irish boom.
I came across an article by Benjamin Powell which explains how EU subsidies in fact did not help, but hindered Irish growth. The article also makes an interesting comparison between EU countries which also received large amounts of subsidies, but who transformed into Tigers or Tiger Cubs.
Here’s the beef:
Did you know that 13% of UK adults face an effective marginal tax rate in excess of 70%? That is, for every additional £1 of income they get, the government will take at least 70p.
For 7% of adults it’s even worse: they face an effective marginal tax rate of 90% plus, meaning they lose at least 90p of every extra £1 they earn.
So who are these people? Mega-wedged investment bankers busily inflating more debt balloons down at the Wharf, perhaps? Rock stars? Undeserving plutocrats having their pips squeaked by our Socialist rulers?
Ah, no. Worst case for all of those high-rolling groups is a marginal tax rate of 41%. The only people who face 80, 90, 100% tax rates are the poor.
That’s because when they earn more, they not only have to pay tax, but they also face the progressive withdrawal of welfare benefits, such as housing benefit. Their Effective Marginal Tax Rate (EMTR) is consequently much higher.
The latest facts are set out in the Institute of Fiscal Studies’ Green Budget published in January. And here’s their overall summary showing how many people are on different Effective Marginal Tax Rates (EMTR):
Labour has made much of its programmes to make poverty history. But as the IFS analysis so clearly highlights, in time honoured tradition, their approach has weakened incentives for the poor to help themselves. The Joseph Rowntree Foundation summarises the key IFS findings for people of working age thus:
"Work incentives are most weakened through the withdrawal of means-tested benefits and tax credits, not through high rates of income tax. Over two million workers in Britain stand to lose more than half of any increase in earnings to taxes and reduced benefits. Some 160,000 would keep less than 10p of each extra £1 they earned.
Overall, reforms under the Conservatives acted to strengthen average work incentives whereas Labour’s reforms to date have weakened financial work incentives on average: since 1999, tax and benefit changes have increased the average EMTR by almost three percentage points."
Another IFS paper charts the history. To understand what’s happened, focus on the purple line: it shows the minimum effective marginal tax rate paid by the 10% of workers facing the very highest rates- they pay at least that much.
As we can see, under the Tories, the worst placed 10% of workers were those paying the 40% higher rate of income tax. Which is what we would expect. But since 1999, the worst placed 10% of workers are no longer those 40% income tax payers: rather, they are poor people facing crippling withdrawal rates on their welfare benefits.
This puts complaints about benefits scroungers into their proper perspective. No matter how much you and I may criticise them, for someone facing a 90% – or even a 70% – effective tax rate, working harder and longer is just not a rational option. And that feeling is reinforced when they hear tales of benefit recipients who’ve gone out to earn more, only to face later demands to repay hundreds of pounds in overpaid benefits: DWP’s systems are simply unable to keep track of their earnings in the context of Brown’s fearsomely complex benefits system.
Brown’s means tested benefits for pensioners have similarly undermined incentives to save for retirement. Just at the time when another of his master-strokes (dividend tax) put the boot in on our company pensions, his pension credit system has blown the incentive to save in a personal pension. Why bother, if the government will only grab the benefit by withdrawing its own payments to you?
The reality of Gordon Brown’s war on poverty is that by hugely expanding the scope and magnitude of means tested welfare benefits, he has made it much harder for the poor to earn their own way out of poverty. Even if they might want to. Despite all his talk about hand-ups replacing hand-outs, he has seriously reinforced long-term welfare dependency.
"The consensus on tax within the political establishment isn’t matched by the population at large. The same YouGov poll (pdf) that found strong support for David Cameron’s Conservatives found even greater support for tax reduction: 67% of all voters said that the government should tax less and spend less and 20% said the tax and spending mix was about right. Only 8% of Labour supporters want more tax and spend, but our political leaders are deaf to these new facts. They are still living in the 1990s, when voters thought Britain was underspending. I imagine Cameron, Brown and Clegg going home to watch This Life DVDs and to listen to Portishead. They are all out of step with the new mood of voters. Voters want a refund from a political establishment that has wasted much of the extra taxes that have been paid."
Over the weekend, the Shadow Chief Secretary to the Treasury told the Sunday Telegraph:
"If we get into office and we deliver the efficiencies and we put the money in the bank, we put it by and then we go back to the electorate and we say not, ‘we would like you to believe that we will find these savings, that we will eliminate this waste’, but ‘we have actually done it, we’ve made the savings, we’ve got this money in the bank, now we are going to tell you how we will use that to cut your taxes in a way that is prudent and sustainable’…. It will be the great bonus of the second election. You go into government with a set of fully funded promises and during that first term of office, by delivering an efficiency programme, we will pile up the headroom to be able to offer reductions in taxation… When the money’s piled up in the pot, then you give it away in tax cuts."
It’s worth pointing out that Hammond also said in the same interview:
"Families were looking for some relief [in the Budget] and what they got was another hit. If you ask families the question, ‘do you feel your tax burden is too high or too low?’, I suspect invariably the answer will be too high."
So Hammond’s answer to the following questions would presumably be: Do you think taxes are too high? "Yes". So will you cut them? "No, well, maybe in 2014".
What utter rubbish!
People might be forgiven for thinking it is just the largest and most polluting cars that are going to face increased tax with the big boost to Vehicle Excise Duty today. This report, from the BBC News website, suggests that Darling has raised taxes on "high-polluting" cars:
"In his first Budget Mr Darling raised taxes on high-polluting cars, alcohol and cigarettes and announced new tests for incapacity benefit claimants."
In fact, new TaxPayers’ Alliance research reveals that a heavy majority of the different car models in current production will face increased taxes under the new charging structure, even compared to the 2008-09 rates:
The higher rate in the first year, the "showroom tax", will apply to most cars – with only a small number paying less in the first year:
To find out how much you will have to pay for your car download our spreadsheet with details of every model in production: