A Tax Cut To Cut Borrowing


An old idea explained again

Mr Cameron is reportedly thinking about rescinding the planned tax rise for those earning over £150,000 pa.

Good. And let us hope his thinking doesn't take too long, because the planned new 50p tax rate will almost certainly cost the government money.


Well, it's a textbook example of the famous Laffer Curve - the idea that beyond a certain point, increases in tax rates will reduce tax revenue, as individual taxpayers change their behaviour to escape the higher rates. In the words of the Institute for Fiscal Studies, higher income tax rates incentivise taxpayers to "work less, retire earlier, emigrate, contribute more to pension or charity, convert income to capital gains, incorporate, and invest in tax avoidance".

Now, according to the government, even after taking account of those behavioural responses on the part of taxpayers, the new 50p rate will raise £2.4bn pa. But according to the independent IFS, it "could actually cost money".

For one thing, the IFS points out that the government's figures exclude the impact of the higher income tax on consumer spending. That will undoubtedly fall, cutting VAT and other indirect tax receipts "by up to £1.5 billion". Which slashes the government's £2.4bn revenue figure by over 60%.

The IFS has also done its own analysis of experience during the 1980s when the Thatcher government famously cut top income tax rates and saw a substantial rise in income tax revenues from higher rate taxpayers. They identify a much stronger response than the government assumes.

Indeed, they estimate that the revenue maximising marginal income tax rate for those on incomes of £150k and above is just 41%.

Cutting the gobbledigook, the IFS is saying that Thatcher/Lawson's existing top 40% rate is more or less spot on the peak of the Laffer Curve, and any increase is likely to cost the government money.

Here's the IFS's striking chart:

As we can see, whereas the IFS (labelled BSS) places the peak of the Laffer Curve for high earners at a marginal income tax rate around 40%, the government (HMT) places it at well over 50%.

So who are we going to believe? A government which attempted to cover up the unpleasant spending measures built into its own budget, or the IFS, which distinguished itself by exposing those hidden measures?

The new 50p tax for high earners may well appeal to populist politicians, but it is pretty clear it will end up costing the government money. As a result, we will all have to pay more taxes, and we will all be poorer. 


Mssrs Cameron and Osborne should have to courage to do what is right for the public finances, and pledge to rescind this perverse tax increase.
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