New Policy Exchange report on tax and economic growth

PXtaxgrowthandemployment Policy Exchange have an excellent new report by Andrew Lilico and Hiba Sameen out today on how taxes affect economic growth.  Some of the results they've produced with the Oxford Economics model - chosen because it is a lot like the Treasury one - are a bit implausible, as the authors themselves acknowledge in the report.  But the analysis yields some fascinating insights, here are the key points:

1.  The hike in Employer's National Insurance announced at the Budget could be disastrous for jobs.  We have an advantage in keeping unemployment down thanks to our labour market flexibility relative to our European peers, but big hikes in the tax on jobs will undermine that.  Here is a key paragraph in the report:

"Under circumstances where wage growth is already very low it might be particularly difficult for employers’ to cut wages further in response to a rise in employers’ NIC, and so the key effect might be raised costs of employment, resulting in greater unemployment."

2.  The TPA have been campaigning against hikes in VAT, which is a big tax on the poor.  The report highlights that the economic case for VAT as a relatively efficient tax may be a lot weaker than it used to be:

"However both recent academic evidence and experiments on the model suggest that increasing VAT may be as bad as, or worse, than increasing the basic rate of income tax. Some firms will try to absorb some of the effects of a VAT rise – e.g. because they do not operate in competitive markets, or because they are in financial difficulties and need to maintain turnover. Consequently, not all prices will necessarily rise by the same amount, distorting relative prices, re-directing economic activity inefficiently and so reducing growth."

3.  Taxes overall are a major drag on growth:

"...the overwhelming message of more recent studies is that increasing tax levels reduces the growth rate of economies — in the most authoritative studies, a 10% rise in the overall ratio of tax to GDP is found to be associated with a 0.5%-2.0% fall in the growth rate of GDP."

For more, read the full report.

The debate over the economic merits of a VAT hike will continue, some people at the launch today expressed scepticism over that part of the report's findings, but the social effects of increasing VAT rates or removing exemptions are clear.  Increasing tax on the poor will mean greater poverty and benefit dependency.  The report offers further confirmation that, after a decade of tax hikes, any tax rises are going to have serious economic and/or social effects.  That's why we need big spending cuts instead.

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