The tax fal­lacy

The Boris Project risks un­rav­el­ling in con­fu­sion over how to pay for Covid

The Daily Telegraph - Business - - Front Page - Jeremy Warner

Trea­sury min­is­ters and their of­fi­cials risk clas­sic “Laf­fer Curve” in­jury by talk­ing of plans to raise an ad­di­tional £30bn a year in taxes to plug the hole in the pub­lic fi­nances left by the Covid-19 pan­demic. They also risk tear­ing the Tory Party apart.

It is not just the law of di­min­ish­ing re­turns that threat­ens im­ple­men­ta­tion of such a ma­jor tax grab, nor is it even that it runs counter to much Tory po­si­tion­ing as the pro-en­ter­prise, self re­liance party of low tax­a­tion.

No, there is a more po­tent rea­son still – sim­ply that it is eco­nomics 101 that you do not im­pose a fis­cal squeeze in the midst of a cri­sis, nor even in the re­cov­ery phase of a bad re­ces­sion. You wait un­til the econ­omy is again fir­ing on all cylin­ders and, even then, gov­ern­ments must tread war­ily so as to al­low growth the room it needs to reestab­lish it­self. To do oth­er­wise risks stran­gling the re­cov­ery at birth.

All this makes the cur­rent hys­te­ria around the idea of im­mi­nent tax rises faintly puz­zling. Of course the Trea­sury will one day have to take steps to re­pair the pub­lic fi­nances. If it doesn’t, then buy­ers of gov­ern­ment debt will ques­tion Bri­tain’s long-term cred­it­wor­thi­ness and raise the cost of money ac­cord­ingly. Higher in­ter­est rates would fur­ther steepen the chal­lenge of man­ag­ing the deficit and of eco­nomic re­cov­ery in the round. But that’s all for the fu­ture. For the mo­ment, the Gov­ern­ment needs to be fo­cused like a laser on restor­ing growth, and if any­thing, that means fur­ther cut­ting the tax bur­den, not rais­ing it.

This is such stan­dard eco­nomics th­ese days that one can only sup­pose that sug­ges­tions of a big tax rais­ing push, to be an­nounced in the au­tumn Bud­get and to take ef­fect as early as April next year, must be wide of the mark. The Chan­cel­lor will have to en­gage with fis­cal con­sol­i­da­tion at some stage, but to do so pre­ma­turely would be ut­ter mad­ness.

Ge­orge Os­borne’s fis­cal squeeze didn’t be­gin un­til nearly two years af­ter the fi­nan­cial cri­sis, and even that was ar­guably too early. Growth stalled; it wasn’t un­til he re­laxed the squeeze that things be­gan to re­vive again.

Arthur Laf­fer may be the in­tel­lec­tual god­fa­ther of sup­ply side eco­nomics, but he never ac­tu­ally ar­gued what is of­ten at­trib­uted to him – that by cut­ting tax­a­tion you stim­u­late growth and there­fore raise more money, or that higher tax rates nec­es­sar­ily raise less money. Rather his “curve” is clas­si­cally bell shaped. If your tax rate is zero, you plainly raise no tax; sim­i­larly, if it is 100pc, you raise no tax. But at some point in be­tween there is an op­ti­mum rate of tax­a­tion

‘The Chan­cel­lor will have to be­gin fis­cal con­sol­i­da­tion, but to do so pre­ma­turely would be mad­ness’

which raises the max­i­mum pos­si­ble amount of tax. If your pur­pose is max­imis­ing the tax take, then strik­ing that happy me­dian is all im­por­tant.

Raise the rate too high, and it might re­sult in an ex­o­dus of tal­ent and in­vest­ment, a re­duc­tion in en­tre­pre­neur­ial drive and an in­crease in tax avoid­ance and eva­sion, thereby re­duc­ing the amount of tax paid.

The key ques­tion to ask of any tax rise, then, is whether it is go­ing to re­sult in sig­nif­i­cant be­havioural change. When Labour pro­posed rais­ing the top rate of in­come tax from 45pc to 50pc, Robert Chote, then head of the Of­fice for Bud­get Re­spon­si­bil­ity, de­scribed the pro­posal as “strolling across the sum­mit of the Laf­fer curve”. It was hard to tell whether it would in­crease the amount of in­come tax raised; there was good rea­son to be­lieve it might ac­tu­ally re­duce it.

The same ques­tions can be asked of all the big tax rais­ing pro­pos­als said to be cur­rently un­der con­sid­er­a­tion at HM Trea­sury – fur­ther ero­sion in pen­sions tax re­lief, align­ing cap­i­tal gains and in­come tax rates, and rais­ing the rate of cor­po­ra­tion tax. Would they ac­tu­ally re­sult in the ad­di­tional £30bn a year sug­gested, and even if they did, might the tax take as a whole be dam­aged by con­se­quent, poorer rates of eco­nomic growth?

Even­tu­ally, the Gov­ern­ment is go­ing to have to con­front th­ese ques­tions. If now’s not the mo­ment, the mar­kets do at least need some com­fort that it is the Gov­ern­ment’s sin­cere and even­tual in­ten­tion to get the pub­lic fi­nances on an even keel again. New fis­cal rules will have to be put in place, and some kind of cred­i­ble plan for meet­ing them out­lined.

Ac­cord­ing to the fa­mous Juncker curse – af­ter the for­mer Euro­pean Com­mis­sion pres­i­dent, Jean-Claude Juncker – “we all know what to do, but we don’t know how to get re-elected once we have done it”. That may not seem par­tic­u­larly rel­e­vant to a

Gov­ern­ment with an 80 seat ma­jor­ity barely nine months into its term.

Yet al­ready we see the po­ten­tial for dis­in­te­gra­tion in an ad­min­is­tra­tion which was elected to de­liver Brexit but lit­tle else. Boris Johnson’s problem is that Brexit was never a co­he­sive po­lit­i­cal move­ment, but a cam­paign­ing is­sue that united mul­ti­ple dif­fer­ent and some­times con­flict­ing po­lit­i­cal con­stituen­cies. His great tal­ent is his abil­ity to be all things to all men – both a na­tion­al­ist and a glob­al­ist, a lib­er­tar­ian and an NHS wor­ship­ping, big state cor­po­ratist, low tax and high spend, a high Tory and a Red Wall pop­ulist. This is a great for­mula for win­ning elec­tions, as we have seen, but a night­mare to manage when it comes to gov­ern­ment and de­liv­ery.

Even be­fore Covid, the chal­lenge of rec­on­cil­ing the mul­ti­tude of prom­ises that have been made looked daunt­ing, with Thatcherit­e, low tax lib­er­tar­i­ans in­creas­ingly at odds with one na­tion, Nick Ti­mothy type Con­ser­va­tives, who looked back to an al­to­gether dif­fer­ent Tory tra­di­tion. The pan­demic has put them on col­li­sion course.

Those ten­sions can only grow over the months and years ahead as Johnson and his al­lies wres­tle with whether it is taxes or spend­ing that must do the heavy lift­ing of fis­cal con­sol­i­da­tion. One thing is for sure; it is not go­ing to make for co­he­sive gov­ern­ment.

Boris Johnson and his Cab­i­net team have been in power for nine months and in the run up to the end of the year face tough choices

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