Have They Ever Heard Of The Laffer Curve?

Written by Mike Swadling

A couple of weeks ago in an article in the Telegraph, Johnny Leavesley the former Conservative Party treasurer party donor asked of the Government “Have they never heard of the Laffer Curve?”. You have to wonder. Surely a Conservative government would have heard of the Laffer Curve, but alas it appears not. This is a government that has increased corporation tax and is increasing National Insurance rates.  Do they really believe this will raise more money?

Whilst it is unlikely anyone reading Free Speech is unaware of the Laffer Curve, it is maybe worth just noting what it is in case anyone from the government is reading. Named after Arthur Laffer, the Laffer Curve illustrates the relationship between the rate of taxation and the resulting government revenue.  The curve shows that no income is raised at a zero per cent tax rate, and similarly at a one hundred per cent tax rate, as no one would work to pay all their earnings to government.  Somewhere in between is a tax rate that maximises revenue for government.

Separate to a moral case for keeping more of your own income, even if you believe in a high spending government, higher tax rates make no sense. People often assume the higher the tax rate, the higher the tax take – but this is not the case. As a little thought experiment, do you believe more income would be raised with an eighty per cent tax rate or twenty per cent tax rate?  If you think of your own circumstances, it’s likely that at an eighty per cent tax rate it would not be worth your while working in your current role. It is quite possible you would look for cash in hand work and you certainly wouldn’t be looking to take on more hours in a role taxing you so high, whereas a twenty per cent tax rate is possibly less than you pay today. You might be tempted to work more hours or take on a more stressful but rewarding role knowing you get to keep more of your money.

My own experience with the Laffer Curve came some years ago working with a team of engineers who were all approaching a new higher tax bracket. Much of our work involved weekend overtime and everyone’s hand would shoot up at first opportunity to work a lucrative Saturday. Then suddenly our incomes that year had breached the threshold, we noticed we were no longer taking home the lion share of our income for the weekend, instead it was split fairly evenly with government. Strangely none of us could remember the Minister or the Senior Civil Servant coming in to help us with our work at the weekend, but somehow, they were always there to help us with the income for it. From that point onwards finding someone to cover a weekend became increasingly difficult, and ‘bribery’ in the form of overtime no longer automatically worked.

The great mistake people often make is to forget that working itself comes at a cost. The cost is your free time, your energy, time not spent with your family or friends. This all has to be weighed up against the rewards you receive for working. This is equally true for businesses, as setting up a business requires an investment of money and energy. Many people set up businesses in areas they’d already worked and where they could already draw decent income. When you take on the risk and extra effort of running your own business you need to see the extra reward. What feels like a small increase in corporation tax maybe the difference from someone starting their own enterprise, employing people, and creating value or staying in a role they have today and letting somebody else hold the risk.

Nevertheless, the government seems committed to the idea that raising tax rates will raise the revenue needed to recover from the economic armageddon of lockdown. Prior to the pandemic, the United Kingdom government had been spending just over thirty-nine per cent of gross domestic product. It shot up to over fifty-two per cent last year and is likely to remain over forty per cent for some years to come. What does the government know that we don’t, and why do they think increased tax rates will somehow help?

Since the 1970s, government tax receipts have never exceeded thirty-eight per cent of gross domestic product. Mostly, they have hovered around thirty-five per cent. In this time, we have had governments of Labour, Conservative, LibLab Pacts, Conservative-Liberal coalitions, the UUP propping up James Callaghan, and the DUP propping up Theresa May.

The basic rate income has been as high as thirty-five per cent and as low as twenty per cent. The top rate has been as high as eighty-three per cent and as ‘low’ as forty per cent. Yet the total tax take has never been lower than thirty-two and a half per cent of GDP and has never exceeded thirty-seven and a half per cent of GDP.

Higher tax rates don’t increase tax revenue. The Laffer Curve is something this government has clearly never heard of.

Read more articles from this edition of Free Speech here.


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