It’s GCSE economics: high taxes don’t work

Dr Eamonn Butler explores the Chancellor’s lack of understanding of basic economic theory, whilst pin pointing, through basic science, why his policy on tax will have a harmful effect on the public.

The Chancellor would get a C for his new tax rises and fail history outright. He will also leave the Treasury worse off.

Given the damage that the new 50 per cent tax rate will probably inflict on the UK economy, the Chancellor seems to have been very cavalier about it. When the House of Commons Treasury Select Committee asked how he decided to impose the new rate on everyone earning £150,000 or more, he replied: “There was no science behind it. It was simply my judgment.”

No science? If there is one part of economics that lends itself to scientific analysis, it is tax policy. Taxation has been under the microscope ever since Adam Smith first distilled the principles of good and bad taxation in the 18th century. Two hundred years of evidence later the science is clear: high taxes don’t work. They bring the Treasury less revenue, not more. And on the way, they really mess up your economy.

It’s shocking that the Chancellor, in his desire to wrongfoot the Tories, has simply ignored this evidence. In the science of taxation, he wouldn’t merit a grade C at GCSE. And he would fail history outright, having completely forgotten the lessons of an earlier Labour Chancellor, Denis Healey.

Healey actually relished the “howls of anguish” from the 80,000 people rich enough to pay his top tax rates of 83 per cent – or even 98 per cent for those who lived off investments. But as capital took flight and brains drained from Britain, Healey was forced to go to the IMF for a bailout. Labour’s reputation never recovered and, 30 years ago this week, the country fell sobbing into the arms of Margaret Thatcher.

Despite these economic and political warnings, the Chancellor’s “judgment” is that it makes sense to impose higher taxes not on just 80,000 people but, according to Treasury figures, on 283,000 – the top 1 per cent of UK taxpayers. That’s a lot of folk.

And the tax rise is massive, too. It might sound like just another 10 per cent, but if you’re paying tax at 40 per cent and the rate goes up to 50 per cent, you are actually shelling out 25 per cent more than you did before.

Which means a lot of people face a lot more tax, and Darling’s unscientific tax rise will have a large – and damaging – effect, just as Healey’s did. A 25 per cent tax hike is well worth avoiding, even if you earn £150,000. People will simply hire expensive accountants to find ways round it, or do what Sir Michael Caine is threatening and shift themselves or their money abroad. Or take longer holidays and retire early.

In fact the Treasury itself thinks that 69 per cent of those hit by the new tax will find ways to escape it. That’s why the respected Institute for Fiscal Studies figures that the tax won’t raise anything like the £1.3 billion that Darling forecasts – if it raises anything at all. And the Centre for Economic and Business Research reckons that 25,000 entrepreneurs may simply emigrate, costing the UK £800 million.

Raising taxes, then, can leave the Treasury worse off – a simple piece of tax science popularised by the American economist Arthur Laffer with his “Laffer Curve”, and of which the Chancellor should be fully aware.

And contrariwise, scrapping high tax rates actually boosts both the economy and tax revenues. In 1979 the Conservative Chancellor Geoffrey Howe slashed the top rate from 83 per cent to 60 per cent. Before the cut, the top 1 per cent of taxpayers – Darling’s target group today – paid just 10 per cent of the total tax take. By 1988 they were paying 14 per cent of it.

Then Nigel Lawson cut top rates even more, from 60 per cent to 40 per cent and revenues surged again. By the time of the 1997 election, the top 1 per cent of earners paid a whopping 21 per cent of the total tax bill. By halving the top rate of tax, Howe and Lawson had doubled the amount paid by top earners.

Other countries back up this simple science. The United States has had four big tax cuts over the past century. In 1921, President Coolidge cut the top rate from 63 per cent to 25 per cent. Five years later the top earners (people on incomes over $100,000) were paying 86.3 per cent more than they had before. The economic boost fuelled the Roaring Twenties.

In 1964 President Kennedy cut the top rate from 91 per cent to 70 per cent. Two years later the top 5 per cent of earners were paying 7.7 per cent more in taxes, while the bottom half were paying 9.2 per cent less.

When President Reagan cut the top rate from 70 per cent to just 28 per cent between 1981 and 1988, the share of revenues paid by the top 1 per cent of taxpayers rocketed from 17.6 per cent to 27.5 per cent. He cut capital gains tax as well, from 28 per cent to 20 per cent – and again, revenues leapt by half, from $12.5 billion to $18.7 billion in only two years. The cuts launched the longest period of wealth creation the world has known. And under George Bush’s cuts too the wealthy ended up paying more, not less.

Nearer home, a dozen of the former Soviet countries, including Russia, Estonia and Latvia, have replaced their high, complicated, dysfunctional tax rates with a single-rate flat tax as low as 10 per cent. They enjoyed a huge economic boost as a result. Ivan Miklos, the former Finance Minister of Slovakia, told me that slashing taxes was the only decision he lost sleep over: but in fact his flat tax was a huge success, and Slovakia never looked back.

Alistair Darling, by contrast, has made several mistakes all at once. His new tax is so high that people will do their darnedest not to pay it. He won’t pull in the revenues he needs to pay off his spiralling public debts.

At the same time, his changes to allowances and national insurance further complicates a tax code that runs to 10,000 pages – great for accountants and tax bureaucrats, perhaps, but not for the rest of Britain.

Third, he has forgotten that “the rich” don’t just inherit their money any more. Most of them today earn it. His new tax on work will simply drive the UK’s entrepreneurial spirits – and their money – abroad.

It’s science, Mr Darling. But it’s not rocket science.

Dr Eamonn Butler is director of the Adam Smith Institute and author of The Rotten State of Britain

Published in The Times here

Blog Review 953


How often does this have to be said? Incentives matter. And when will our rulers understand it?

So should the jobs of economists be protected? No, despite the desperate need for them.

Sweary but right. Political decisions, despite their lamentable quality,. be the decisions of politicians, not bureaucrats.

For example, look what happened the last time "the consensus" ruled.

It needs to be pointed out: just because someone made a lot of money that doesn't make them wise about money. It makes them wise about making money, something rather different.

Polly won't like this at all. Apparently mothers of the young working reduces the intelligence of the young.

And finally, a description of the politicians of today.

Tax, spending and pensions


In preparation for a recent media appearance, I had to work out what I would do if I were prime minister for a day. The programme turned out to be less serious than I had anticipated – invading France and bringing back the stocks were typical topics of discussion – so much of what I had planned to say went out of the window. Regardless, here's what I was originally thinking...

My first priority would be sorting out the public finances. The government is now overspending by something like £15m an hour, 24 hours a day, 7 days a week. They are going to borrow £175bn this year, and more than £700bn over the next five. That's on top of the £3tn or so of debt we've already got, once you include PFI, the nationalized banks, unfunded public sector pension liabilities, and the rest. With figures like that it's perfectly clear that the government's £15bn 'efficiency drive' just isn't going to cut it – far more radical cuts are needed. I think £100bn should be the absolute minimum, and like former Blair adviser David Halpern, I'd argue 20% is a good figure to aim for. Things just can't go on as they are.

My other economic priorities would be tax and pensions. On the tax front, radical simplification would be the order of the day. At 10,000 pages Britain's tax code is now the longest in the world, and imposes an administrative cost of more than £5bn a year on the UK economy, which is just ridiculous.

On pensions, I'd start by acknowledging the extent of the problem. Over 65s now outnumber under 16s. And while there are currently four potential workers to support every pensioner, by 2050 there'll only be two. As a result, our PAYGO pension system (where current taxes are used to pay current pensions) is simply not sustainable. I'd follow Chile's lead and introduce compulsory private savings accounts, in place of national insurance contributions. As Kristian Niemitz points out on the IEA blog, Chile's highly successful system just celebrated its 28th birthday, so it's high time the UK caught up.

Greener grass?


As I wrote yesterday, I'm quite a fan of California (OK, I'll be honest this time – the weather and the beaches do have something to do with it...). All things being equal, I'd rather like to live there. And who knows? Given the way things are going in the UK at the moment, maybe I'll want to join the next 'brain drain' and flee gloomy Britain for the land of the free.

The only trouble is I'm not sure the land of the free is really that free anymore. Take California as an example – assuming I earned the same in relation to the average wage as I do in the UK, I'd end up handing over 30 percent of my income to the government if I lived there (adding up federal and state income taxes, and various payroll taxes). In the UK, it's closer to 25 percent. True, sales and excise taxes are much lower in the US, but property taxes are also much higher. It's hard to see me being much better off.

There are a couple of qualifications I should make. Firstly, California is clearly not the best example to choose, being one of the most left-leaning states in the Union. One could move to Iowa and not pay state income tax at all. Secondly, something like 50 percent of Americans don't pay income tax at all, thanks to their crafty use of credits and exemptions, so it's not that bad for everyone. Of course, single men are not typically the recipients of much legislative largesse, so I doubt there would be much in the complexities of the tax code for me.

Anyway, the main point is, where are we libertarians meant to escape to these days? Are we all going to have to go seasteading?

Blog Review 952


Yes, Netsmith supports this. Polly Toynbee for Poet Laureate. She is after all no more than a praise singer....

Quite possibly the best description of the Prime Minister and the influence the Kirk has had on him written to date.

The might not be accurate in each and every particular, this analysis of the interactions between the unions and the Labour Party. But there's certainly some truths in it.

Five things the next government is going to have to do. Anyone believably promising to implement them would get Netsmith's vote, whatever their party label.

The importance of property rights can be difficult to overstate. But some just will not get it. So why not try using the New Testament to explain them?

You really shouldn't believe all of the international statistics you see floating around. Many of them are really not all that accurate.

And finally, Stanford turns himself in. Probably so that he can say he did and they didn't arrest him, so he can say he's innocent, right?


A libertarian Fed?


A bewildering article in the Financial Times by economist Henry Kaufman made the peculiar claim that the Federal Reserve had a commitment to libertarian dogma and laissez faire. He obviously does not understand these words. Despite Alan Greenspan’s early writings, his actions at the Fed should have disabused any of the idea that the Greenspan Fed was in any sense libertarian.

Indeed, throughout his tenure, Greenspan was constantly berated by free-market and libertarian economists. Bill Fleckenstein called him “bubble-blower in chief".

In his widely-noted article in the FT, Kaufman cites as examples of the Greenspan Fed’s failings the growth of securitization, quantitative risk modeling, and the infamous failure to recognize bubbles. But there are in no sense libertarian; the last, indeed, is just blindness and ignorance.

There is now widespread discussion among U.S. establishment economists about how to recognize asset bubbles; Treasury Secretary Tim Geithner wants to establish a study group to devise ways of making sure bubbles to do not become dangerous. But many observers, including libertarian-inclined economists and even more casual observers, warned repeatedly about the housing bubble and the Fed’s primary role in creating it, by keeping monetary policy far-too-easy for far-too-long after 9/11. This is not Monday morning quarterbacking; the warnings were loud and repeated as the bubble built.

The “Greenspan put" (by creating an asymmetry between risk and reward), was another major legacy of the Greenspan Fed; it helped ensure the bubbles grew larger and longer; there is no sense in which that can be deemed “libertarian".

We might agree on some of the failings of the Greenspan Federal Reserve, but we should at least call it something it clearly wasn’t.

Indeed, the very concept of the Federal Reserve is the antithesis of libertarian dogma: it is a price fixer (interest rates) and a government-enforced monopoly (issuer of monetary notes). There is now a move afoot in the U.S., led by Rep. Ron Paul, a Misean, to abolish the Federal Reserve. More likely to get somewhere in the short term is another move, also led by Paul but with growing bi-partisan support, to force the Fed to open its books. After all, despite all the much-vaunted talk of independence, the Fed is just another branch of government and taxpayers and savers are on the hook for its profligacy.

Adrian Day is president of a money management firm specializing in global and resource equities. He can be contacted via his website.



The gloomy economic news from the European Commission is that they expect European economies to shrink this year by 4 percent, which is twice what they forecast in January. UK Chancellor Darling has forecast our shrinkage at 3.5 percent this year, but many think even that over-optimistic.

This will mean more job losses across Britain and Europe; more school and university leavers will fail to get jobs; people will see their disposable incomes shrink and have to cut back. Generally it means leaner times and tighter belts. There will be fewer opportunities to do pleasant things.

It is as well to remember that there are people who welcome this. The anti-growth brigade think that we should be producing and consuming less, and that economic activity should shrink. In the name of the planet, the environment, or their own notion of what it takes to make people really happy, they welcome a recession because it forces us to a lower level of output, one that might be 'more sustainable,' or more conducive to a 'fulfilling lifestyle.'

It is not just those receiving their pink slips who should feel contempt for this attitude. Lower economic activity and reduced wealth mean fewer choices for all of us, and less opportunity for advancement. It means people being less able to do the things they want to do. It also means slower technological advance and innovation because of reduced investment, and less ability for us to solve our problems.

Ironically some of the fashionable causes beloved by anti-growthers are taking the hit. Locally grown and organic produce are luxuries people can afford in prosperity, but are less willing to pay for when times are harder.

Growth is good, as Gordon Gekko might have said. It generates the resources with which we can achieve our goals and solve our problems. There are few problems so big that they cannot be solved by throwing money at them. But in a recession the money is not there. Those who welcome the bleak forecasts about economic contraction might think about that.

In praise of Los Angeles


A couple of weeks ago I had a holiday in Los Angeles. I'd been there before in 2004, but it was only on this second visit that I realized what a fantastic city it is. To some that might seem a controversial statement: a lot of people are quite negative about LA, its sprawl, its smog, and its supposed superficiality. But I loved it.

The reason is that LA strikes me as one of the world's only truly modern cities, designed around the kind of lives we have today, and not the ones we led hundreds of years ago. Ayn Rand once wrote that, "civilization is the progress toward a society of privacy", and that's how Los Angeles feels: private. You can drive everywhere. You're not forced to live on top of one another. You have all the benefits of suburbia, combined with all the amenities and attractions of a major urban area.

That's a product of the way LA sprawls, of course, but why shouldn't a city expand? It's not like there isn't room for it to do so. Besides, whatever the government planners try to tell us, people don't want to live in the sort of high-density developments they're so fond of – people want detached houses and space to themselves.

Another thing that struck me was how much better at suburbia the Americans are than us. Whereas British suburbs too often contain an endless monotony of virtually identical houses (another product of our wonderful planning system), in LA it looked like everyone has designed their own houses. Some, naturally, were testaments to bad taste. But the overall effect was to create a much more attractive environment.

One last point: anyone who thinks that the state needs to subsidize and support 'culture' should visit LA's Getty Center (pictured). It's free to enter and contains a magnificent art collection, housed in a series of buildings that showcase modern architecture at its best. And the whole thing is privately financed.