All tax systems tend to the Laffer Peak - or over
This is not a proof, this is a musing. But we have a strong feeling that all tax systems tend to their Laffer Curve peak.
Yes, the Laffer Curve exists, it’s a mathematical certainty, the only useful argument is over what is the rate at which revenue is maximised. This will be different for each separate tax and in each separate jurisdiction and collection of surrounding laws. A perfectly decent analysis of where that peak is in US society is 54% for taxes upon income. Note that this is not the wealth of society maximising rate, which is considerably lower. This is the maximum that can be shaken out of pockets without revenue then, over time, declining. We’re making the useful, if not wholly accurate, assumption that the UK peak will not be higher than this. Not higher, on the grounds that the US has passport based taxation, the UK residence. It’s much, much, easier to simply leave and not pay UK tax than it is US.
Which then gets us to this worry:
Here’s the problem, however: it will be a disaster for the economy. Ever since the Conservatives froze the point at which you start paying 40pc income tax at £50,270, more and more of us have been dragged into this bracket. The OBR already estimates that 7m people will pay that rate in the coming tax year, 2.5m more than would have without the freeze.
Back in 1990, only 1.7m people paid what was then the top rate of 40pc. Even in 2010 it was only 3.3m. With another two year freeze on thresholds, it will go to 10m. With only a modest uptick in inflation, it could perhaps hit 12m or 13m. At that point, we might as well just be honest about it: 40pc will be the standard rate of tax, with the 20pc rate for a few low-earners. Anything else is just kidding ourselves.
Immediately someone’s going to say that a 40% income tax is not, in fact, a tax upon incomes of 54%. But that tax upon incomes is carefully defined - it is all taxes upon incomes including any employer paid. Thus including employers’ national insurance. This means that in the British system a 40% income tax rate is, around and about, at that Laffer Peak.
If we combine that with such things as the interaction of income tax with personal allowance withdrawal, child benefit, child care and so on then we’ve rather a wide band of income where the rate is over the peak. Well over. And we have at least anecdotal evidence that people do indeed refuse to work more, take promotions and so on as a result.
If we were to start with the idea that politics will only take as much out of the population as is necessary to run a decent state then there would be no reason to expect taxation to trend toward this peak - or over it. If, on the other hand, we take the more cynical - we prefer realist - view that people go into politics for the fun of spending other peoples’ money then we can see that, quite naturally, we’ll end up with ever rising taxation. The process will only stop when there’re no more feathers to be had, whatever the hissing.
Again, we already see this. For decades we and other sensibles have been pointing out that stamp duty on shares reduces total revenue collected. There’s strong evidence that stamp on houses does so too. Now we seem to have the income tax system heading to where we’re not just over the peak for the rich we’re also getting to it for everyone.
This then neatly explains the current shrieking about wealth taxation. Even if not consciously folk are realising that there cannot be more fun - that fun of spending other peoples’ money - by increasing income taxation further. Therefore the invention of new, even more damaging, forms of taxation to allow the joy to continue.
But that musing. We do think that taxation systems will trend, over time, to that Laffer Peak and a little over. Not because that’s what is necessary to run a society but because spending other peoples’ money is fun. Therefore every new generation of politicians will whack up the rates so that they get some of that fun rather than just having to stick with what has already been done by previous ones. The limitation being only when higher rates do not bring in that more revenue by which time, of course, they’ll already have spent the revenue that didn’t arrive and will have borrowed it instead.
This last then neatly explaining why we’ve taxation at levels not seen since the last major war and also a deficit at levels not seen since the last major war. Just because spending money is fun therefore politics will extract as much fun out of the population as it can.
So, err, how do we stop them?
Tim Worstall