Britain can’t tax its way to prosperity

John Baron calls on the Government to deliver on its 'One Nation' vision by delivering tax reductions to spur on a virtuous circle of lessening the cost of living for households up and down the country.  

The Government recently announced a £20 billion 'birthday present' to mark the NHS' 70^th anniversary. Whilst the Prime Minister rightly made clear that part of this would come from the 'Brexit dividend' once our large EU contributions cease, she also gave strong indications that tax increases were on the horizon. This is not a very Conservative instinct – not least because we trust individuals and companies to make the right decisions with their money, and because we believe those who work hard should be able to keep their earnings. Furthermore, the evidence suggests low taxation increases prosperity and, therefore, ultimately revenue.

Higher tax rates encourage people to find ways of not paying them, either legally through avoidance or illegally through evasion. Counter-intuitively, cutting tax rates appropriately often leads to higher tax revenue, as individuals and companies readily pay their taxes, happy that the lower rates strike the right balance between their obligations to society on the one hand and their bottom line on the other.

This is often described as the 'Laffer Curve', a graph which describes the optimum tax rates to maximise the tax take. Western countries provide fertile ground to prove this point, as taxes have invariably crept up over time. In the UK, for example, HMRC last year collected almost 50% more tax money with a corporation tax rate of 19% than it did at a rate of 28% under the last Labour Government. Similarly, when George Osborne reduced the additional income tax rate from 50% to 45%, the amount raised from the richest taxpayers markedly increased.

Across the Atlantic, President Trump's tax reforms were derided by his critics, who warned that they were a recipe for plunging tax receipts. These reforms included cutting corporation tax rates from 35% to 21%, as well as a reduction in the top rate of income tax from 39% to 37% and raising its threshold to $500,000. Reductions in inheritance tax and expansions to child tax credit also formed part of the package.

Yet, instead of disaster, the figures so far tell a very different story. The tax collected in April – the first month since the reductions took effect – were 12% higher than the previous year and broke all records, registering a surplus (after government spending) of $214 billion against the previous record of $180 billion in April 2001. It is suspected this pattern will continue later in the year, particularly as companies opt to report a greater share of their income in the US.

These facts should stand as a corrective to proposals to swell Government coffers by raising taxes. Instead, Ministers should give serious consideration to reducing taxes to achieve this aim, which at the same time would give businesses and individuals a welcome shot in the arm. They should also reflect on the fact that increasing taxes is invariably going to increase the cost of living for ordinary people – the richest taxpayers will no doubt find inventive but legal ways to avoid these rises – at a time when we are trying to do everything we can to reduce it.

One of the most alarming proposals to fund more Government spending is to freeze the forthcoming planned increases in the Personal Allowance. Increasing this tax relief has been one of the Government's best initiatives since the 2010 election, giving an income tax cut to 31 million people and taking four million of the lowest-paid out of income tax altogether. It is also an important part of ensuring the Government's welfare reforms are fair, by ensuring those who move off benefits and into work get to keep more of their earnings.

When considering how to raise extra funds, the Government would do well to remember the lessons of the Laffer Curve and favour tax reductions over tax hikes. These will create a virtuous circle of lessening the cost of living – in keeping with 'One Nation' principles – and giving the Government greater resources to tackle the problems of the day.