Tax is usually taxing

Taxes are too high. If we are to speed recovery, should we come down to the level which would maximise growth?

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Can we find the level of taxation which would maximise growth?
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John Redwood MP
On 2 April 2012 14:22

Taxes are too high. Taxes have, in recent years, got higher. They need to come down. There are too many of them. Too many of them stifle enterprise, success and saving. They deter investment, encourage tax avoidance, lower incomes, and slow private sector recovery.

Let us introduce a couple of ideas to help the analysis. The first is that we should accept there is a maximum sustainable taxable capacity in any country, a level of national income that a government can take, before avoidance, disincentive and other factors kick in to make it difficult to collect more. It is the level elected politicians feel is the limit to their ambitions to spend more.

The second concept is that if a government goes over this level, it can reach Tax Saturation, the level at which revenues start to fall, as the tax levels hurt enterprise and reduce activity and income. This is a kind of Laffer curve applied to the whole economy and to the totality of taxes levied. 

You can see the UK this year has reached the point of tax saturation on Self-Assessment Income Tax, which is forecast to fall by almost 10 percent despite some modest growth in the economy as a whole. There has been a sharp reduction in higher incomes in response to the 50 percent tax rate imposed. That was before news came of its future reduction. The higher CGT rate is forecast by the government to induce a fall in revenues from that tax next year.

So what is the maximum sustainable level of total taxation in the UK? If we compare the percentage of national income taken in taxes since 1970-71 (Red Book June 2010 p 104) we see that the maximum tax take was 38.2 percent of GDP in 1982-3 and 1984-5, both years when the then Conservative government was trying hard to get the inherited deficit down against a background of a recovering economy. The highest under Labour was 36.4 percent in 2007-8. The lowest was 31.8 percent under the Conservatives in 1993-4 and 33.1 percent under Labour in election year 1978-9.

All this would imply that at the very least democratic pressures seem to prevent a government taxing much more than 38 percent of GDP. It is especially interesting that socialists who tend to believe in higher public spending on a wider range of items than Conservatives have thought the limit of our taxable capacity is around 36 percent of GDP during their eighteen years in office since 1970.

Total current public spending is forecast at 42.5 percent in 2011-12, with total public spending at 46 percent. If the aim is to pay for current spending out of current tax revenue in normal years, only borrowing in cyclical downturns, it implies that we need a lot of growth to get public spending down to the Sustainable tax level without making further cuts.

Of course, there is another theoretical level which is difficult to estimate: the level of taxation which would maximise growth. It will be below the sustainable level of taxation, but the question is how far below? Would it be better to get there quickly to speed recovery? And what reductions in public spending would be necessary to achieve that without losing fiscal credibility?

The Rt Hon John Redwood MP is the Member of UK Parliament for Wokingham and the Chairman of the Conservative Economic Affairs Committee. His articles are cross-posted on his blog by agreement

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