Controversial though it was, Thatcher’s successors left the top rate at 40p
until 2010, when the Labour Government introduced a new 50p rate on all
income above £150,000. The Coalition has since reduced this to 45p but
Laffer argues the Government should abolish it altogether.
“It’s already done long-term damage having it at 45p rather than 40p,”
Laffer claims that if the Government scrapped the top rate and “levelled
the playing field” at the top it would entice more people to work here,
generating more income for the Exchequer.
“If you lowered the tax to 40p, your prosperity would come back, your
revenues, your budgets would come back and you would get back what you had.
And if you lowered it even further, Britain would even do a better job.”
Official estimates show that reducing the top rate of tax to 45p cost the
Exchequer just £100m but there is a more important point.
According to the Institute for Fiscal Studies, the 1pc of taxpayers earning in
excess of £150,000 now pay between 25pc and 30pc of all income tax, up from
21pc a decade ago. Tinkering with the way this group are taxed carries a
risk for any chancellor.
Laffer’s solution is simple: introduce a flat tax that would bundle together
income tax and national insurance, get rid of tax credits and the “absolutely
offensive” inheritance tax.
According to Laffer, a flat tax would discourage “gaming” of the
system, level out the playing field and ultimately generate more revenues.
“Taxes change all sorts of incentives, and that’s why you want to have a
tax system that allows for the least gaming of the tax code,” he says.
“Taxes should be there to collect revenues. If you’ve got poor people
whom you want to help, don’t play around with taxes. You can’t help poor
people with taxes but you can spend money on them. “Under a flat tax,
everyone pays the same rate so there’s not an incentive for tax dodgers and
loophole seekers and lawyers and favour grabbers and consultants and
deferred income specialists and accountants. Let them all get real jobs!”
A flat tax is radical but not impossible to implement. Back in 2005,
Chancellor George Osborne spoke out in favour of a flat tax, while a study
by the Adam Smith Institute suggested introducing it at 22pc, supported by a
higher personal allowance of £12,000 (up from £4,740), would yield long-term
benefits despite an initial £40bn black hole. More recently, the 2020 Tax
Commission called for a 30pc flat rate of income tax, with National
Insurance, inheritance tax and stamp duty on shares scrapped altogether.
A flat tax has been the norm in several Eastern European countries for
decades. Estonia introduced a flat tax of 26pc in 1994, clinging to a 21pc
rate during the depths of the financial crisis and opting instead to raise
revenues by raising the value-added tax and slashing government spending.
The deficit never exceeded 3pc of GDP during the crisis, and the budget has
been mostly in surplus since then. Yet some other flat-tax converts in the
region, such as Ukraine and Belarus, are economic basket cases, while
Slovakia has abandoned its flat tax in favour of a more progressive system.
Laffer admits that introducing a flat tax in the UK would face too many
political hurdles: “But you’ve got to have a vision of what the world
should be so you can always judge policies as to whether they can move you
towards what it should be, or away from what it should be.”
Laffer has attracted as many critics as admirers. They claim that the Reagan
tax cuts and Bush cuts in 2001 and 2003 actually reduced revenues and pushed
the deficit higher. Harvard professor Jeffrey Frankel argued that while tax
cuts could raise more revenues under certain conditions, common sense would
suggest that overall cuts reduce revenues.
Laffer says it’s more complicated than that, citing the example of cutting
capital gains tax, which encourages investment and therefore increases the
tax yield from income taxes, corporate profits taxes and sales taxes.
A recent Treasury analysis found that government plans to reduce corporation
tax to 20pc next year from 28pc in 2010 would increase the size of the
economy by between 0.6pc and 0.8pc.
Laffer points out that punitive tax rates suffered by US companies wishing to
return money to the US will spark more inversion deals, such as drugs giant
Pfizer’s attempted takeover of AstraZeneca.
“Do you really want businesses to make decisions based on their taxes?
No-one does. Businesses should do business because it’s good for business,
not basing their decisions on tax codes.”
Forty years on, the Laffer curve is still causing a stir, but what exactly
happened that night in Washington? “I would have dinner every week with
Donald Rumsfeld when he came back from NATO,” recalls Laffer. “He
invited his deputy and my classmate from Yale, Dick Cheney, and I invited my
friend Jude Wanniski. “At the end of the dinner, Jude picked up the
napkin and it’s now held by his wife.
“I denied it was on a cloth napkin until I actually saw it. Can you
imagine going to a fine restaurant and drawing on a fine napkin? If my mum
knew, she’d say, Arthur, get a piece of paper – please.”
The Margaret Thatcher Conference on Liberty takes place on Wednesday June
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