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On the wrong side of the Laffer Curve

The title of this article written some months ago by noted US economist, Arthur Laffer, has never been more apt after I finished reading through the UK government’s latest outrage, its annual budget statement.

A new, top rate of income tax of 50 per cent comes in from next year, applying to annual incomes of £150,000 and above. The government, which probably knows it is doomed anyway, has made the base calculation that the Tories won’t dare to repeal it. I actually am not too sure about that: while £150,000 a year is a lot of money, for many self-employed folk with lumpy income streams, such a new tax band will hit them very hard in marginal terms, encourage further emigration from the UK, deter anyone with any entrepreneurial brio from entering the UK, and probably reduce, not raise, revenues. It is also a boon to the tax-planning and accountancy profession, since anyone who can restructure their affairs to convert income into a capital gain – CGT is just 18 per cent in the UK – will do so.

Update: I share Guido’s reaction. No wonder, by the way, that the G20 nations – hypocritically – chose to attack “tax havens” and create a global tax cartel. If you are someone like Gordon Brown or The Community Organiser, the last thing you need is for your high earners to escape abroad. But I’d be willing to bet that there will be quite a rush now of people out of this country. Expect to read lots of stories about how “Mr X, who runs a small business in the Midlands, said he was heading off to Australia/Canada/wherever to get away from high-tax, high-crime Britain”. Expect there to be a relentless, drip-drip of such stories in the months ahead. (Mr Jennings snorts about my mention of Australia: yes but at least there are other benefits to moving there).

Update: Madsen Pirie of the Adam Smith Institute and some top wealth management folk give the budget a thorough hammering over at CNBC. The guy from Denton Wilde Sapte is particularly good.

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27 comments to On the wrong side of the Laffer Curve

  • I’ve a different objection (not that yours aren’t valid). I understand that generally my employer hopes to make more money from my labour than I do – that’s why they call it working for a company rather than working for yourself – and it’s a deal I’m willing to make. I also understand that it’s entirely possible to have an effective overall tax rate of >50% (it’s not necessarily easy, but income tax, NI, council tax, VAT, etc. can add up pretty quickly).

    But with a 50% income tax, even a marginal rate, and even one that I can’t ever see myself paying, the government is explicitly saying that their comes a point where it has first (or second) call on my labour. In other words I work for my company first, my government second, and when they’ve both had what they want I get the rest. Whether that’s economically wise or otherwise is an interesting discussion, but it’s academic because for me it’s already failed a moral test.

  • Monoi

    It is the 1st time in over 20 years in the city that I have english people talking overtly of moving abroad.

    I think now is a good time to buy property in Switerland….

  • John Louis Swaine

    I was vacillating about moving to Guangzhou for business. Not anymore.

    I am Gone. I am Finished. I am OUT.

    I had already structured my finances to avoid concentrating any wealth in the UK. This only proves that I was right.

  • Jim

    I moved all my cash out of the UK a few years ago. Personally I’m staggered that this has gone on so long, the debt is on an exponential path and has been for years. I’m still wondering what the trigger for currency collapse will be. Still, as Keynes said, ‘the market can remain irrational longer than you can remain solvent’.

  • Current

    Wusses.

    Evading tax is really good fun.

  • said he was heading off to Australia

    Can I confess that this particular example made me laugh so much I almost burst my spleen?

  • Jimbopa

    Where do you expect to read these stories of people leaving the UK? They don’t fit the narrative. If you see these stories, it will only be if they are slanted to show the selfishness of the emigrant, and state that the government should stop allowing people to leave.

  • guy herbert

    What many people seem not to have spotted yet is the 60% top tax rate for those earning between £100,000 and £150,000 created by the withdrawal of allowances. That’s a vastly bigger deal than the 50% above, because it will affect many more people, many more of whom are overborrowed andd short of cash.

    Also note the increase in redundancy payput into effect, with the predictable extra unemployment as forecast here:
    http://www.samizdata.net/blog/archives/2009/02/it_is_are_you.html

    Treasury forecasts on growth are oddly optimistic as they always are. How on earth do they justify them to themselves? (The Treasury, that is – we know the Government is happy with made up numbers since ministers are blase about lying, and most can scarcely add up anyway.) Surely there should be an empirical deflator applied to the iffy model by now?

  • Ian B

    The significant point isn’t the tax rise. It’s that neither of the opposition parties is prepared to say they’ll abolish it.

  • guy herbert

    Jonathan,

    Expect to read lots of stories…

    I don’t. Leaving is a big wrench, and may involve some manoeuvring. You would just go, if you were doing it. But not many will.

    The effect is more likely to be felt in fewer entrepreneurs and high earners coming here, and in the shift of effort from earning to survival and avoidance, and in the successful retiring earlier, since they are going to be barred from adding to their pensions.

  • Subotai Bahadur

    Noting that it is theoretically possible that some Brits will leave, and some will want to come to the United States; some advice.

    If you come, might I recommend the state of Texas for a destination? No income tax, and a business friendly environment. Better than half of all the jobs created in the United States in the last year were created in Texas. Yeah, culturally it is pretty far from EU-influenced Britain, but it is free. If you are willing to stand on your own two feet, it is definitely better than Britain. It is hotter and has more intense weather, but if you are willing to leave your country for Australia or China it should be bearable. My own personal preference would be for the climate of the North West, but the political climate in Washington is less than friendly for those whose loyalty is to the Constitution rather than unlimited government power.

    Oh yes, I realize that our government does not want legal immigrants, especially from Europe. However, if you are willing to come to Texas; do it by way of Mexico and after a short stroll you should be able to have your goods shipped in.

    For the record, I am not a Texan, but that might change.

    Subotai Bahadur

  • Agreed, especially Ian B’s point. The subtle difference being that Labour do it as a ‘bash the rich’ exercise, but the Tories(Link) do it in order to “rescue the economy” and/or because “priority must go to debt reduction”.

    But as I have said elsewhere, the problems are that even if this is sufficient to show that there is a Laffer Curve

    a) A lot of people just deny hard evidence if it doesn’t accord with their own world view

    b) If 50% is on the downward slope, then who’s to say that the revenue maximising rate isn’t somewhere in the region of 45%? I have a nasty feeling that the revenue maximising rate for ordinary people who can’t do fancy tax planning or bugger off abroad is more like 60%-plus.

    Whether 45% or 60%, both are overall-wealth-reducing-rates, that’s the point.

  • Johnathan Pearce

    Where do you expect to read these stories of people leaving the UK? They don’t fit the narrative. If you see these stories, it will only be if they are slanted to show the selfishness of the emigrant, and state that the government should stop allowing people to leave.

    There have been plenty of stories already about the numbers of Britons who are leaving; I remember the 1970s (just!) and the stories about all the expats; I remember reading endless stories of how actors, businessfolk etc, were moving to the US, Switzerland, or anywhere that was better. I think that when a critical mass of top-paid folk bugger off, it will be hard for the discredited Neu Arbeit spin machine and its BBC toadies to shut this up.

    Mark, well, if people deny hard evidence if it does not fit with their prejudices, then this obviously explains why these cretins wanted to establish a new top rate despite the strong arguments against it.

  • musingmarket

    Based on this IFS report (page 14):
    http://www.ifs.org.uk/bns/bn84.pdf

    a 50% rate will cost the exchequer more than £600m per annum. The most startling aspect when looking at the sums for the previously proposed 45% rate:

    It would appear that the Treasury has not allowed the behavioural response to affect revenues other than income tax receipts.

  • Patrick

    Also, try Tennessee. No state income tax here, either. Life is a lot cheaper, here, too, and there’s lots to do in the more urban areas. Plus, we have a lot of wilderness and rural areas to relax in. The downside is that unemployment has been a little high. Still, there are jobs available for trained and energetic people. Middle and East Tennessee are doing reasonably well, considering everything. While people here tend to be no-nonsense types, they are usually accepting of political differences.

  • It seems your Labour government and our Obama may have similar notions of work and wealth.


    Richard Epstein discusses Barack Obama

    Richard Epstein is the James Parker Hall Distinguished Service Professor of Law at the University of Chicago, where he has taught since 1972. He was a colleague of Barack Obama when Obama taught as an instructor. Epstein had mutual friends with Obama, and talked to Obama about some issues.

    There is a section that is relevant here:

    Obama worked as a community organizer and was in many cases very constructive. He organized public/private partnerships to help the homeless and downtrodden.

    But, the difficulty you get, for someone who has only worked in that situation, is that he believes the creation of private wealth is something the government cannot influence or destroy. He has many fancy redistribution schemes, in addition to his health plan and new labor laws, which are all wealth killers.

    He is about to engage in a series of proposals to redistribute wealth that we do not have.

  • employer

    I understand that generally my employer hopes to make more money from my labour than I do – that’s why they call it working for a company rather than working for yourself – and it’s a deal I’m willing to make.

    I’m sick of this bullshit employer/employee exploitation stuff – it assumes that the employer just sits around while you do all the work.

    Try this model. I work self-employed to produce revenue to my company of 100 which I pay to myself.

    If I “employ” someone together we can produce a revenue of 250. So 100 to me 100 to my employee 25 to the government on the employer portion of the employee taxes. So it costs me 125 to employ a 100 employee. The other 25 goes to growing the company so I can generate more revenue.

    Now out of that 125 it cost me to employ you to generate that extra 25 for the company 25 went in employer tax, 40 goes to the tax man from you in employee tax and you get the remaining 60. The employer is still doing the same work and still getting his 100.

    Where did your employer gouge you? I got 25 the government got 65 and you got 60 of the extra 150 revenue I could generate by “working with you”.

    Signing the front of pay checks instead of endorsing the back gives you a whole different view on how the world really works.

  • Laird

    Employer, I think you were missing Paul’s point (and being unfair to him). Go back and read his post again. He wasn’t begrudging his employer a profit on his labor; in fact, he explicitly accepted that (“it’s a deal I’m willing to make”). His a argument was against the government also claiming a share of the excess value; it’s basically the same complaint you’re making.

    BTW, I’m self-employed myself and also “sign the front of the paychecks”, so I feel your pain.

  • guy herbert

    musingmarket,

    That’s a very useful document. It is not just the Treasury that fails to allow for behavioural responses properly.

    Most government departments seem not to be able to take account of any consequence of regulation other than weightless compliance, and seem to imagine that people can move in only one dimension so that compliance can be obtained by threats and all else will be invariant.

  • Marc Sheffner

    a 50% rate will cost the exchequer more than £600m per annum

    (Thanks for the link, musingmarket(Link)).
    This suggests that either the Treasury is insane, or there is some other reason for the tax hike. Whatever could it be, boys and girls? (Of course, it’s not a strictly “either-or” situation, as both could be true).

  • Thanks for the comment, Laird, you’re right. I don’t think my employer is gouging me at all. In fact I’ve worked in one or two places where potentially they *were* gouging me (my billing rate was >3x what I earned) and I accepted that deal quite happily, because it was the best deal for a person of my particular talents. You *should* be sick of the bullshit you describe, employer, but you might do better to direct your ire at someone who’s in favour of that bullshit.

  • 655177

    I’m not big fan of the laffer curve. Oh, don’t get me wrong, I think it’s correct but I just have issues with its use.

    Firstly, it’s often used to justify pushing for tax cuts on the grounds that it would increase revenue. Firstly, I have not seen any evidence that we are on that point of the Laffer curve where cutting taxes would increase revenue. Maybe it would, I just haven’t seen the evidence. Secondly, our arguments for tax cuts should be based on the fact that it’s the taxpayer’s money, not the governments and not revenue based at all.

    The other issue I have with the Laffer curve is how it was used by those who created it. Did they just cut taxes and spending and wait for the revenue to sort itself out? No. They cut taxes but kept spending about level and borrowed the difference. This assumes that the cuts will cause the economy to grow enough to cover the interest on the loans. Firstly, this is dodgy financial management and secondly, you drag the economy servicing the interest in any case and thirdly, you’re still engaging in wasteful spending (which is the real issue in the end).

  • Eric

    In other words I work for my company first, my government second, and when they’ve both had what they want I get the rest.

    As a child I witnessed an excellent presentation by an actor/historian who went around to local schools and delivered a stealth history lesson as a medieval English peasant. The thing that sticks with me all these decades later was his description of the disposition of his crop. This much went to the crown, this much to the local feudal lord, this much to the church, and the little bit left was the amount the peasant would have to survive the winter. They couldn’t possibly have taken more, because if they did the poor guy would starve and there’d be no taxes the following spring.

    Thank God feudalism went out with the middle ages.

  • Laird

    Not much argument from me with the points made by 655177 (interesting moniker!), except for the statement that “I have not seen any evidence that we are on that point of the Laffer curve where cutting taxes would increase revenue.” The empirical evidence is overwhelming that we are far past the inflection point. Every major tax cut in the last 50 years (Kennedy, Reagan, Bush) has resulted in increased government revenues. The marginal rates have crept up to uneconomic levels and need to be pushed back down again. So while I fully agree with the other arguments (it’s the taxpayers’ money, wasteful spending, etc., etc.), I’ll use any weapon in the arsenal in the fight to reduce the tax burden. (Deficit financing is an entirely different issue.)

    The Laffer Curve isn’t some magical formula by which to calculate the optimal tax rate; you can’t just take the first derivative and solve for the inflection point. It’s a device to graphically illustrate the concept of declining marginal utility when applied to taxes. It’s more akin to a metaphor than a model; don’t ascribe to it powers which Arthur Laffer never claimed.

  • Paul Marks

    The left used some of Prof Richard Epstein’s comments last year.

    The stuff about Barack Obama being a really nice man.

    However, Richard Epstein also said that Bill Ayers (another man he meant in academic circles in Chicago) was a really nice man.

    Actually it should not astonish me – the reason that left concentrates so much on presentation training (voice control, body language and so on) is to get this sort of “what a nice person” reaction.

    Most people are not paranoid Redhunters (like errrr – me) and do not think to themselves “why is this man speaking to me nicely – what is he up to?”.

    The training methods are used because they work with most people.

    I will leave aside the public-private partnership stuff (terrible though it is – and with a history that goes back to pre World War One Vienna).

    As for Art Laffer.

    A man who backed Clinton back in 1992 – and who makes a good case still that he did the right thing (given the mess Bush senior helped create, and how pragmatic Bill Clinton proved to be).

    Laffer is a fairly good policy man – and he is not “just taxes”.

    He opposes the bailouts (and that is an important test).

    He also has got a good nose (or “is paranoid” – it depends on your point of view).

    The “nice man” view of Obama holds that he will change policies when they have terrible effects.

    The other view of Obama is the terrible effects are the reasons he supports the policies he does. That the present society (“capitalism”) must be discredited and destroyed for the new society to be built.

    No prizes for guessing which view of the President of the United States and Commander in Chief of the Armed Forces of same, that us paranoid people hold.

    As for tax rates.

    50% plus (and it is plus – look at the details) in Britain.

    It will mean less revenue over time (wherever the “laffer point” is it is certainly lower than 50%) but the present government in Britain is thinking politically (no surprise).

    Specifically the Labour party is seeking to “shoot the Lib Dem fox”.

    The calculation is that many voters just hate the rich and could not care less about longer term consequences.

    And, thanks to the work of the education system and the broadcasting media, the calcultation is most likely correct.

  • M

    Laffer is a fairly good policy man – and he is not “just taxes”.

    I disagree. I think he deserved to be included in the housing bubble hall of shame.

  • Paul Marks

    I apologize M

    I did present too positive a picture of Art Laffer.

    I am a political at heart (not a good thing to be – I know).

    If someone comes up and says “I denouce these bailouts of Bush and Obama – and this Obama person is a collectivist ……..”.

    I tend to “forget” nasty things I know about that someone.