Since its development in the 1970s, the Laffer Curve has shifted even more in favour of jurisdictions with low and simple taxes.
This is driven by three megatrends: Globalisation, Technology and Inequality.
Thus, high and complex tax systems drain more resources than ever, while low tax countries are eating their lunch.
The UK government needs to cut and simplify taxes fast to become one of the Laffer Curve's winners. If it does not act fast, it will see the national wealth and tax take shrink.
Governments Beware: The Laffer Curve Has Moved
In 1974, the economist, Art Laffer, famously sketched out his theory of taxation on the back of a napkin. It would later be called the The Laffer Curve.
Laffer’s point was that tax rises are subject to diminishing returns and eventually negative returns. This is because as tax rates rise, taxpayers will increasingly avoid or evade those taxes; or if they cannot, exit the country entirely. Furthermore, by discouraging profitable activity, high taxes actually shrink economic activity. Hence there is a double whammy to excessive taxation: you end up collecting a smaller proportion of a shrunken GDP.
The Laffer Curve is now widely accepted, and we can see evidence of it aplenty. For example, thanks to its punitive wealth taxes, France has been losing around 10,000 millionaires a year to lower tax havens like Switzerland and Singapore. Even for a country the size of France, that is an extraordinary drain of tax revenues and productive people. Greece meanwhile has some of the highest tax rates in the world. Yet tax collection is far lower thanks to large scale evasion.
In the UK, shortages of senior public sector workers, such as consultant surgeons, are being exacerbated by crippling tax rates on income and pensions. For many wealthy professionals, why bother working when over half your wages will be taken away? Is it surprising that non-doms, such as Aksharta Murphy, have not been falling over themselves to participate in the British tax system?
Governments should beware because these trends of evasion, avoidance and exit are accelerating. In other words the benefits of raising taxes has reduced and the costs have increased. Conversely, the rewards for low tax economies have risen.
This is because, in the decades since Laffer sketched his curve, the world has changed dramatically. Thanks to the megatrends of Technology, Inequality and Globalisation, the Laffer curve has shifted in favour of low tax regimes.
Let’s start with Technology. Technology makes it easier to move money around for businesses and individuals. Thus it is much easier to run tax avoidance schemes or to shop around for the best jurisdiction. To take a simple example, in February my second son was born. A few weeks later I set up a Junior ISA account for him using my existing online broker account. It took all of five minutes, and allows us to save £9000 a year tax free. I did not need to hire a lawyer, fill out forms or even post a letter.
Technology also makes things cheaper. Last year, the Blairs made headlines for avoiding £312000 of stamp duty by using an offshore company. Go online and you can set up such a company for roughly the price of a Big Mac.
Related to technology is the spread of Globalisation. We are all international citizens now. Even after Brexit, wealthy tax payers and skilled workers enjoy an unprecedented level of free movement. Globalisation makes it much easier for people and companies to move abroad and escape high domestic taxes. Every capital city now boasts top drawer international schools. English is spoken globally as the language of business. Flights have got cheaper. And of course, smart countries have worked out the benefits of offering golden visas to highly skilled and wealthy individuals.
The third megatrend is the growth in Inequality. Specifically, more of the world’s wealth is concentrated in the hands of Billionaires and mega-corporations. If you’re earning £25k a year, it is not worth hiring a team of international lawyers to shave a few percent of your tax bill. If you’re earning billions it most certainly is. Thus, more of the world’s wealth is subject to sophisticated tax avoidance schemes than ever before.
The Laffer Curve is a core component of economic policy making. But the curve itself is dynamic. Thanks to the megatrends of Globalisation, Inequality and Technology, the Laffer curve has moved.
In today’s world, high or rising taxes bring a government little benefit, while imposing an enormous economic drain, as contributors avoid, evade and exit. Meanwhile dynamic countries with low and simple tax regimes, can eat their lunch.
With UK tax rates at 70 year highs, the government almost certainly travelled way past the peak of the Laffer curve; thereby trashing our economy while collecting less than it could.
As if the cost of living crisis weren’t enough, this is yet another reason for bold tax cuts and simplification. Fortune Favours The Tax Cutters.