The tax-and-growth theory beloved of Britain’s Conservatives is a Reaganite throwback that will hurt workers and the poor
Two comedians have been put in the spotlight in the current debate that has been opened up on tax in Britain. One is Jimmy Carr. The other is Arthur Laffer.
Listeners to the Today programme on Radio 4 on Wednesday were treated to a knockabout interview with the architect of the Laffer curve: a graph which purports to show that lower tax rates for the rich will lead to higher tax revenues.
It’s also a theory which has been widely discredited, both on a theoretical level and in practice. Because with the Laffer curve – perhaps unusually for economics – we have a historical instance of it being implemented by a direct proponent. Laffer was an associate of the Reagan administration, which had a staged cut in the marginal higher rate of personal income tax from 70% to 28%. The effect on the budget deficit was also striking. Reagan doubled it to $155 billion and tripled government debt to more than $2trillion. His successor, Bush senior, was forced to raise taxes as the deficit doubled again.
Not all taxes were treated the same. Payroll taxes were increased. So taxes were cut for higher earners while workers paid more. Corporate and capital gains tax rates were also cut in an earlier outing for current “austerity” policies, the transfer of incomes from labour and the poor to capital and the rich.
The Laffer curve relies on the twin assumptions that the rich create the output in an economy and that they need incentives to choose idleness over work. But there is little evidence to support these hypotheses. On the contrary, economists from Adam Smith to Karl Marx have known that all value in an economy is created by labour. Those who labour are obliged to work in order to purchase the necessities of life.
The question is why such an utterly failed policy is now being revived by the BBC, the Murdoch press and the Tory party. If Reagan had not been constitutionally barred from running for a third term, he probably would have won the 1988 presidential election by a landslide. Our own neo-Reaganites and neo-Thatcherites are desperately unpopular, and imagine aggressive tax cuts might restore their own poll ratings, despite the unpopularity of the last budget, which cut the marginal rate of income tax from 50p to 45p.
What they have forgotten, and what accounted for Reagan’s popularity, is that the US government’s budget deficit was funded by borrowing from abroad, primarily from Japan. Nobody in the US was forced to pay for it. This created the famous “twin deficits” on both the government’s budget and on the external accounts of the whole economy. Reagan was able to simultaneously cut taxes for the rich and massively increase military spending in a successful attempt to bankrupt the Soviet Union while living standards rose for the majority of the population as the US went from a lender of capital to the rest of the world to a borrower from it.
It seems unlikely that even the US government will be able to repeat that trick now, let alone the British one. The major creditor nation now is China, but its purchases of US government debt seem to be on the wane as its trade surplus declines.
There will be no surge in support for the current government based on lower taxes for the rich (sometimes called “flatter” or even “fairer” taxes by the wilder Reaganites). This is because nobody else in the world is likely to pick up the tab for the inevitable reduction in living standards that otherwise follows.
But that is not to say tax cuts won’t happen. Yet they can only come from cutting the incomes of workers and the poor. It will require stoking up resentments against the low-paid, immigrants, Muslims, foreign governments and the EU. It won’t be funny.
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