Britain may have a new Prime Minister and a new Chancellor, but its problems stubbornly remain the same: economic stagnation. Before the 2008 financial crash, Britain was on course for near parity with the US in terms of GDP per capita. Today, however, Britons are around 40% poorer than their Atlantic cousins.
Stagnation's Toll on Families and Public Finances
If the UK had returned to its own trend growth rate, families today would be over £10,000 a year better off and the UK economy around 25% larger than it is today. Low growth is never good news, but it's a disaster now. Britain is even struggling to find the money to defend herself. She must contend with an ageing population and the pressures of continued illegal migration with all the associated costs.
Bad policies have left the most basic promises of government to the people unfulfilled. Brits deserve better, and rightly want higher living standards. Growth is the answer to many of the challenges Britain faces. But in the absence of growth, government scrambles to find other ways to meet the rising pressures on public finances.
Tax Rises Prove Self-Defeating
Too often that means tax rises. The tax burden has now risen to 37% of GDP and is forecast to reach a post-war high of 38.5% by 2031. The Labour Party in government have so far delivered two tax-raising budgets, with a third looking increasingly likely. But increasing tax rates is not an alternative to growth, nor is it even necessarily the way to increase tax revenues. In fact, raising tax rates of late almost always ends up being self-defeating. It kills growth and often damages tax yields.
Lower tax rates encourage growth and affordability by incentivising the production of more goods and services. This is a critical point. Economics is fundamentally about incentives and taxes crush them. Put another way, high taxes damage economic activity and budgets can't be balanced on the backs of the unemployed, underemployed, and failing businesses.
Principles of an Efficient Tax System
Taxation should be light on production and collected as efficiently as possible. But this is not where Britain is headed. In a tax system of maximum efficiency, marginal tax rates need to be low, to maximise incentives to work and invest, and the tax base should be as broad as possible with the least number of deductions, exemptions, exclusions, write-offs, and credits as possible to reduce distortions and loopholes. The system should also be as simple as possible.
As tax rates increase, incentives to produce steadily decline and output falls. There comes a point where the decline in output from any additional tax more than offsets the increase in tax take, and tax revenues fall. We have seen this play out in reality time and time again. The Treasury's own analysis suggests that raising the rate of Capital Gains Tax would lead to lower receipts, while more and more of the wealthiest are leaving the country and taking their substantial tax contributions with them. Of course, facts won't stop the voices egging the Chancellor on to hike taxes again. But rest assured, if taxes are raised, the economy will slow, revenues will stall, and many people will be hammered.
Setting tax rates is not just about finding the point of maximum revenue for the Exchequer either. Everyone knows if you tax something, you get less of it. This is the principle at the heart of the Laffer Curve. Stamp Duty, for example, taxes transactions in the housing market and therefore renders people immobile. Fewer transactions mean fewer people moving to where they can get better jobs and be more productive; it means less business for moving companies and estate agents, decorators, and plenty of other contractors. And their lower incomes will be spread through the whole of the economy.
While there is a short-term cost to the treasury attached to abolishing Stamp Duty, its elimination will have an enormous effect on growth, which is exactly why the Conservatives have committed to abolish it entirely on primary residences. Some people take away the wrong lessons from the Laffer Curve and treat all tax cuts as if they can pay for themselves - that is not the case. There are very worthwhile tax cuts which in the long run will pay huge growth dividends, but in the short term still need to be funded, which is why spending cuts are so important, starting with welfare.
The whole welfare system needs fundamental reform. The best form of welfare is still a good, high-paying job, but there are still some people who can work, yet who prefer welfare payments. This should cease to be an option, but the government is showing no inclination to grasp this nettle.
A Path to Closing the Prosperity Gap
Approaching the Budget, the Chancellor must first do no more harm. That means stop raising taxes and prioritise controlling spending instead. Then, delivering “good growth in every postcode” can be pursued by cutting the taxes that are destroying economic activity, disincentivising work and investment, and holding Britain back.
Only by fundamentally scrutinising our tax system, and being laser-focused on growth, can we begin to close the prosperity gap and make Britain rich again.
