Taxing Growth

Mrs May has reserved her position on the triple lock, responding to questions by saying with some pride how the Tory’s are the party of low tax as if this were axiomatically good. I am with Oliver Wendell Holmes Jnr on taxes, they are what we pay for a civilised society. Taxes are used to defend the country from external aggression, prevent and punish crime, maintain its transport infrastructure, educate its people and care for them in times of need whether caused by ill health or economic necessity. These are all good things and worth paying for. At the moment all of these services are subject to major challenge following almost a decade of Austerity and cuts to their budgets.

The government is constantly making “difficult choices” which involve cutting services to the bulk of the population. We need to do this, we are told, as the national debt means we simply cannot afford the services we once had. It is a very brave politician that suggests we might increase taxes to ease the problem of funding our public services, as Jeremy Corbyn has done. Even if it is proposed that those with the broadest shoulders might take the largest share of any increase. We are warned such a naive move would kill enterprise. Those who earn vast amounts of money would stop working so hard if they were taxed at too high a rate. This would undermine growth, GDP would go down and everyone would be worse off.

At first glance this might seem to all make sense. By not overtaxing the rich we get a more dynamic economy providing more jobs. Some even suggest that by doing this you will actually generate more tax receipts because a bigger and more productive economy means more jobs and more taxes. This is what supply side economics was all about. This last step in the argument might be thought to be manifestly  untrue as you would think we would not have the problem that we have in paying for the services of a civilised society if it were, given that we have indeed been lowering tax rates for the past half century or more.

However, if we consider the first part of the argument, that it is counter productive to tax the rich. Is it true? There seems to be growing evidence that low taxes and high growth are not very well correlated.

 

Graph 1

Graph 1 looks at evidence from the United States of America. It compares the GDP growth rate since 1947 with the highest income tax rates in the same years. It is a bit of a shock to look back at tax rates in the 1950’s. For more than a decade from 1951 the top rate of income tax was 91% or more. Through the 1970’s the rate had declined to 70% but in the 1980’s it fell from 70% to a low of 28% and then never got above 40% even after the crash of 2007/08.

Was this huge reduction in tax rate accompanied by an increase in the rate of GDP growth as the better rewarded entrepreneurs worked all the hours they could to increase their wealth even more? Seemingly not. In fact the growth rate roughly speaking halved as the tax rate more than halved.

Over the past half century the taxes on the very rich have reduced significantly. What is more the effective rate has probably reduced even more as ever more sophisticated means of avoiding taxes have been adopted by individuals and corporations. It may seem self evident that if you collect less tax it will be more difficult to fund the services of a modern state. There are of course a lot of very wealthy individuals who have a vested interest in making the majority of the electorate think that lower taxes will benefit everybody despite the growing evidence to the contrary.

Whether Mr Corbyn has what it takes to be a leader he is raising some interesting questions. They deserve to be taken seriously.