Promises, promises….. New Labour’s pledges in three elections running included a commitment not to raise taxes. All three manifestos declared: “There will be no return to the penal tax rates that existed under Labour and Conservative governments in the 1970s. To encourage work and reward effort, we are pledged not to raise the basic or top rates of income tax throughout the next Parliament.”
By bringing forward last November’s proposed top rate of 45% from April 2011 to April 2010, and by raising it to 50%, the Chancellor has patently breached his party’s 2005 manifesto promise. “Ah”, you can hear him saying, “but in the circumstances of such a severe and unanticipated recessionary crisis all such promises must surely lapse.” Well, no.
our economic survival instincts are ultimately indomitable
Firstly, there is nothing unique about having a crisis, any crisis. In the 1970s we had a recession accompanied by hyperinflation, and interest rates of 25% plus; in the late ‘80s/ early ‘90s we had another recession and a far steeper property price collapse than the present one; we have survived a Black Wednesday and a Black Monday and the collapse of our currency when we exited the exchange rate mechanism. Just as we have survived bird flu, the SARS virus, mad cow disease and (hopefully) swine flu, we’ll come through the current malaise for one simple reason: our economic survival instincts are ultimately indomitable, even when pitted against odds made many times worse by well-meaning but woefully unprincipled legislation.
Rates versus yields
Does no one in the Treasury know about the “Laffer Curve” that plots tax rates against tax yields? In a Washington hotel in 1976 Dr Arthur Laffer drew his famous curve on a cocktail napkin to explain tax principles to a certain Donald Rumsfeld, then a White House staffer: since tax rates of both 0% and 100% will produce a zero yield, the aim should be obvious. Pitch rates at a level that optimizes yield.
The latest rise to 50% is supposed to yield an additional £2 billion in revenue. But will it? My own untutored guess, based on psychology rather than economics, is that the Treasury’s tax strategy will actually result in less tax, especially when considered as a package that includes adverse NIC changes and pernicious reforms in small print, notably relating to pensions. After all, when Nigel Lawson cut the top rate from 60% to 40% in 1988 the total tax yield went up. Why should the reverse not apply?
Even if this hike, which gives Britain the highest marginal rates among G7 countries, were to succeed in raising the odd billion, what is the use of that against public borrowing projections running at £150 – £200 billion a year?
Government spending: sharing the pain
The problem of deficits is bound to impact on the Treasury’s borrowing capability. It cannot assume there is a limitless supply of ready takers for every bond issue. Fortunately the UK’s AAA ranking appears not to be under threat. We do not face the humility and damage experienced in Ireland following a downgrade in its sovereign debt status. But at what level of gilt yields and sterling will our huge debt mountain be financed? We could be heading for an even weaker currency and correspondingly higher gilt yields.
Where in this complex matrix lies the linchpin? The economy could just about absorb the deficit explosion if tax yields fail to materialize. The real problem, however, is the unprecedented rise in public spending projections relative to GDP. Start with pensions. Why should the once secure system of private pensions be the perennial target of exchequer raids while that scandalous national overhead, the unfunded public sector pension liability, is treated as immune from commercial reality?
The pain will have to be shared. Otherwise those who now aim to punish greedy bankers will end up destroying the welfare state.