John O’Connell is Chief Executive of the Taxpayer’s Alliance.
Ever since the mini-Budget in October 2022, many Conservative MPs have understandably been hesitant about making the positive case for tax cuts. This included the very highest echelons of government, with both Jeremy Hunt and Rishi Sunak insisting for months that tax cuts were not on the agenda.
They weren’t helped by a Twitter-driven landscape hostile to the idea that people spend their money better than the government does. In certain corners of it, a near-consensus has emerged that there is no solid link between levels of taxation and rates of economic growth.
After Kwasi Kwarteng’s mini-Budget seemed to play this out in the real world, perhaps it is no wonder many politicians who might otherwise believe in the dynamic effect of tax changes felt the need to keep their heads down.
It wasn’t just that there was no link between tax and growth; on the contrary, economists argued that indeed there was a link – a negative one. Take Eric Beinhocker and Nick Hanauer, who wrote for The Guardian, that “the evidence is clear: not only does it not work but it does enormous damage to the economy and society.”
They included in their analysis the example of the United States as proof of their case. Forget the fact that the US has one of the lowest tax burdens in the OECD, and a GDP per capita 60 per cent higher than it is here.
So should Conservatives do away with Adam Smith’s maxim about prosperity depending on “peace, easy taxes, and a tolerable administration of justice?” Is the idea that low taxes help to drive growth now belied by the evidence?
New research by the TaxPayers’ Alliance finds that lower tax burdens are supportive of growth, jobs and investment. A survey of more than 40 academic studies finds that tax burdens of somewhere between 20 and 30 per cent of GDP are optimal for better rates of growth. Take one study as an example, by Folster and Henrekson: this finds that “an increase in the expenditure ratio by ten per cent of GDP is associated with an annual growth rate that is 0.7-0.8 percentage points lower.”
That doesn’t mean that the level of taxation is the only factor dictating growth. It doesn’t even mean it’s the most important. Low levels of taxation wouldn’t come close to compensating for sectarian conflict, for example. Nor does it mean there is an agreement over the optimal level. They might differ in their definition of what constitutes a high tax burden – but they all agree that a high tax burden hurts growth.
In another study, Scully finds that the “growth-maximising tax rate for the United States over the 1960–1990 period was an estimated 19.3 percent of gross domestic product (GDP).” They also find that a certain degree of public spending, particularly on defence, justice, public health, and infrastructure, not only don’t harm growth, but in fact help it.
Government can play a positive role, but almost certainly far less of a role than it currently plays if we care about growth. This is surely a comfortable position for any conservative to take.
On the structure of the taxation system there is a little more divergence, but a couple of points can still clearly be made. Generally, recurrent taxes on immovable property, especially land, are least damaging, and on transactions and business profits taxes are most damaging. Estimates usually find taxes on income to be more damaging than taxes on expenditure.
What are the implications then, for policymakers and politicians? Clearly, growth is not the sole priority for government. The TPA-led 2020 Tax Commission’s Single Income Tax, our comprehensive plan for an optimal taxation system, which we updated just this year, would put receipts at 33 per cent of national income.
This is a level markedly above the consensus level for growth, which is in the twenties. That’s because we recognise that the adequate funding of public services is worth a reduction in the maximal level of economic growth.
But the flipside is that with taxation at a record high, and growth non-existent, we are achieving the worst of both worlds. People aren’t becoming richer and more prosperous, and the cripplingly low growth levels means that public services don’t appear as well-funded as they should be, given the size of the tax burden.
The public tell pollsters they want the focus to be on public spending, yet it is so rarely explained to them that the trade-off isn’t as simple as it might appear on paper.
It’s clearly time for a course-correction. Taxpayers are told repeatedly that you can have low taxes or high-quality public services. But at the moment, we have neither. As Hunt considers tax cuts for the upcoming budget, it’s a perfect time to remind any shy politicians that the evidence is there that a lower tax burden can help to drive growth.
John O’Connell is Chief Executive of the Taxpayer’s Alliance.
Ever since the mini-Budget in October 2022, many Conservative MPs have understandably been hesitant about making the positive case for tax cuts. This included the very highest echelons of government, with both Jeremy Hunt and Rishi Sunak insisting for months that tax cuts were not on the agenda.
They weren’t helped by a Twitter-driven landscape hostile to the idea that people spend their money better than the government does. In certain corners of it, a near-consensus has emerged that there is no solid link between levels of taxation and rates of economic growth.
After Kwasi Kwarteng’s mini-Budget seemed to play this out in the real world, perhaps it is no wonder many politicians who might otherwise believe in the dynamic effect of tax changes felt the need to keep their heads down.
It wasn’t just that there was no link between tax and growth; on the contrary, economists argued that indeed there was a link – a negative one. Take Eric Beinhocker and Nick Hanauer, who wrote for The Guardian, that “the evidence is clear: not only does it not work but it does enormous damage to the economy and society.”
They included in their analysis the example of the United States as proof of their case. Forget the fact that the US has one of the lowest tax burdens in the OECD, and a GDP per capita 60 per cent higher than it is here.
So should Conservatives do away with Adam Smith’s maxim about prosperity depending on “peace, easy taxes, and a tolerable administration of justice?” Is the idea that low taxes help to drive growth now belied by the evidence?
New research by the TaxPayers’ Alliance finds that lower tax burdens are supportive of growth, jobs and investment. A survey of more than 40 academic studies finds that tax burdens of somewhere between 20 and 30 per cent of GDP are optimal for better rates of growth. Take one study as an example, by Folster and Henrekson: this finds that “an increase in the expenditure ratio by ten per cent of GDP is associated with an annual growth rate that is 0.7-0.8 percentage points lower.”
That doesn’t mean that the level of taxation is the only factor dictating growth. It doesn’t even mean it’s the most important. Low levels of taxation wouldn’t come close to compensating for sectarian conflict, for example. Nor does it mean there is an agreement over the optimal level. They might differ in their definition of what constitutes a high tax burden – but they all agree that a high tax burden hurts growth.
In another study, Scully finds that the “growth-maximising tax rate for the United States over the 1960–1990 period was an estimated 19.3 percent of gross domestic product (GDP).” They also find that a certain degree of public spending, particularly on defence, justice, public health, and infrastructure, not only don’t harm growth, but in fact help it.
Government can play a positive role, but almost certainly far less of a role than it currently plays if we care about growth. This is surely a comfortable position for any conservative to take.
On the structure of the taxation system there is a little more divergence, but a couple of points can still clearly be made. Generally, recurrent taxes on immovable property, especially land, are least damaging, and on transactions and business profits taxes are most damaging. Estimates usually find taxes on income to be more damaging than taxes on expenditure.
What are the implications then, for policymakers and politicians? Clearly, growth is not the sole priority for government. The TPA-led 2020 Tax Commission’s Single Income Tax, our comprehensive plan for an optimal taxation system, which we updated just this year, would put receipts at 33 per cent of national income.
This is a level markedly above the consensus level for growth, which is in the twenties. That’s because we recognise that the adequate funding of public services is worth a reduction in the maximal level of economic growth.
But the flipside is that with taxation at a record high, and growth non-existent, we are achieving the worst of both worlds. People aren’t becoming richer and more prosperous, and the cripplingly low growth levels means that public services don’t appear as well-funded as they should be, given the size of the tax burden.
The public tell pollsters they want the focus to be on public spending, yet it is so rarely explained to them that the trade-off isn’t as simple as it might appear on paper.
It’s clearly time for a course-correction. Taxpayers are told repeatedly that you can have low taxes or high-quality public services. But at the moment, we have neither. As Hunt considers tax cuts for the upcoming budget, it’s a perfect time to remind any shy politicians that the evidence is there that a lower tax burden can help to drive growth.