The Chancellor believes in the Laffer curve. He accepts that when a tax gets to a certain level, if you raise the rate further you will suffer a loss of revenue, not a gain. He has been trying to get the Treasury to include this effect in their models, as they have now conceded that you can raise a tax too high to maximise revenues.
Labour still find this a difficult idea to grasp. When I last explained it again in the Commons recently a triumphant Labour MP asked me why as I wanted lower rates for CGT and top rate income tax, I did not ask for a lower rate for VAT as well. The answer is obvious. I want rates of Income Tax and CGT that maximise the revenues, not diminish them. At 17.5% or even at 20% if you raise the VAT rate higher you get more revenue. If you raise the Top rate of Income Tax above 45% you get less revenue, as the government has now proven in its latest figures. The easier it is for people to avoid a tax, the lower the rate has to be to maximise the revenue. The higher the rate of the tax, the more likely it is to be at or above its revenue maximising rate.
This week we are hearing reports in the news that the Treasury has admitted cutting Fuel Duty as this government has done has beneficial effects on output and incomes. Of course it does. Thank heavens the Treasury has tried to redo its sums whilst recognising this. They have come to conclusion that over the long run (20 years) the Fuel Duty tax cuts will only lose the Treasury 44%-63% of the alleged revenue lost in the first full year of the cuts.
This study comes up with a laboured and very long term answer to a different question to the Laffer question – what is the tax maximising rate? We can see the difference starkly if we look at a similar study of the effects of Corporation Tax cuts which the Treasury published with less media interest in December last year. That study, like the Fuel Duty one, concluded that over a 20 year period there would be a boost to GDP from the Corporation Tax cuts. This would recoup 45-60% of the revenue they say the Treasury loses in the first full year of the cumulative tax cuts. This again is a poor long term answer to a different question.
So what has happened with the progressive cut in Corporation Tax from 28% for larger companies and 21% for smaller companies to 20% by 2015-16? In Budget 2013 Onshore Corporation Tax was scheduled to fall from £35.5bn in 2012-13 to £33.5bn in 2015-16, a decline of 5.5%. (“Is it wise, Chancellor, to “give away” so much to big business when we have such a large deficit?” you could hear the mandarins ask).
In Budget 2014 the Treasury tells us Onshore Corporation Tax rose from the original £35.5bn in 2012-13 to £36.6bn in 2013-14, and is now forecast to rise to £42.3bn by 2015-16. Instead of a 5.5% fall there is now to be a 19% increase.
Of course these figures are sensitive to changes in growth forecasts for the economy, but the changes are so stark you have to conclude the Treasury model is still unable to handle the Laffer effect. Clearly the CT rate has fallen and is falling a long way – a fall of 28% in the rate for large companies over the full period, taking it down from 28% to 20%. Far from leading to a loss of revenue as the long term Treasury model now tells us , the actual Treasury forecast is for a gain of revenue over that time period. Why the difference?
I think the Treasury needs to do some more work on Laffer. I am sure from my own work that the current CGT rate is above the level to maximise revenue. That means if you cut the rate you will collect more money for the Treasury. I think we can all agree VAT is still below it, as probably is fuel duty. That does not mean I want to raise them.
Corporation Tax is more difficult to gauge. Given the huge swings in Treasury forecasts of Corporation Tax revenue in recent years, the Treasury clearly find it impossible to predict reliably. These latest studies are far from convincing, and laden with warnings that they are not predictions of revenue for the next few years, which is what we really need to know. I suspect the Treasury still does not want to admit that you can cut a tax rate and get more revenue in, though the evidence shows that is the case.