The myth of low-tax Britain
7 October 2022
SUGGESTED
Economic Theory
Energy and Environment
20 October 2022
Housing and Planning
On 2 October, the IEA’s Kristian Niemietz took part in a panel discussion entitled “The Wealth Paradox” at the “How the Light Gets In” festival, organised by the Institute of Arts and Ideas. The event description read:
“Since Thatcher and Reagan there has been widespread political agreement on the need for a low tax environment to encourage growth, which through ‘trickle down’ would benefit everyone. Yet many argue this has been a grave error. Disparities in wealth have grown, the top 1% have taken a greater and greater proportion of GDP over the last 40 years in both the US and UK. While at the same time growth has slowed. Should we simply reverse the strategy and hike taxes for the top 1%?”
The article below is a loose transcript of Kristian’s opening statement.
First of all, I would strongly dispute the claim made in the event description that Britain is currently, or has ever been, a small-state, low-tax economy. The truth is that Britain is not hugely different from a typical Western European social democracy, even though, for some reason, everyone seems to think we’re like Hong Kong or Singapore.
Take public spending. Before Covid, and after a decade of relative spending restraint, public spending stood at just over 40% of GDP. That is a perfectly normal figure for an OECD country. It is well below the figures for Belgium or France, where the state spends over 50% of GDP, but that does not make us a low-tax economy. The low-tax economies are the aforementioned Hong Kong and Singapore, as well as Taiwan, and, to a lesser extent, South Korea, Ireland and Switzerland.
About half of that public spending is social spending. In terms of social spending, we are not a million miles away from the Nordic welfare states. Yes, Nordic welfare states are somewhat more generous. But not to the extent that you could describe them as a completely different socioeconomic model.
The tax system we use to finance this large welfare state is also a fairly progressive one. Take income tax, which is by far the biggest revenue-raiser. The top decile of income taxpayers account contribute about 60% of total income tax revenue, and the top percentile alone accounts for almost 30%. National Insurance and VAT are not quite as progressive, but the households at the top of the income distribution still clearly account for a disproportionate share of the revenue. I know that everyone thinks that rich people don’t pay taxes, and that they channel everything to the Cayman Islands, but that is just not what we see in the data. If anything, we have a tax system that is overly reliant on a small group of top earners.
That said: I am not suggesting that Britain’s high tax burden is the reason why the British economy refuses to grow. I accept that some people who are broadly on my side of the argument – by which I mean free-market liberals – have sometimes exaggerated the importance of tax cuts in stimulating economic growth. There is such a thing as “naïve Lafferism”. This is probably a hangover from the 1980s, when top marginal tax rates were a lot higher, and when attitudes to taxation where, indeed, a good predictor of whether you were a pro-market or an anti-market person. But being a defender of free markets means a lot more than just being in favour of tax cuts. South Korea has fairly low taxes, but I don’t think it’s an especially liberal economy overall. Denmark, on the other hand, has very high taxes, but they are quite liberal in other ways. Which of the two systems is preferable, from a liberal perspective? It’s not entirely clear to me.
On the relationship between tax levels and growth, I would say: if you have an economy that is dysfunctional in other ways, tax cuts alone are not going to bail you out, and conversely, if you have an economy that gets many other things right – you can get away with a higher tax burden.
Unfortunately, Britain is clearly the former type of economy. The main problem in Britain is that it is a NIMBYocracy. Britain is neither run by free-marketeers nor by socialists; Britain is run by anti-development obstructionists. Every time someone wants to build something, whether that is housing, offices, infrastructure, or energy generation, some initiative of time-rich troublemakers with nothing better to do will try to shut it down. And they usually get their way. That is what’s holding back the British economy, and the new Prime Minister’s main problem is that a lot of these people are her own voting base.
The current government says they have a two-pronged strategy consisting of both tax cuts and supply side reforms. That is fine in principle. The problem is that while the first part of this agenda is specific and near-term, the second one is a vague medium-term aspiration. It’s “Let’s have some tax cuts now, and then think about supply-side reforms later.”
I would have done it exactly the other way around. I would have started with a very clear supply-side reform agenda, to be implemented straight away. And I would then have used the growth gains from that supply-side agenda for tax cuts – if, when, and to the extent that those gains materialise.
So in the present situation, supply-side reforms are more important than tax cuts. But if the supply-side bottleneck blockage can be resolved – of course a low-tax environment, or more precisely, an environment of low, simple and non-distortionary taxes, can be an important ingredient in a pro-growth policy package. Not through some fantasy notion of “trickle-down”, but simply by not hindering the process of wealth creation.
“Since Thatcher and Reagan there has been widespread political agreement on the need for a low tax environment to encourage growth, which through ‘trickle down’ would benefit everyone. Yet many argue this has been a grave error. Disparities in wealth have grown, the top 1% have taken a greater and greater proportion of GDP over the last 40 years in both the US and UK. While at the same time growth has slowed. Should we simply reverse the strategy and hike taxes for the top 1%?”
The article below is a loose transcript of Kristian’s opening statement.
First of all, I would strongly dispute the claim made in the event description that Britain is currently, or has ever been, a small-state, low-tax economy. The truth is that Britain is not hugely different from a typical Western European social democracy, even though, for some reason, everyone seems to think we’re like Hong Kong or Singapore.
Take public spending. Before Covid, and after a decade of relative spending restraint, public spending stood at just over 40% of GDP. That is a perfectly normal figure for an OECD country. It is well below the figures for Belgium or France, where the state spends over 50% of GDP, but that does not make us a low-tax economy. The low-tax economies are the aforementioned Hong Kong and Singapore, as well as Taiwan, and, to a lesser extent, South Korea, Ireland and Switzerland.
About half of that public spending is social spending. In terms of social spending, we are not a million miles away from the Nordic welfare states. Yes, Nordic welfare states are somewhat more generous. But not to the extent that you could describe them as a completely different socioeconomic model.
The tax system we use to finance this large welfare state is also a fairly progressive one. Take income tax, which is by far the biggest revenue-raiser. The top decile of income taxpayers account contribute about 60% of total income tax revenue, and the top percentile alone accounts for almost 30%. National Insurance and VAT are not quite as progressive, but the households at the top of the income distribution still clearly account for a disproportionate share of the revenue. I know that everyone thinks that rich people don’t pay taxes, and that they channel everything to the Cayman Islands, but that is just not what we see in the data. If anything, we have a tax system that is overly reliant on a small group of top earners.
That said: I am not suggesting that Britain’s high tax burden is the reason why the British economy refuses to grow. I accept that some people who are broadly on my side of the argument – by which I mean free-market liberals – have sometimes exaggerated the importance of tax cuts in stimulating economic growth. There is such a thing as “naïve Lafferism”. This is probably a hangover from the 1980s, when top marginal tax rates were a lot higher, and when attitudes to taxation where, indeed, a good predictor of whether you were a pro-market or an anti-market person. But being a defender of free markets means a lot more than just being in favour of tax cuts. South Korea has fairly low taxes, but I don’t think it’s an especially liberal economy overall. Denmark, on the other hand, has very high taxes, but they are quite liberal in other ways. Which of the two systems is preferable, from a liberal perspective? It’s not entirely clear to me.
On the relationship between tax levels and growth, I would say: if you have an economy that is dysfunctional in other ways, tax cuts alone are not going to bail you out, and conversely, if you have an economy that gets many other things right – you can get away with a higher tax burden.
Unfortunately, Britain is clearly the former type of economy. The main problem in Britain is that it is a NIMBYocracy. Britain is neither run by free-marketeers nor by socialists; Britain is run by anti-development obstructionists. Every time someone wants to build something, whether that is housing, offices, infrastructure, or energy generation, some initiative of time-rich troublemakers with nothing better to do will try to shut it down. And they usually get their way. That is what’s holding back the British economy, and the new Prime Minister’s main problem is that a lot of these people are her own voting base.
The current government says they have a two-pronged strategy consisting of both tax cuts and supply side reforms. That is fine in principle. The problem is that while the first part of this agenda is specific and near-term, the second one is a vague medium-term aspiration. It’s “Let’s have some tax cuts now, and then think about supply-side reforms later.”
I would have done it exactly the other way around. I would have started with a very clear supply-side reform agenda, to be implemented straight away. And I would then have used the growth gains from that supply-side agenda for tax cuts – if, when, and to the extent that those gains materialise.
So in the present situation, supply-side reforms are more important than tax cuts. But if the supply-side bottleneck blockage can be resolved – of course a low-tax environment, or more precisely, an environment of low, simple and non-distortionary taxes, can be an important ingredient in a pro-growth policy package. Not through some fantasy notion of “trickle-down”, but simply by not hindering the process of wealth creation.
2 thoughts on “The myth of low-tax Britain”
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Government spending is the real tax, because any deficit has to be financed through bonds (paid by future tax payers) or inflation (the most destructive tax of all). Problem is, no politician has the backbone to cut spending!
Who funds you though?