In today’s issue:
- Labour are dangerously close to a Liz Truss moment
- The Laffer Curve is out of time
- North Sea Oil pays the green energy bills
The trouble with setting a precedent is that it can come back to bite you. Having harangued Liz Truss out of office for her mini budget, Labour are now walking a fine line themselves. If the bond market wobbles, will they all resign too?
There’s no shortage of fiscal fears to worry about. Everyone and their pet hamster is out predicting Labour will go on a tax raid the likes of which we haven’t seen since Vikings. It’s quite a list… of taxes and soothsayers.
The Tony Blair Institute predicted a £50 billion tax raid over the course of this parliament.
The Treasury presented Labour with a middle-class pension contribution tax raid for a £2.7 billion increase in tax according to the Institute for Fiscal Studies.
Senior Tory MP and former chair of the parliamentary Treasury committee Dame Harriett Baldwin reckons the Labour Party is asking the IMF to run the Exchequer again.
Apparently Labour are “copying and pasting recommendations straight from the IMF’s playbook” of higher taxes. Which might sound conspiratorial, but the truth is far worse. Dame picked the right institution, but the wrong book to warn about.
Everyone can agree that something needs to be done to fill the “black hole” of fiscal deficits. An apt metaphor, if ever there was one…
Of course, they all have it terribly wrong. Hiking taxes doesn’t necessarily raise more money. Blood out of a stone, killing the goose that lays the golden egg, flogging a dead horse… you get the idea.
I don’t know whether you feel more like a horse, a stone or a goose, but it should be blatantly obvious that the British taxpayer is drying up. The Telegraph reports on one example of more taxes leading to less revenue already:
A tax raid on second homeowners risks backfiring and driving up avoidance that could cost the Exchequer £172m, experts have claimed.
Almost 150 local authorities plan to use enhanced powers to charge second homeowners double council tax, in a move that is due to rake in millions for councils in holiday hotspots.
But experts have warned that the clampdown is resulting in second homeowners “flipping” their properties so they are classed as small businesses, which do not have to pay council tax.
Small businesses can then claim 100pc tax relief on business rates, meaning both the local authority and central government are deprived of tax revenue.
Real estate company Colliers estimated this will cost the Treasury more than £170m a year, up from £150m in 2022.
That’s the estimate. Of course, what actually ends up happening is never quite clear. There’s just too much going on in an economy to tease out the impact of one change to tax policy.
And so economists can use whatever assumptions they need to reach whatever estimated conclusion they are paid to reach. Some say tax hikes raise revenue. Others say it’ll actually cut it. Nobody ever finds decisive proof. Only the economists doing the numbers benefit for certain.
The Laffer Curve is short on time
President Reagan’s adviser Art Laffer famously came up with the theory that describes the trade-off between tax rates and tax revenue. He argued that raising tax rates raises more money if you start at low tax levels. But, at some point, you reach a peak. And then raising taxes actually lowers revenue because it shrinks the tax base. People stop working, earning and setting up businesses if tax rates are too high. A graph of this idea shows what’s called the Laffer Curve. (It’s more of speed bump shape.)
According to the Laffer Curve, governments can seek to find the peak – the level of tax rates that maximise revenue. The big question is, where is that point? And have we gone well beyond it already?
I’ve always found it fascinating that this is controversial. It seems blindingly obvious to me that there’s a simple trade-off. After all, you can obviously raise taxes so high that it ruins your economy. So, where is the right level?
But the key factor is one I don’t think Laffer mentioned much in his theory: time.
Hiking taxes raises more revenue in the short run. But it also cuts economic growth by lowering incentives to invest and earn. Over time, this means a smaller economy and thereby a smaller tax base to which your tax rate applies.
Thus, the relevant question for a tax hike is not where you are on the Laffer Curve, but when. It’s “How long before higher tax revenue in the short run is outweighed by a stunted tax base in the long run?” Or, as Liz Truss would put it, “How long it’ll take for lower taxes to raise more tax revenue by growing the economy faster?”
That might sound confusing. But computer game geeks have an intuitive understanding of it. They build it into their games.
As the ruler of some lost empire, you can’t just hike taxes to raise more money. That would make the game boring. And so the mechanics of the game make it work like this…
If you put taxes too high, you stunt your economic growth and your enemies will have a much larger economy than you later in the game. If you put taxes too low, your enemies will raid your puny army before your economy can outgrow them.
For some reason, politicians argue this doesn’t apply in reality. They just assume more tax means more revenue and forget about timeframes. And then wonder why the economy is performing ever more poorly…
Who pays the price?
Given all this, I’m terribly worried about various Labour leaders’ political careers. They’re getting dangerously close to what happened to Liz Truss, just erring in the opposite way. Raising taxes too much could hit economic growth so badly that it undermines the country’s long-term ability to sustain its national debt. Just as cutting taxes but not spending undermines the short term.
There’s no better example of this than the combination of Labour’s North Sea Oil policy and energy transition policy.
Right now, we produce and use a lot of fossil fuels which raise a lot of tax revenue. The government collect taxes on fuel, on oil companies, resource royalties and plenty more. We are home to global leading oil firms that pay their taxes here too.
Conversely, the green energy system is damn expensive for the government. The subsidies are eyewatering. It’s already causing some serious budget problems for the German government, for example. And they’re still busy building new coal mines.
Labour’s policy combination is dangerous. Changing from an energy system that is revenue creating for the government to one that is a fiscal drag could upend the budget badly.
No wonder green governments are having to dream of ways to recoup the lost tax revenue from their fossil fuel-whipping boy. A “pay per mile” tax on driving, for example.
It’s also about productivity – the true key to growing the economy. Oil companies produce a lot of oil and make a lot of money per employee. A renewable energy system is different. It is very labour intensive to build.
Politicians like to tout all the jobs a green energy system would create. As though this is a good thing.
But energy is a basic necessity of modern life. The more people tied up in providing it, the less people we have producing other things we want, like cars.
The jobs also add costs to the energy system, which must be paid by those using the energy. Thus, the more people working in the energy system, the less efficient it is. And that lowers overall productivity.
Just as we should celebrate the rapid decline in agricultural workers over the last 200 years, because it was a measure of productivity, progress and prosperity by freeing up labour to produce other things, we should be panicking about how many of us will soon have to work on providing basic energy services in a green energy world.
To sum up, Labour’s policies risk a fiscal miscalculation and a productivity crash. Given how fragile the UK bond market is, the reckoning for all this is mostly likely to show up there first. And Labour could be hoisted by their own petard. Then they’ll have to call in the IMF again for real.
Until next time,
Nick Hubble
Editor, Fortune & Freedom
