• Britain doesn’t really have a tax problem but a spending problem
  • Already a carcass, defence can’t be cut further
  • The only way to cut spending is to go after sacred cows

In part 1, I presented Arthur Laffer’s eponymous curve and the implications it has for British tax policies. In brief, there is really no way for tax rates to go anywhere but lower from here.

Of course, there is no free lunch in economics. All we’re really observing here is that the private sector tends to grow fastest when tax rates are low. Over time, lower tax rates naturally grow the tax base and, hence, revenue. This is not rocket science. It is macroeconomics 101.

The problem with a larger tax base is that it becomes a temptation to increase spending. Tax rates might be held stable but spending is likely to grow with revenue, or even in excess if the government runs a deficit. Over time, spending can grow to the point where it overwhelms even the maximum tax revenue achievable on the Laffer Curve.

Governments are not shy borrowing money to fund their programmes. Indeed, the resources available in the capital markets can seem endless. Well, until they’re not, as Truss and Kwarteng found to their dismay. There is such a thing as the “bond-market vigilantes” after all, as it were.

So where does this leave us? Laffer would have the government reduce marginal tax rates. But what if this merely encourages the bond market vigilantes to pounce anew? What then?

The key is not merely to cut tax rates, but to cut spending. That way, you can realise the benefits of moving back to a higher-growth point on the Laffer curve, one that is likely to grow revenues over time, but you can do so in credible fashion, that is, without signalling to the financial markets that spending growth will continue unabated, negating the benefits.

Starting from the position of the highest ever tax burden in peacetime, it is perhaps worth stating the obvious: the government doesn’t have a tax problem – it is already taxing that which is taxable, and at historically high rates.

No, the government doesn’t have a tax problem at all. The government has a spending problem. The future of government finances, for better or worse, is really going to be determined on the expenditure side, not the revenue side.

This is the grim reality. Politically, we know how difficult meaningful spending cuts can be to come by. While the NHS may be the largest of the sacred political cows, there are others.

There is also the not insubstantial need to rebuild the military. Far from being a sacred cow, in recent decades the military budget has been repeatedly chopped up at the butchers, leaving little but a carcass.

The Royal Navy has had a particularly embarrassing year, with a series of unfortunate events making the formerly great Imperial Navy something of a global laughing stock. It is hardly a time for defence to be the subject of cuts. No, cuts will have to be applied to Britain’s bloated welfare state bureaucracy instead.

Not myself a politician, I have no idea how an aspiring young MP might go about trying to advance a discussion on social spending matters. But it would probably be best to begin with the good news: that marginal tax rates could be cut without material loss in revenue and, over time, could actually achieve modest gains instead.

While in of itself that will not be enough to rebuild the Royal Navy or patch up the NHS for the umpteenth time, it would at least be a start and it would set a positive rather than negative tone.

It has been a long time since the UK had a low-tax champion in Parliament. Truss gave it a go, and failed. It would be a shame indeed if no one else were willing to step up and try again. Could it be done? Or would a credible call for lower taxes in Britain be just the romance of history, a faint echo of a bygone political age?

One thing to note is that income distribution in the UK is highly skewed by age. The old are far more likely to be affluent than the young. Hence any attempt to tackle spending is going to need to appeal to the aspiring young who are seeking to at least keep up with if not exceed the relative economic prosperity of their parents and grandparents.

At a minimum, work will need to be seen as attractive. Today, with the exception only of the poorest of workers, work pays worse than it ever has when tax and National Insurance – tax by another name really – are taken into account.

Indeed, it would not be a stretch to claim that high taxes are the friend of socialism. The young see their meagre pay cheques eaten away, line by line, and wonder how they’ll ever climb the economic ladder. Lower taxes, by contrast, leave much more income for the bottom line.

Seeing the benefits first hand of a freer, more dynamic, private-sector-dominated economy pay cheque to pay cheque would go a long way towards re-energising a new generation of British workers. It would help to transform feelings of resignation into ones of optimism and hope for the future.

Arthur Laffer famously sketched impromptu the first version of his eponymous curve on a paper napkin at a restaurant. Taking out a napkin of my own today, I could draw another curve. This one would plot workers’ optimism, enthusiasm and hope versus tax paid on their pay cheques. I think I know just what it would look like. Do you?

John Butler
Investment Director, Fortune & Freedom