The TaxPayers' Alliance - Economics 101

Roger Helmer on The Flat Tax Debate

Roger Helmer, MEP for the East Midlands (Conservative) and a TPA supporter, blogs at http://rogerhelmermep.wordpress.com/

Imagine that we had an income tax rate of 10% (wishful thinking!), and we reduced the rate to 5%.  Chances are tax revenues would fall by roughly half.  But what if we had a starting rate of 60% and reduced it to 30%?  Your first thought might be that revenues would also halve.  After all, you've cut the rate by half.  Yet all the pragmatic experience, over and over again in many countries over several decades, suggests the opposite.  Revenues might well double.  It's wholly counter-intuitive.  When Reagan announced major tax reductions, commentators called it "Voodoo Economics".  But Reagan was right, and the commentators were wrong.  When Russia recently reduced tax rates from 80% to 16%, revenues increased by 150%.

The fact is that if people feel taxes are onerous or excessive, they find ways of avoiding or evading them.  They may work less, or move investments off-shore, or hire fancy accountants, or opt for the black market.  Low-income people may decide that welfare is a better deal than work.  Foreign investors vote with their feet, and go elsewhere.

But reduce taxes, and the reverse happens.  People in the black economy will switch to the mainstream and go legit.  The marginally unemployed will look for work.  Higher up the income scale, expatriated investments may come home.  There'll be less creative accounting, but more capital formation to back entrepreneurs, more inward investment, higher growth, increased prosperity.  And there'll be more revenues for government to spend on social goods.  (For a more technical explanation, Google the Laffer Curve).

On May 27th, I had the privilege of co-hosting a seminar on the flat tax in the European parliament, with the European Enterprise Institute and the Adriatic Institute.  In the Chair, we had Edward Lucas, a Deputy Editor of The Economist.  Our two main protagonists were my old friend Dan Mitchell of the Cato Institute in Washington, a supply-side tax reform expert, who made the case for a pure flat tax, and Robert Batinovich, a successful entrepreneur and former government official, who argued for a slightly less austere version designed to answer the criticism that the pure flat tax, while it would clearly work, would tend to favour those with unearned income, and therefore be seen as favouring the rich.

Both speakers made a powerful case for lower and simpler taxes, and highlighted the dangers of the EU's implacable hostility to what it calls "unfair tax competition".  I argued that no tax competition is unfair: rather that the EU's efforts at harmonisation are a cartel operated by governments against the interests of the people.  The EU's opposition to low tax rates could come back to haunt it in Ireland on June 12th, since fear of pressure to increase Ireland's hugely successful 12.5% corporate tax rate is a powerful weapon for the NO campaign.

The debate was very well-attended and successful, and I was pleased that we managed to bring together such a distinguished panel.  I am also delighted that back at home the Conservative Party is starting to respond to public demand for lower taxes, and to feel its way, however tentatively, towards lower and simpler taxes, if not the full nine yards of a pure flat tax.  If we follow this route, then (as someone used to say) "things can only get better".  I am determined to fight Labour's great fallacy.  Whenever we talk about lower tax rates, Labour politicians ask "Which schools and hospitals will you close?".  But they are the ones closing hospitals.  The proper question for Labour is this: "If you fail to reduce taxes, if you fail to use lower taxes to increase revenues and prosperity, what public services will you have to cut?"

Private equity firms show the need for simpler, lower taxes for all

The Taxpayers’ Alliance exists first and foremost to defend the interests and rights of ordinary hardworking taxpayers.  It is ordinary taxpayers who have to foot the mounting bill for a monolithic government bureaucracy wasting money on pointless, feel good projects.  Taxpayers have seen more of their own money swallowed up by the state and seen comparatively very little in return.  Yet it is the voice of those taxpayers who fund the gravy train that seem to count for least within the political process.  It is thus for the pensioner who is unable to pay spiralling council tax bills, the first time buyer unable to get onto the property ladder due to stamp duty, and the low paid worker who faces cripplingly high marginal tax rates and so little incentive to work that the Taxpayers’ Alliance exists to defend.

Private equity executives, whatever else they may be, do not quite fit the description of the ordinary taxpayer struggling to make ends meet.  However, following the barrage of criticism recently unleashed upon them by various left wing groups and politicians, we felt the need to come to their defence.  Most of the concern has focussed on the fact that the majority of the compensation offered to private equity comes from carried-interest, which is taxed as a capital gain rather than income, and so tax rates of 10% or less rather than 40%.   The interim report of the committee of MPs investigating private equity firms considers both this issue and the use of the non-domicile status as a tax loophole, along with the impact of private equity funds on the wider UK economy.

In the age of international capital mobility, firms are able to easily relocate around the world.  So when many other European countries are moving towards a system which treats carried-interest as a capital gain, it seems foolish for us to move in the opposite direction, by creating a tax system that penalises private equity firms and so gives them a clear incentive to make the most of their foot loose status and move abroad.  Private equity firms have produced £55 billion of investment over the last five years, whilst they contributed £26 billion of tax revenue to the exchequer last year.  That would be quite some loss to the British economy.

There is a broader point here.  One reason the rich do not need the Taxpayers’ Alliance to defend their interests is that they can afford an army of accountants and lawyers to exploit our outrageously complicated tax code to find its numerous loopholes.  It is these loop-holes that allow them to pay much lower marginal tax rates than many of the poorest workers.

A flatter, simpler tax would remove many of the loopholes that allow the richest to end up paying the lowest tax rates.  It is an empirical fact that tax cuts and simplifications lead to the richest providing a greater percentage of total government revenue.  Tax simplification, not clobbering a vital component of the British economy to appease the trade unions, should be the government’s economic priority.  To his credit, Alistair Darling said much the same thing when he asked to be judged on his success in simplifying taxation.  However, as the FT so brilliantly puts it, the government’s claim that it will continue to simplify our taxes is rather like “the Mafia [pledging] to continue deepening its commitment to the rule of law.”

A fact that seems to have escaped everyone’s attention, though, is that rich people paying lower marginal rates than poor people is no argument for raising the rate on the rich, it is an argument for cutting it on the poor.

Liberal Democrat Tax Proposals

Download Reducing the Burden:  Policies for tax reform (PDF)

There are some good ideas in the Liberal Democrat tax proposals:

1. Simplification of the tax code and postcard-style returns could ease the administrative burden faced by individuals and companies.  Britain has the most complex tax system in the world, having recently overtaken India; there has to be room for simplification.
2. A cut in the basic rate would give millions of Britons some of their money back.  Very welcome.
3. Replacing the council tax would address the problem of a tax which hits the vulnerable the hardest and reduces pensioners to penury.

However, there are also some bad ones:

1. An extension of green taxes would be an inefficient way to raise revenue, would likely prove regressive and could do serious harm to British industry.  In particular, plans to increase the variation in vehicle excise duty on the basis of emissions would probably still not take lifetime emissions into account: some estimates that do include costs of construction and design suggest that a Toyota Prius Hybrid puts out more emissions than even a huge Hummer H3.
2. Taxing the rich more may appeal to social democratic notions of fairness but could do the British economy serious harm.  Estimates by the Liberal Democrats suggest that the tax bill of a City banker earning £250,000 would be increased by 11,800 pounds.  If the bank that employs that banker moved to another country to avoid the additional bill or international investment was diverted elsewhere we would all lose out.
3. There are risks to introducing a 'General Anti-Avoidance Rule'.  As the Conservative Tax Reform Commission pointed out:  "It is not easy to define exactly what such a rule should say, and experience in other jurisdictions shows that it may take some time before sufficient issues have been brought before the courts to enable to scope of the GAAR to be clarified."  Until clarity is achieved there is a lot of uncertainty in the law which exposes business leaders to unfair legal risk.

In short, a mixed bag.  Certainly an improvement over past Liberal Democrats plans to introduce a new 50 per cent tax band.  This platform would make important positive changes to the tax system by simplifying it.  If only the Liberal Democrats could get over the need to keep these changes revenue neutral they could avoid compensating measures that might undermine our economic competitiveness.

Flat Tax: Towards a British Model by Allister Heath

A fair income tax which taxed all income at the same percentage would dramatically improve incentives, while bureaucracy could be dispensed with almost entirely. This idea, already sweeping Eastern Europe, is the 'flat tax'.

Published by The TaxPayers' Alliance and The Stockholm Network

You can order a copy of the flat tax pamphlet by either:

• Sending a cheque for £10 to The TaxPayers' Alliance, 1 Warwick Row, London, SW1E 5ER
• Sending the TPA £10 via the PayPal button below (You do not need to create a PayPal account, simply use the first option on the page):

Or, Download Flat Tax: Towards a British Model by Allister Heath