Leaders shy away from 30% tax hike predictions

The NIESR says big tax rises are inevitable. But the three would-be PMs steer well clear of the subject on TV.

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Last Updated: 31 Aug 2010

Heavyweight economic think-tank the National Institute for Economic and Social Research says cuts alone won't pay off our debts. It is predicting that big tax hikes - equivalent to a 6p rise in income tax - are also needed in order to get the deficit below the target 3% by 2020.

Funnily enough, despite the obvious gravity of these findings, none of our three would-be election winners seemed to have much appetite for discussing tax hikes in the final TV debate last night. In fact, for a debate supposed to be on the economy, there was precious little detail on exactly what we could expect from any of them post-May 6.

This is presumably on the ‘turkeys don't vote for Christmas' principle - their various armies of spin-doctors had doubtless worked out in advance how many votes the first person to mention the deficit would lose, and issued strict instructions to Gordon, Dave and Nick not to say a word on the subject.  Fair enough politically, we suppose, but it does make it rather tricky for voters to make an informed decision.

So what kind of an impact would such a hefty rise in income tax actually have? It would mean bigger bills for everyone, of course, and it might also lead to a higher rate of tax evasion. But there is also a subtler macroeconomic consequence, which you might describe as the productivity disincentive of taxation.

It's an effect quantified in economics by the Laffer Curve, and what it says is that more you tax somebody, the less hard they are inclined to work. So at a theoretical zero tax rate we work like dogs because we get to keep all the fruits of our labour, and at 100% tax we all down tools and go home because there's no point. Somewhere in between - and this is really the crux of it - there is a point where any further increase in tax rate produces a net decrease in total tax take. Precisely opposite to the desired effect, in other words.  Those of a certain age might recall that both Mrs T and Nigel Lawson were big fans of Prof Laffer's eponymous theory back in the day.

Of course, like most big ideas in economics, it oversimplifies the complex and unpredictable business of human behaviour. But it does help to illustrate the intractable nature of the problem which will face the next government, of whatever colour it may be. You can only pull so hard on one lever before the law of diminishing returns starts to make itself felt and you have to start pulling on another one. But with a deficit the size of the one the UK is currently running, our next PM - whether Brown, Cameron or Clegg - could find themselves rapidly running out of levers.

Perhaps that's what Bank of England governor Mervyn King meant when he reportedly told a US TV host yesterday that whoever ends up in power will become so unpopular that their party will be unelectable for a generation. Maybe that hung parliament idea isn't so crazy after all...


In today's bulletin:

Leaders ignore 30% tax hike predictions
Barclays cashes in on investment banking as profits leap to £1.8bn
Tesco and Sky off the hook with regulators - for now
Mervyn King: Election win will be poisoned chalice
Marks & Spencer has brief encounter with Which?

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