Taxing issues
The Director General of the Institute of Economic Affairs on the Laffer curve, minimum wage and better breaks for businesses
This article is part of a special series on growth – where will it come from and what can be done to stimulate it?
The realisation that the economy is not recovering as hoped – and may even be on the brink of tipping back into recession – has revived the debate about how to encourage GDP growth.
The government is right to stick to its deficit reduction strategy. But it is worth noting that, for all the sound and fury, government spending is being reduced by only about 1% per annum in real terms. Furthermore, George Osborne actually intends to add several hundred billions to the national debt between now and the next general election. If you hear anyone talking about “paying down the debt”, they have a wholly inaccurate view of the public finances. The limit of the government’s ambition is simply to stop adding to the national debt over the next four years.
The general perception is that the coalition has little room for manoeuvre in terms of fiscal policy. The last government’s outgoing Chief Secretary to the Treasury, Liam Byrne, famously conceded this in his memo for David Laws, which baldly stated, “There’s no money left.”
Of course, it is often assumed that tax cuts will worsen the deficit. This is too simplistic a view. The tax burden is now so high in the United Kingdom that it seems reasonable to assume that at least some of our taxes are on the wrong side of the ‘Laffer curve’. Art Laffer, a key economic adviser to Ronald Reagan, stipulated that if you wish to raise revenues, you might be better off reducing taxes. When tax rates get too high, he suggested, they act as a disincentive to work, prompt very high earners to relocate abroad, and lead to a tendency for people to seek to reduce their hours of employment rather than, for example, work hard to secure promotion. The 50p top tax rate may well have these effects. It will bring in some revenue, of course (which will be relatively easy to measure), but rather harder to calculate (or even estimate) will be the dynamic negative effects of the rate. Similarly, any benefits of raising the VAT rate from 17.5% to 20% may well be offset by reductions in consumption and the loss of jobs.
In addition to considering tax reform and reductions, the coalition should embark on a programme of substantial deregulation, particularly with regard to employment law. We need to concede that a national minimum wage of £6.08 per hour is a contributing factor to the grim youth unemployment figures, which stand at more than a million. Making it illegal to employ a 21-year-old at, say, £5.50 per hour removes the first few rungs on the career ladder and freezes young people out of gainful employment. If the government isn’t willing to scrap the minimum wage altogether, it should at least raise the age at which the full rate kicks in to 25 or 26. There is also a strong case for regionalisation – the minimum wage in the North East surely shouldn’t be identical to that in London, as the living costs of the latter are considerably greater.
Employment law in general is acting as a barrier to businesses taking on new staff. If things don’t work out, the cost of parting company can be high. This encourages firms to press their existing staff to work longer hours rather than expand the number of people on the payroll. The government is increasing the length of service employees need under their belt before they can claim unfair dismissal (from one year to two), but more could be done. Smaller companies should also be allowed to take on their first ten or 12 employees on an entirely self-employed basis, making it much less of a gamble to build up a micro-business from sole-trader status to one where others are earning a living.
There is no single magic bullet to super-charge the UK economy. But the government needs to show greater political will in taking some practical and helpful steps to removing the barriers that are holding businesses back.
