The Laffer Curve is about to blow up the SNP

In later research on UK data, I found strong evidence of such Laffer effects, joining other international evidence.

If this analysis can happen north of the border, why not in the UK generally? 

It has been very largely ignored by both the Treasury and the OBR, which have failed to evaluate the supply-side effects on tax revenue of our top marginal tax rates, not simply the 45pc notional top rate but also the 60pc rate created by the withdrawal of the personal allowance at the 40pc threshold.

All hell broke loose over the proposal to abolish the 45pc rate in 2022’s Truss-Kwarteng mini-Budget, even though its abolition would probably have raised tax revenue.

But dynamic costing should not stop at these basic effects on revenue due to labour supply shifts. The effects go far further, to impacts on capital investment and productivity growth from both business taxes like corporation tax and the higher rates of income tax paid by entrepreneurs on their profits.

These do two key things: they reduce the return on capital, reducing investment and capital through substitution with labour. 

Also, more radically and with much bigger long-term growth consequences, they reduce the return to innovation, alias productivity growth. The rise in these, and allied disincentives, accounts for our dreadful growth performance in recent years.

Again, much research supports these effects on growth, as does the most casual look around the world at successful cases of growth, whether Texas among US states, or Poland in recent decades, or China under Deng Xiaoping (versus today’s slowing under Xi Jinping’s interventionism). 

The best accessible review of the post-war evidence on how growth is damaged by tax is still the Institute of Economic Affairs’ Sharper axes, lower taxes, published in 2011 and edited by Prof Philip Booth.

Our Cardiff work based on the simplest of ideas, that a firm’s owner-managers will divert energy to innovation if its returns exceed the costs in tax, regulation and lost wage income, predicts that low marginal tax rates and light regulation spur growth. 

And richer entrepreneurs are less worried about the downside because they have a stronger balance sheet. 

One of the challenges for the tax-growth nexus is establishing causation and not just association, and opponents of the low-tax agenda exploit this problem. 

To overcome, it requires building causal models of growth and testing their ability to replicate the facts of economies’ behaviour.

With today’s powerful computers and recent advances in econometrics, we are able to do this by simulating these causal models and checking how well their simulations statistically match that behaviour, a roundabout procedure known as “indirect inference”.

In research carried out by me, my colleagues and our PhD students (some still unpublished) at Cardiff, we have found that this model can satisfyingly explain trends in growth and inequality in the UK both recently and over the last century and a half, as well as in the postwar US, and across Chinese regions.

The UK effects are clearly visible in our lived experience since the Thatcher reforms of the 1980s, largely retained during the 1990s but since then progressively reversed by ill-considered, mostly EU-led, regulation combined with rising marginal tax rates. 

On GDP per capita, we had overtaken France and Germany by 2000 as those reforms took effect, only to fall back relatively since then.

Yet for all the declinist talk of our parlous situation, we have the world’s eighth largest manufacturing sector, we are a leading world centre for business and financial services, and we rank second in Europe on the EY rankings for foreign investment attractiveness.

The growth prospect can be turned around if only this government would pay attention to the case for cutting down our high marginal tax rates on income and business.

This should go hand in hand with the generally agreed agenda for liberalising business regulation and development planning.

The trouble has been that the community of commentators has forgotten the supply-side lessons of Lawson and Thatcher, and drifted into thinking that productivity growth is unexplainable and “exogenous”,  nothing to do with government policy.

Hence the view that tax can be raised to pay for redistribution and public services at no cost to the economy’s performance.

This view is convenient for those on the political Left, who are strongly represented in that community, but both theory and evidence contradict it, as we are now discovering with a vengeance.

This Conservative government tells us it believes in low tax and good business incentives. Yet its record seems to reveal opposite beliefs, in line with its Labour rivals for power.

It is time for it to revert to its true principles and restore the economy’s health and dynamism. Much is at stake, with an election coming that could well see the emergence of a damaging Left-wing agenda concealed under an apparently conservative cloak designed to fool the voters. That could really drive a stake through our still-revivable business culture.

This government needs to find once more the courage of its real convictions. For the SNP, it is already too late.

Patrick Minford is a fellow of the Centre for Brexit Policy and professor of applied economics at Cardiff University