The pundits say that supply-side economics is dead. If they mean it is unfashionable, I agree. If they mean that supply-side reductions in tax rates will not help ailing economies, or that increases will not hurt them, I disagree. Anyway, the argument is about to meet a real-world test in Britain.
It has long been argued by supply-siders that reductions in marginal tax rates will bring in more revenue, not less. More jobs will be created and the economy will flourish, everything else being equal.
Many analysts do not accept this argument, partly because of our careless use of language. We talk of “tax cuts,” a phrase that conflates tax rates and revenues — prices and quantities. Such language builds into our thinking the assumption that tax revenues rise or fall in proportion to rates. It ain’t so.
Think of it this way. You run a fast food place and you sell hamburgers for $10. But not enough money is coming into the till. So you raise the hamburger price to $11. Do you really expect sales to increase ten percent? Think again. How about reducing the price to $7.50? Does you revenue then go down, or up?
Think of tax rates and tax revenues in the same way.
In the U.S., the most important applications of the supply-side idea arose with the Kemp-Roth capital gains tax rate reduction in 1978, and then with President Regan’s reduction in the top income tax rate (from 70 to 40 percent) in 1981. These changes launched an economic boom that lasted for 25 years. They also brought in tax revenues that were vastly higher than predicted.
Journalists almost always talk of “tax cuts” or “tax increases” when reductions or increases in tax rates is what they should be saying. Their excuse is that “tax cut” is more convenient and uses half the space. But in this case brevity is the soul of confusion. Also, of course, most journalists are liberals and want to believe that if the government raises tax rates, we have no choice but to fork over more money. Taxes are compulsory.
Here are the changes that Alistair Darling, the British Chancellor of the Exchequer, promises for next year. In April, the top income tax rate will be increased to 50 percent, from the current 40 percent, and will apply to taxable income above 150,000 pounds. This is the sharpest increase in tax rates seen in Britain for over 30 years.
That is the first piece of bad news for Britain, but here is something equally bad. The country must hold a general election no later than June. Almost certainly it will be in May, 2010. The leader of the Conservative Party, David Cameron, is ahead in the polls, but his support has fallen, and a hung Parliament now looms as a possibility.
What does Cameron say about the approaching tax-rate increase? If elected, he says, he will not — at least in the beginning — do anything about it. He merely holds out the hope that he will be able to reduce the top rate before the end of his first term.
I heard this last month from my brother, who is involved in Conservative politics at the local level in Britain. He even got himself elected as a councilman. Anyway, my immediate reaction to that news was that Cameron deserves to lose the election, simply on the tax issue alone.
In several other ways, Cameron has attempted to minimize his differences with Labour, as though he believed that the problem for conservatives is that they are not politically correct enough. He soon signed on to the global warming scare, for example. As a conservative, Cameron is to Margaret Thatcher what Bob Dole was to Ronald Reagan.
Here are some more tax increases that are due to go into effect in England. Fuel tax will be increased by 3.5 percent in April. (A gallon of gas already costs $7 to $8 in Britain — mostly taxes.) And the value added tax, reduced this time last year to 15 percent to alleviate the financial crisis, will soon be moved back up again to 17.5 percent. The Labour Government is also drawing up plans for a windfall tax on the bonuses recently paid to bankers. And a planned increase in the threshold level at which inheritance taxes take effect has been scrapped.
Here is a one-word reason why these assaults on the rich are a bad idea: Switzerland. The rich whom the government is taking aim at are also the best placed to avoid the poison that is being prepared for them. They can leave the country and claim non-domiciled status for tax purposes. Switzerland is the destination that has been in the news.
A high-end real estate agent in London has recently been holding Swiss-relocation seminars and some of the city’s wealthiest people have been briefed on the advantages of heading off for Geneva or Zurich.
“There was virtual indifference to the U.K. tax system when people were paying 40 percent,” said the managing director of the group holding these (oversubscribed) seminars. “But when you’re talking about 50 percent, all of a sudden HM Revenue and Customs is in for a bit of a surprise. There are high net worth guys out there saying enough is enough.”
As the supply-siders would say, 40 percent of something is a lot more than 50 percent of nothing.
“Companies from McDonald’s, the fast food operator, to Informa, the British publisher, are on the move to Switzerland, because of onerous corporate tax rates,” according to the Sunday Telegraph.
As for the rate at which tax refugees are taxed in Switzerland, my brother tells me that it can be negotiated with the government. Negotiated! That is what you call enlightened government. The Sunday Telegraph reported:
“Swiss personal tax rates are as low as 20 percent and there have been reports of UK-based executives being offered a ten percent rate as the government steps up its drive to entice high earners in.”
One problem: Housing supply “is limited and rules denoting who is able to buy a property are rigorous.” Property prices in Switzerland are high, “but pale compared to top end sites in London.”
In addition to collecting revenue, the looming tax changes in Britain are intended to punish the rich. President Obama has the same attitude. He was told by a leading journalist last year that the reduction in capital gains tax rates by both President Clinton (in 1998) and President Bush (in 2003) had been followed by revenue increases. (And the stock market promptly boomed in both cases.) Obama’s response was that that didn’t matter because raising those tax rates was a matter of “fairness.”
Prediction: The performance of the British economy is set to decline. In the last year the (London) FTSE 100 stock index has largely mirrored the movement of the Dow Jones Industrial average. Today, it costs $1.65 to buy a pound. That price will surely decline. One caveat: If Obama and the Democrats succeed in raising tax rates here next year, paralleling the changes expected in Britain, then all bets are off. I doubt if that will happen. But if it does, Obama can say goodbye to his Democratic majority in Congress.
