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Economics

Laffer Curve and UK Corporation Tax

Tom White

11th June 2014

I was drawn to a Telegraph headline, Europe is jealous as Britain resurrects the Laffer Curve. According to the author, by next year Britain will have the equal lowest headline rate of corporation tax in the G20.

The Laffer Curve offers an intoxicating promise to politicians. It suggests that if the tax rate is too high (above t* in the diagram above) then a cut in tax rates will actually boost the amount of revenue raised!

The Laffer Curve is usually taught in the portion of a course where students are exploring the possible limitations of demand management, using levers like fiscal and monetary policy. Many economists prefer to emphasise the long run importance of supply side policies. This approach is broadly more inclined to welcome lower rates of government spending, and certainly lower taxation.

Take the author of the article, Jeremy Warner. He writes that the UK is continuing to pull away from the rest of Europe in terms of Foreign Direct Investment (FDI). The UK secured nearly 800 projects last year, the highest ever, accounting for around a fifth of all European FDI, far in advance of any other country. On a global basis, only big emerging markets – China, India and Brazil – and among advanced economies, the US, are ahead. He thinks the reason for this are largely because of the tax system, where the UK is the most competitive in the G20.

By next year, Britain will have the equal lowest headline rate of corporation tax – at 20% - of the G7 major advanced economies. Other G7 countries range from 25% to a crushing 38% and 39% in France and the US. According to Warner, by also taking measures designed to make tax decisions more open and transparent, the UK has succeeded in giving businesses a virtually unparalleled degree of tax certainty. He thinks more major tax reforms (not just cuts) could have even bigger effects. He accepts that Britain should improve the policing of its tax systems too.

That’s the Laffer Curve in action: reducing corporation tax has reversed the outflow of corporate head office functions, and doing so has substantially added to overall employment, output, income tax, national insurance and VAT receipts. Lower tax rates are helping to drive a higher overall tax take. The “Laffer curve” lives.

The UK is not yet a low-tax economy, nor is it ever expected to become one under any mainstream political manifesto. At around 37pc, the UK is about middle of the G7 pack for tax as a proportion of GDP.

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