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Nick Wood: Dynamic modelling? Not Kate Moss, but tax cuts that pay for themselves

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How much will it cost? That is just about the first question the rookie reporter is taught to ask when confronted by a vote-seeking politician promising the earth.

And, of course, it is not a bad question. Too often, our political masters seek to bribe us with our own money, holding out the prospect of smaller classes or shorter waiting lists without admitting that our taxes will have to rise to cover the costs.

But there is more to economics than simple arithmetic. Theoretically, at least, it is possible to cut taxes and raise more revenue for worthy projects such as education and health.

In modern times, it all started with the American economist Arthur Laffer, who, in the 1970s, produced his famous curve, supposedly drawn on the back of a napkin, to demonstrate that there is a level of taxation at which further increases produce less rather than more money from the taxpayer.

The idea is simple enough. A zero per cent tax produces no tax revenue. Equally, and this is the original bit, at a tax rate of 100 per cent, revenues also fall to zero as people stop paying taxes, emigrate, cheat or turn to bartering.

In between, zero and 100, there lies the optimum rate of tax, the one that maximises revenue while enjoying plenty of public support and while encouraging the best and brightest of entrepreneurs and business people to put their shoulders to the wheel.

The trouble is, no one knows exactly what that rate of tax should be.

Enter dynamic modelling. No this is not a show featuring Kate Moss and Naomi Campbell.

It is an economic theory that suggests that by cutting taxes, governments can raise more revenues, narrow deficits and generally run the country in a fiscally prudent way.

Voters and the press should stop worrying where the money comes from to pay for the latest goodies.

Tax cuts will more than pay for themselves by encouraging businesses to grow, thereby hiring more workers and generating more cash for the government in the form of higher profits (which mean more taxes) and bigger VAT, national insurance and income tax payments.

Under Ronald Reagan, egged on by Laffer and his curve, and Margaret Thatcher, the US and the UK cut tax rates, especially at the top end. The results were spectacular.

In the UK, the top rate of tax, on investment income, plummeted from an eye-watering 98 per cent. Tax on earned income was slashed from 83 per cent to 60 per cent and then to 40 per cent. The result? Tax revenues rose, not fell, and the economy grew.

Only a couple of weeks ago, HM Revenue and Customs revealed that since Chancellor George Osborne cut the top rate of income tax from 50 per cent to 45 per cent, the amount of money raised from high earners (those over £150,000 a year) has shot up from £40 billion a year ago to £49 billion this year.

In other words, an income tax cut for the wealthy has raised an extra £9 billion – which equates to about one quarter of the annual defence budget or just under 10 per cent of what we spent on the NHS every year.

Sounds crazy, doesn’t it? Cut taxes and raise more money.

But it is not so hard to see why. If tax rates are low, tax lawyers and accountants suffer because their dubious skills are less in demand. But when they rise, the wealthy seek every possible way – including fleeing abroad – to keep their tax bills in check.

Now Osborne is back at the wicket, publishing a Treasury and HMRC paper, showing that cutting petrol duties has sparked enough economic growth to offset half the lost revenue.

These are just straws in the wind. The basic argument that tax cuts equate to economic growth – and therefore higher revenues for the Exchequer – has been in the deep freeze since the Tory Party lost its nerve and kicked out Mrs Thatcher.

But in politics the game is never won nor lost. Osborne – or a successor – might one day embrace the principle of the flat tax, thereby cutting income tax rates right across the board.

He might wake up to the fact that the independent OECD has just confirmed that Britain has a tax system that uniquely discriminates against the traditional one-earner family.

He might realise that, in a world where major international competitors such as Singapore, India and China do not burden themselves with creaking welfare states, Britain will have to embrace a low tax, low spend economy.

Osborne might even figure out that mothers who stay at home to look after their children also look after a lot of other people, including elderly friends, relatives and neighbours.

In many ways they are David Cameron’s fabled and forgotten Big Society made flesh. And their children are likely to grow up to be happier and healthier adults.

Cut taxes to release the animal spirits of the entrepreneur and businessman. Rebalance the tax system to let mothers and fathers make a genuine choice about who takes paid employment and for how long.

Limit the size and cost of the State by encouraging the growth of the voluntary impulse of the non-working spouse (usually a woman). Even Kate Moss would get it.

This article was first published on the Media Intelligence Partners blog.

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Nick Woodhttp://www.mippr.co.uk
Chief Executive of Media Intelligence Partners

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