Cutting tax rates equals higher revenues and higher growth

Article by John Blundell

MY instincts tell me we are about to experience one of those pivotal moments when long shared assumptions shatter, when all is turned on its head. Almost all our politicians believe it is their duty to deliver "free" services and then tax us to pay for them.

Taxes rise each year. The quality of the services declines each year.

My instincts are more than hunch. Look eastwards. The former Warsaw Pact nations are adopting sharply lower and much simpler taxes. This is the so called Flat Tax movement. As a result their economies have a dynamism unimagined in France or Germany or Britain. They rocket up at rates that will have them overtaking the UK soon.

Here is my proposition. Yes, it is counter-intuitive. Truth often is. Lower Tax Rates Generate Higher Tax Revenues.

It may be worth adding that lower taxes would translate into more votes for those that deliver them. But I am an economist not a politician. That is for others to decide.

Remember the grim moment in the spring when the brave Howard Flight MP was beheaded by Conservative leader Michael Howard for suggesting the Tories might lower taxes in the future by cutting public expenditure more than had been said in the Tory manifesto? This idea was treated as a betrayal. He had his seat removed. He was cast out of public life. For now but not for long, I suspect.

The Heritage Foundation in Washington DC compiles a magisterial annual encyclopaedia on economic freedom and prosperity which looks at the economies of every nation. It cries out with two simple conclusions: countries prosper with the rule of law plus low taxes. Those nations adopting modest tax rates grow at 6% compounding into prosperity. Countries with high tax rates wheeze to grow at 1% a year. Low tax nations double gross domestic product (GDP) in less than 12 years. The sclerotic high tax territories take 70 years to achieve the same. If 1% and 6% growth rates seem extreme just take say 2% and 4%; the former doubles in 35 years while the latter takes a mere 17 years.

How can it be that lower taxes bring about higher revenues? The answer lies in human nature. You might even say it is a moral argument. Lower taxes alter everyone's perceptions and behaviour. The entire price-signalling system of the market transmits clearer messages.

In Britain today both the act of employment and the act of giving employment are polluted by the burden of Income Tax and National Insurance.That mirage personality, the statistically average Brit worked for Chancellor Gordon Brown until 30 May this year. And next year it will be 2 June, and the year after 4 June and so on.

As matters stand, no ordinary mortal can understand the UK or US tax codes. Even the fiscal experts often have to resort to the courts to try to comprehend what the legislation means. An entire professional expertise has grown up to help bamboozled citizens complete their tax forms. In the ideal world of low simple taxes, so the bold argument goes, everyone's tax form would be no more than a postcard in size. Corporate returns could be just as simple. Tens of thousands of tax accountants and Inland Revenue paper-pushers would have to find gainful employment for the first times in their lives.

A low tax regimen means the end to the thickets of tax breaks, concessions and allowances.

If this all sounds fanciful look at what is bubbling up in Eastern Europe - but within the European Union (EU). Estonia has a flat tax rate of 20%, Lithuania 33% and 15% on corporate earnings. Outside the EU Serbia has a rate of 14%, Ukraine 13% and Slovakia 19%. Perhaps, most surprising, of all is Russia which now has a flat tax of 13%. No, that isn't a misprint: it is 13%.

A wide sweep of history, best attested in Adam Smith's The Wealth of Nations confirms low simple taxes boost revenues but we have two vivid examples just offshore - Guernsey and Jersey have no tax above 20%. Their bubbling prosperity is obvious to all.

In Hong Kong the 16% tax rate rules - as it has since the 1947 ordinances. In one sense nobody has a paternity claim to this idea. In another sense, I believe, two scholars at the Hoover Institution, Robert Hall and Alvin Rabushka, kick-started this happy theme with their study The Flat Tax in 1985.

With a uniform tax of, say, 15% in the UK our social and political landscape would be transformed but, and this is the real surprise, revenues would rise too. All the energies and skills that now go into avoiding or evading taxes would be switched to doing what we do best - swapping goods and services. Economic activity now offshore would be repatriated and black economy activity would become white. This alone would give revenue a boost.

Those Baltic nations that have led the way with flat taxes do not find their treasuries dry up. Economic vitality lifts off: 15% of a dynamic commercial economy is worth far more than 50% of an inert one.

Britain's highly complex and detailed tax regimes are really only the debris of an idea that has died and has had its day. The defunct idea is that the state can manage and direct our affairs and police "social justice". Joining them on that deathbed will be the notions that unearned income and inheritances are disorders rather than blessings.

Most of our front rank politicians are mesmerised by the patently false notion that higher taxes bring in more cash. One long-term exception is David Davis, the bookies favourite to lead the Conservatives by the autumn. As a former chairman of the Public Accounts Committee he developed an acute awareness of the waste and inefficiency of the state however benevolent it is trying to be. And through his studies at London Business School, Harvard and some of the world's leading think tanks (as well as his observations of the Thatcher tax rate cuts of the '80s) he realised high rates equal low revenues, while low rates equal high revenues.

The best analogy may be the bonfire of controls and regulations Germany enacted in the late 1940s. The Federal Republic dazzled the rest of Europe. Yet all it did was free its people to trade freely and use price signals. The current Germany is slowly atrophying under its accretion of ever more taxes and regulations.

New Labour still has the ability to surprise us. Its new principle of road pricing is a bold free market idea that the Tories funked. Yet is it not reasonable to say that Gordon Brown is dedicated to an ever more convoluted redistributive tax system? Tax lawyers alone have been enriched by his c