Fraser Nelson Fraser Nelson

Why we need a proper debate about the 50p tax rate

As every Hitchhikers fan knows, the answer to life, the universe and everything is 42. The question about the new tax on the super-rich is framed in a similar way. Will it raise £2.4bn as the Treasury claims? Or will it lose about £800m as the IFS model suggests? All of this – the future of Britain’s status as a low tax economy – depends on the gradient of the Laffer curve. And if the debate is had properly, and had now, then we may be able to stop David Cameron making a dreadful mistake.

CoffeeHousers will know the idea behind the Laffer curve, but perhaps not the story. In 1976 Prof Art Laffer, from the University of Chicago, was explaining the basics of tax collection to Donald Rumsfeld in the Hotel Washington over dinner. A journalist from the Wall St Journal was there too. It’s basic, Laffer said: tax nothing, you raise nothing. Tax 100% and no one will bother earning. To maximize your revenues, you have to find a optimal point.  To illustrate this, he drew a graph on a cocktail napkin along the below lines. The journalist later wrote this all up, and the Laffer Curve was immortalised.

But it was not 1970s idea. Adam Smith explained it in the Wealth of Nations. Even Keynes said that taxation can grow so high as to defeat its purpose. Since then, economists have managed to hone their understanding on this. Different income groups respond in different ways. The poor, for example, are seldom in a position to expand or contract their hours – or to hire accountants. The very rich, by contrast, can decide whteher to take on another project. In his Hollywood days, Reagan would speak about the point where an actor stopped working: when his income reached a certain level, it wasn’t worth it.

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