UK economy can aborb higher taxes

The major parties seem to agree that public spending cuts will have to bear the brunt of the effort to reduce the deficit because higher taxes would be worse for the economy than spending cuts. This consensus is based on a view that countries with higher taxes perform less well than countries with lower taxes. In fact, the long-run evidence to support this claim is flimsy.

The debate over the UK’s budget deficit – and how to cut it – is likely to dominate politics in the run-up to the next election. Reform have published Vince Cable’s raft of ideas for public spending cuts, and at the Liberal Democrats conference he has also announced radical plans for changes to the tax system. The other major parties might give us more details of their plans during their own party conferences. All, though, seem to agree that public spending cuts will have to bear the brunt of the effort to reduce the deficit because higher taxes would be worse for the economy than spending cuts.

This consensus is based on a view that countries with higher taxes perform less well than countries with lower taxes. In fact, the long-run evidence to support this claim is flimsy.

Looking at OECD data for 22 developed economies since 1970, two conclusions emerge. First, the UK is not a heavily taxed economy. On average over this period, taxes have accounted for 35 per cent of GDP in the UK – a little above the OECD mean average of 32 per cent. But this is lowered by the two largest economies – the US and Japan – having low tax-to-GDP ratios. When countries are ranked by their tax-to-GDP ratios over the whole of this period, the UK comes 10th out of 22 (i.e. very close to being  the median country). In 2007 – the latest year for which comparable data are available – the UK was 14th out of an expanded group of 30 countries, again just above the median. Any suggestion that the UK is a relatively heavily taxed economy is a myth.

Second, there does not appear to be any relationship between tax take and long-run economic performance. The correlation between average tax revenues as a share of GDP over the period 1970 to 2007 and real GDP per capita growth over the same period is very close to zero for the 22 countries for which the OECD has produced data over the full period. Switzerland, which had the second lowest tax revenue-to-GDP ratio, had the lowest growth rate of GDP per capita. The UK was close to the median for both tax revenues and growth.

Tax take vs. growth in GDP per capitaThis suggests that there is scope for higher taxes to be part of the solution to the UK’s deficit problem (when the economy is strong enough to allow them to rise) and that these higher taxes are no more likely to affect economic performance than cuts in public spending.

5 Responses to “UK economy can aborb higher taxes”

  1. Shamik Das

    RT @leftfootfwd: The UK can absorb higher taxes without causing additional harm to the economy says Tony Dolphin http://bit.ly/vCSsa

  2. Rory

    I don’t think anyone is really arguing that the UK’s taxes are high by European standards. It’s well known that continental Europe has historically had higher taxes and a larger state than the Anglo-Saxon economies such as the UK and US.

    Also, why exclude the US from this discussion? Surely it became the world’s biggest economy and only superpower by being a low-tax economy built on the principles of Adam Smith.

    It may be the case that some economies thrive while having high taxes but the experience of previous Labour governments in the UK does not bode well. The argument was won when Margaret Thatcher came to power, reduced the size of the state and the Labour Party was only able to return to power by embracing most of her thinking.

    I would like the next general election to be a debate about the merits of high tax, Scandinavian-style economies vis-a-vis low tax, economically liberal ones, but I don’t expect any clear arguments from any of the main parties on the subject.

  3. Michael Bristol

    UK economy can absorb higher taxes | Left Foot Forward http://bit.ly/16Bw6r

  4. Roger

    Rory – I am not at all sure that the US ‘became the world’s biggest economy and only superpower by being a low-tax economy built on the principles of Adam Smith’.

    Firstly the Adam Smith beloved of free market ideologues is not necessarily the same as the real Adam Smith.

    Secondly the US was for at least its first 70-years a low tax economy primarily because for most of that period it eschewed all those expensive budget items like having a real army or navy, a national bank and national debt or much in the way of a federal government at all.

    However historically this was because it had no serious enemies on the same continent and not because of any anachronistic devotion to free market principles.

    On two big issues – tariffs and slavery – it was in fact a very long way indeed from what was to become classical liberal orthodoxy.

    As the perennial debates on the national bank and currency reform that filled the nineteenth century show classical liberal theory was by no means as dominant as you would expect.

    After the civil war the US became something a lot closer to a ‘normal’ nation state but even so was still able to get by with a ridiculously tiny army and navy at a time when every state in continental Europe was putting every able bodied male into uniform.

    The spoils system being so obviously indefensible and corrupt also placed real limits on the development of continental style bureaucracy at either federal or state level.

    I’d be inclined to ascribe America’s remarkable growth rates before 1914 primarily due to its combination of extraordinarily cheap and easily available natural resources, its protectionist tariff policies and last but not least to the vital role the Atlantic slave trade played in fostering primitive capitalist accumulation.

    After 1914 it benefited hugely from being able to finance Europe’s wars while expending far less of its own blood and treasure in them tahn any of the other major belligerents.

    Had America’s founding fathers and their successors really read Smith and consistently adopted ‘true’ classical liberal policies throughout history then I suspect they’d still be an isolationist agrarian republic restricted to the eastern seaboard.

  5. Rory

    I think Adam Smith basically invented free-market economics as we understand them and I do not think America would be the world’s only superpower if it had the same economic policies as Scandinavia.

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