June 26, 2006 | posted by Michael Baxter in Uncategorized |

When the George W regime lowered taxes at a time of rising US government spending, commentators were not impressed. Yet, forward-wind the clock a few years, and there are signs the US federal deficit is improving. Maybe the government on this side of the pond should adopt a similar approach. Reducing taxes when the government is being forced to increase borrowing may seem like economic foolery, but that is exactly what a number of top economists are recommending in a letter they sent to the UK government this weekend.

How can the public deficit possibly shrink if you are cutting taxes? Economic theory does have an answer. Back in the ’80s, during the period of Reaganomics, the US Professor Art Laffer argued that to begin with a rise in taxes increased the revenue the government received. But, after a while, a further rise in taxes had the effect of being a disincentive for people to work. Today, it’s also argued that higher taxes increase tax avoidance, whereas lower taxes encourage the formation of new business, and the resulting improvement in profits means more, not less, revenue for the government.

The professor came up with the famous Laffer curve as a way of defining this relationship.

So far this year, the US federal deficit is almost $50bn down on the same period in 2005, much better than had been expected. In all, the US deficit for the first 8 months (the US authorities have their year starting in October) was $272.3bn. And although the May figures showed a monthly deficit of $42.8bn, compared with $39bn a year ago, many economists see the May figures as a blip, and believe that at last the US is gradually getting things under control.
Last week, the UK’s latest public deficit figures were also announced. May saw the highest level of government borrowing for that time of the year ever recorded. And two months into the UK financial year, borrowing is both higher than last year, and worse than Gordon Brown had estimated. .
Many are, as result, predicting an imminent rise in taxes. But, if the Laffer curve is any guide and if the recent US economic experience is proof that it works, maybe the UK government should do the opposite.
For further information

Flat tax - is the new economic Shangri-la coming to the UK? Investment and Business News July 5 05
UK set to pay more tax than Germany Investment and Business News 16 January 06