George Osborne should learn the lesson of his one real tax cut

Since he has been chancellor, George Osborne has been far busier raising taxes than reducing them. But, says Matthew Lynn, cutting taxes is the only serious way to revive the economy and raise more revenue.

Tory chancellors have a reputation as tax-cutters, and there was a time when they were. But in the three years that he has been chancellor, George Osborne has been far busier raising taxes than reducing them. Energy taxes have gone up, as have VAT, capital gains tax (CGT), and stamp duty. There has only been one cut of any significance cutting the top rate of income tax from 50% to 45%.

And what happens? This month we learned that the one time Osborne cut a tax, he raised more revenue. Perhaps he should learn from the experience. Not all tax cuts raise extra revenue it would be extreme to suggest that they did. But Britain is now at the point where taxes are so punitive that cutting rates not only improves the incentive to work, but also means the government gets more money.

Cutting the 50% rate on incomes above £150,000 was one of the most controversial decisions Osborne has taken. The increase in the top rate from 40%, where it had been held since Nigel Lawson introduced it back when the late Lady Thatcher was still prime minister, had been pushed through in the dying days of Gordon Brown's administration. It was mainly designed as a trap for the Tories. If they promised to reverse the rise, they could be portrayed as helping only their rich friends and forcing ordinary people to pay for the financial crisis. If they didn't pledge to reverse it, they would alienate their most natural supporters.

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Maybe it was clever politics. But it was crazy economics. It saddled Britain with one of the highest top rates of tax in Europe at least until Franois Hollande came along with his 75% rate for anyone in France misguided enough to earn a big salary. For London in particular, a global business centre that needs to attract companies from around the world, it was catastrophic and London is the motor of the British economy. Even so, the coalition was reluctant to reverse it no doubt because it feared the politicsof the decision. It waited until the 2012 budget, and even then only cut the rate to 45p. It was the most lukewarm tax cut imaginable. Naturally, that didn't stop the Labour Party attacking the coalition as helping only the rich. "Who Wants to Bung a Millionaire? Dave Does," Labour proclaimed in posters attacking the move. The Trades Union Congress (TUC) described it as "a slap in the face for families", although presumably people earning more than £150,000 sometimes have families as well.

Still, the argument was clear enough. The very rich would have to pay a bit less in tax, which meant the rest of us would have to pay more, or else public services would be cut. As it turns out, however, the lower tax rate has resulted in more money flowing into the Treasury. The new 45p tax rate came into force at the start of the new tax year in April. Last week, we learned that the government collected £11.5bn in income tax in April, a 10% year-on-year increase. So the cut delivered an extra billion pounds of cash.

True, the figure may not be sustained. People no doubt postponed bonuses where possible so that they were paid thisyear, and taxed at 45%, rather than last year and taxed at 50%. But even allowing for that, it is clear that the lower rate is harvesting more money.

It works in reverse too. Osborne has pushed up CGT significantly, from 18% to 28%. The result? According to a report by the Adam Smith Institute, a small government' think tank, that led to a big drop in revenues. CGT is essentially voluntary, in that you only pay it if you dispose of an asset. At 18%, people might accept the tax and pay because they wanted to do something else with the money. At 28% they are leaving it where it is because they don't want the government taking almost a third. Asset sales fell by 76%, according to the report.

In the same way, Osborne raised the stamp duty on sales of houses worth more than £2m to a punitive 7% creating a £140,000 tax bill for someone moving house. In the two months after the increase, the number of houses selling for more than £2m fell by more than 40%. The lesson is a simple one. When you raise certain taxes, the amount of income you collect goes down. When you cut them, it goes up.

Of course, that is not always true. The rise in VAT did collect some extra revenue. People still need to shop for things they require, so it is virtually impossible for them to find any way of avoiding VAT. But as you go up the income scale, and as you move towards taxes on activities that people can opt in or out of, the amounts raised are far more flexible.

At modest, reasonable levels, people won't go to the hassle of avoiding the taxes. At punitive levels, they will do what they can to get around them and will usually be successful. If Osborne cut a few more taxes, he might be pleasantly surprised at how much extra revenue the government started to raise.

The reality is that the British economy is now suffocating under the levels of tax imposed on it. It is impossible to grow when the state takes as much out of GDP as it does now. Cutting taxes is the only serious way to revive the economy. And, as the income tax cut has already shown, it should raise more revenue as well.

Matthew Lynn

Matthew Lynn is a columnist for Bloomberg, and writes weekly commentary syndicated in papers such as the Daily Telegraph, Die Welt, the Sydney Morning Herald, the South China Morning Post and the Miami Herald. He is also an associate editor of Spectator Business, and a regular contributor to The Spectator. Before that, he worked for the business section of the Sunday Times for ten years. 

He has written books on finance and financial topics, including Bust: Greece, The Euro and The Sovereign Debt Crisis and The Long Depression: The Slump of 2008 to 2031. Matthew is also the author of the Death Force series of military thrillers and the founder of Lume Books, an independent publisher.