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Bloody George's Budget: How bad is it really?

Maybe not the end of the world after all

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The basic allowance for income tax, that £6,475 a year you can earn without paying income tax, will rise by £1,000 with the aim of getting it up to the Lib Dem idea of £10,000 a year (pfft, we at the Adam Smith Inst want it to be £12,000). The simple point being that there's very little point in saying that people are so poor they need tax credits, benefits, housing allowances and all the rest and then charging them income tax on the pittance they do earn. Getting the working poor out of the income tax net is a worthy and desirable goal: even if one that cannot be immediate. It also helps with, although does not solve, the tax and benefits trap.

This is the sad but true fact that for some people - people on very low incomes - working more to earn more simply doesn't work. For of each extra pound you earn through more hours or a pay rise (or, heaven forfend, getting a qualification and thus a better job) the taxman takes 20p in tax, then 11p in national insurance, then the benefits people take another 30, 50, possibly even 80p in reduced benefits (yes, there really are a few poor souls who can end up worse off after earning more). This is inevitable in a system where the tax and benefit systems overlap but the rise in the allowance will at least reduce this a bit.

Just before the election this desire to raise the personal allowance was attacked from the left (well, Left Foot Forward, a slavishly pro-Labour blog/campaign site) as being an inefficient use of scarce resources. If you raise the personal allowance then all benefit: even the rich get to pay less tax! This has been neatly solved by reducing the amount you can earn before paying higher rate tax: those who do pay higher rate will not benefit at all.

There are two sets of changes which will have all sorts of people shouting and screaming but both of which seem entirely sensible to me. Again, no, not because I'm some righty who loves torturing kittens, but because they make economic sense.

The first of these is the change to the Capital Gains Tax rate. With some allowances for entrepreneurs (the amount you can make before you have to pay goes up to £5 million in a lifetime) the rate will rise from 18 per cent to 28 per cent. There have been those insisting that it should go up to marginal income tax rates: 40 per cent, even 50 per cent.

However, and here's something that many find hard to swallow, there really is something called the Laffer Curve. There really are tax rates above which revenue collected falls, not rises. This rate will be different for each different tax in each different society and may well vary over time. But there's an interesting little HMRC chart here (pdf). (Boring technical guff: these numbers are not inflation adjusted and they are stepped a year. For CGT is payable a year after the gain is made, not when it is made.)

What that chart shows is that when Lawson raised the CGT rate to 40 per cent back in 1988 the amount collected in CGT then fell for the next decade and a half. In fact, adjusting for that inflation, the yield did not reach earlier levels until 2006: by which time the rate had been lowered again.

As Osborne said today - and he may or may not be correct on the exact rate - higher than 28 per cent CGT would actually mean losing revenue, not gaining it. Certainly 40 per cent lost it.

The second thing that will cause screaming is the joint lowering of the corporation tax rate and the raise in the VAT rate. The general consensus here, at least on the left side in this country, is that companies should pay lots and lots of tax while VAT is regressive and thus should be as low as possible. Well, yes, but this slightly fails the basic tests of a desirable taxation system. We do know that all and any taxes (yes, I'm sure there will be a land taxer among you - LVT does this the least which is why it is the most desirable of all taxes) create distortions. Distortions can reduce the future growth rate.

And we do indeed want to have as much growth as we can while still raising the money to pay for the things we want from government. That's as a simple, basic rule, quite apart from the fact that the more growth we have the more the debt shrinks as a percentage of the economy and thus the easier it is to deal with.

Not only do we know that all taxes cause distortions and thus reductions in growth, we know that different taxes have different effects. There's an OECD paper on that here (pdf, page 13 for the table). And what we know about these different effects is that consumption taxes, ie VAT and excise taxes on booze and baccy, have the least effect upon growth for the money they raise. Then income taxes in the middle and the two taxes which are worst for the negative effects they have on growth compared to the amount they raise are capital taxes and corporate profit taxes.

(This is quite distinct from the obvious truth that while companies can collect taxes they can't actually pay them. Corporate taxes are paid by some combination of the shareholders, customers and workers: in the UK at present the best guesstimate is that 70 per cent of corporation tax is paid by the workers in the form of lower wages.)

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