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Perhaps because Arthur Laffer is extraordinarily rightwing, the curve he drew on a napkin in 1974, suggesting lower tax rates increase revenues, has become a weapon of Conservative thinkers. This is far from ideal. If any government can find tax reductions that change behaviour sufficiently to raise receipts, everyone should be in favour. The problem is that genuine examples of the phenomenon are vanishingly rare.
In last week’s UK Budget, Jeremy Hunt donned the mantle of Laffer throughout his speech. The chancellor’s justification for cutting national insurance contributions was to make work pay. “Lower taxes. More jobs. Higher growth,” he said. Up to a point that was true. The Office for Budget Responsibility, which dynamically scores tax changes, agreed that the policy would boost labour supply by the equivalent of 98,000 jobs and would raise the level of economic activity permanently.
The trouble is that these real gains are small relative to the static cost of the tax cut, which will flow to millions of people. Making work pay better and boosting hours worked would generate a decent £1.7bn in extra revenues in 2028-29, but it was far offset by the total exchequer cost of the move of £10.7bn. Hunt’s rhetoric did not match reality.
When it came to cutting the 28 per cent rate of capital gains tax on second homes to 24 per cent, the chancellor really got into his stride. “Perhaps for the first time in history both the Treasury and the OBR have discovered their inner Laffer Curve,” he declared. This flourish came because the OBR said that the measure would permanently raise net revenue to the exchequer by £4mn a year by 2028-29.
Sadly, even this estimate with “very high” uncertainty is not quite what it seems. It is not a pure Laffer effect where the tax cut boosts economic activity to a level sufficient to raise revenues from that tax. The slightly positive result for revenue comes because the UK has a terrible transactions tax on property — stamp duty — which the OBR reckons will claw in more revenues when property transactions go up in response to a lower capital gains tax rate. Net CGT revenues fall by £82mn.
Proponents of a third potential application of the Laffer curve were disappointed when Hunt declined to reconsider the 2021 decision to axe value added tax-free shopping for non-EU visitors, a policy dubbed by detractors as a barmy “tourist tax”. In work funded by the Association of International Retail, the consultancy Oxford Economics has estimated that the Laffer curve is fully operational. If VAT-free shopping was extended to all tourists, it estimated “the total tax contribution is more than 60 per cent larger than the estimated fiscal cost”.
The Oxford Economics paper appears plausible until you look closely at the assumptions made, which the OBR did in a new analysis published this week. That tax change does not appear to have deterred tourism from non-EU countries. Numbers of visitors to the UK have recovered after the pandemic in a similar way since 2021 to other European countries that did not scrap VAT-free shopping. There has also been no relative decline in visitors from non-EU countries.
The most problematic assumption in the Oxford Economics report, however, was that anyone working in retail would be unable to find any work at all without the shopping subsidy. Using more plausible behavioural assumptions, the OBR estimated that the ending of VAT-free shopping for tourists saved UK taxpayers £539mn. Again, Laffer’s curve is noticeable by its absence.
Without the Laffer curve, the real “tourist tax” question changes. It is: should UK taxpayers be subsidising US, Chinese and Saudi visitors buying French perfume and Swiss watches from low-paid retail employees in Bicester Village? There is a simple answer to that question. No.
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