As the race to be our next Prime Minister reaches its concluding stages and we now know the final two candidates, you may ask the question why so many of the Conservative leadership hopefuls have based their pitch to MPs and party members on tax cuts.
Margaret Thatcher is often lauded as a Prime Minister who cut taxes, but the reality was more complex. The Thatcher era was split into two halves, a sharply rising tax burden during the first half in order to fix the chaotic public finances she inherited from the Labour Party, which then gave way to tax cuts in her later years. Thatcher’s predecessor, Edward Heath, did substantially cut taxes but he left the economy in a mess.
On the face of it, cutting taxes must bring about faster economic growth but if you study the data and history, the truth is much more complex. Voters realise that unfunded tax cuts which add to Government borrowing can result in tax increases later. It is also unclear if tax cuts always result in increased rates of economic growth.
The famous Laffer Curve showed a curve, which above a certain level, increasing taxes would reduce Government income. However, real life examples of the Laffer Curve are elusive. When George Osbourne reduced the top rate of income tax from 50% to 45%, he initially claimed that the cut had brought in more revenue, but many economists disagreed.
An oddity of the UK tax system is what is effectively a very high rate of tax for people on universal credit, with every £1 earned above a certain level resulting in a 55p loss of benefit. Another oddity of our tax system is the high rate of tax at 63.5p which kicks in for people earning between £100,000 and £125,000. The tax rate then drops to 43.5p for people earning over £125,000. These are two perversities of the UK tax system that an incoming Prime Minister would do well to address.
As any future Prime Minister will discover, whilst self-financing tax cuts would work well, in practice, tax cuts cost money and that money must come from somewhere. Investment in public services including the NHS and education to ensure a better tomorrow for our children and grandchildren is also important.
So, my advice to both candidates in these final stages is to not over-promise on tax. Deal with the anomalies in our tax system as a priority and, in particular, allow people on universal credit to keep more of what they earn. Focus on sound public finances, but do not cut taxes at the expense of investment in our schools and the NHS.
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