By Ben Ramanauskas
The recent revelation that many leading political figures around the world have been using offshore tax havens to hide their money has caused widespread outrage in the the UK and abroad. The Prime Minister of Iceland has resigned as a result, and there are calls by many in Britain for David Cameron to do the same. It has also focussed the public’s attention on UK tax law and those who both evade and avoid paying tax in the UK.
Unfortunately, many people have now started confusing and conflating tax evasion (which is illegal), with tax avoidance (which is legal). We are now in a position where politicians and the media are tarring innocent people who move their money offshore to avoid paying excessive and crippling taxes and criminals and dictators who are attempting to conceal their ill-gotten gains with the same brush.
Instead of moralising about those who legally avoid tax, it is time the government understood why individuals and businesses do it. The majority of people are happy to pay some level of tax to the country which they find themselves in – the issue is when it becomes excessive or capricious. Individuals and businesses resent having to pay excessive taxes to fund government schemes which serve no useful purpose. Furthermore, individuals and businesses cannot plan for the future if they are under constant threat of the Chancellor of the Exchequer imposing yet another random tax on them.
If the government wants to eradicate tax avoidance, then they need to dramatically lower taxes. This will actually have the impact of increasing revenue raised from taxation- especially from the wealthy. An examination of the economic history of the United States and the United Kingdom reveals why this is the case.
For example, Calvin Coolidge cut the top tax rate when he was President of the United States. As a result, revenues nearly doubled, and the share paid by the most wealthy rose exponentially. Unfortunately, top rates rose again, but in the 1960s, John F. Kennedy drastically slashed the highest rate. As a result, the share paid by mid-to-high earners rose, and there was a dramatic increase in total tax revenue. And then, in the 1980s, Ronal Reagan introduced the largest tax cut in American history, cutting all taxes, and slashing top rates. Again, there was a huge increase in both the amount of tax paid by the wealthiest citizens and in tax revenues. However, when George H. W. Bush attempted to reduce the deficit by increasing the top rate of tax, his policies had the exact opposite effect. Compare this with his son’s presidency: George W. Bush cut the top rate of tax, which again led to a sharp rise in tax revenue.
A similar situation has been witnessed in the United Kingdom. For example, under Margaret Thatcher’s government, the top rate of tax was slashed from an eye watering rate of 83 per cent in 1979, down to 40 per cent in the late 1980s. As in the US, this resulted in the wealthiest paying more and also to an increase in tax revenue. More recently, the current Chancellor of the Exchequer, George Osborne, has revealed that his cut to the top rate of tax in 2012 has brought in an extra £8 billion in revenue from the highest earners.
This is an example of the Laffer Curve, which is frequently used by economists. It was popularised in the US in the 1070s, but it can trace its origins to the 14th century Muslim philosopher, Ibn Khaldun. It illustrates the relationship between rates of taxation and the resulting levels of government revenue. The Laffer Curve illustrates the concept of taxable income elasticity in that taxable income will change in response to changes in the rate of taxation. As a result, increasing tax rates beyond a certain point will be counter-productive for raising further tax revenue.
The government should also simplify the tax code. The UK has one of the most complicated tax codes in the world. Having such a complicated tax code mens that the ultra wealthy can pay clever lawyers and accountants to exploit the system by finding loopholes. If you simplify the tax code you remove the loopholes.
Politicians and the media need to stop moralising about tax avoidance. We just need lower and simpler taxes.
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