Peak Taxes?

In TMM's careers there has been no shortage of talking heads calling something a "peak". We've had "Peak Oil", "Peak Housing", "Peak Demographics", "Peak Credit", "Peak Deficits", "Peak Liquidity" etc... All of which come down to some assertion (whether valid or not) that said "thing" cannot go any higher for some sustainability reason. And readers will know, the UK is something of an obsession for TMM given they reside there, so ahead of the Budget - especially given the various calls to drop the 50p tax/introduce a Mansion Tax/introduce a Tycoon Tax etc etc - they decided to have a bit of dig. And TMM reckon that they've spotted another peak: Peak Tax. Or more accurately, Peak Tax Revenues.

Much has been said and written over the years about the cultural willingness to pay higher tax rates in Scandinavian countries, and the relative lack of willingness in Anglo-Saxon countries. TMM do not want to start a political debate about either, and generally consider themselves to not be particularly wedded to any political ideologies having voted for all the main parties in the UK from time to time. They are guided by the pragmatism: if something works, then it's worth doing. Which is why they think this particular subject is important. Because whether or not one believes some form of progressive redistribution is a good thing or not (for the record, TMM do), you can only spend what you reasonably expect to raise in revenues over the cycle.

And this is where the problem lies, because since the mid-1960s, the UK has only managed to raise an average of about 35% of its GDP in taxes (see chart below, blue line), with variations largely being driven by the economic cycle. By contrast, it is clear that expenditure has been on a pretty consistent upward trend (red line), rising to 43% of GDP. Since the mid-1970s, the expenditure share of GDP also oscillated roughly around the same 35% of GDP level, and from the mid-1980s in a counter cyclical manner (Keynesian automatic stabilisers). But then something went wrong. Instead of falling in the aftermath of the 2001 mid-cycle slowdown, expenditure continued to rise and well, you know the rest of the story...

Now, calls for wealth taxes, hikes in corporation taxes and higher income taxes etc all might seem reasonable ways of raising revenue. Except, the evidence in the UK would suggest that they don't. Because over the past 40-odd years the UK has had many different types of tax regimes and combinations of various types of tax rates, ranging from income surtax at 83%, high corporation tax and VAT to low versions of all of the above (see the below chart). Despite all these different types of taxes being tried in many different ways, the overall tax take as a share of GDP has barely budged. It appears that the only reason that taxes on production have increased is due to VAT hikes over the years, which obviously, are really taxes on consumers rather than on companies. Of course, that then reduces the amount of money consumers have to spend on things which may or may not be a good thing as far as rebalancing goes, but it is evidently a regressive tax. It is of some irony to TMM that the highest ever tax share raised came under Mrs Thatcher in 1982.

TMM digress. The gist here is that TMM reckon that the UK has hit Peak Tax Revenue at a cyclically-adjusted 35% of GDP. And that going forward, expenditure will have to take this into account. Because under TMM's pragmatic approach, Keynesian counter-cyclical stimulus during a deep recession would kind of, you know, be nice. It is a shame that the UK has been unable to do this properly as a result of the mistakes made between 2001 & 2007.

The point TMM are trying to make is that it really doesn't matter what the Right do with 50p tax rates or the Left scream about for justice and retribution, the most any of them will receive is a cyclically-adjusted 35% of GDP. Expenditure will have to take account of that no matter which party is in power. A corollary, but well beyond the scope of this post, is to what extent do the various tax approaches/combinations affect the rate of GDP growth, the numerator in this equation. Meanwhile, we are sure that Ed Balls and George Osborne will continue to be the source of many column inches as they fight over the wheel of a ship that is not actually connected to the rudder.