The Laffer Rainbow: Employer's National Insurance

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The right-wingers are the only ones who vaguely grasp the concept that income tax would raise nothing if the tax rate were either zero per cent or a hundred per cent, and that the 'revenue maximising point' must lie somewhere in the middle (nobody quite knows where - it's different in different jobs or at different income levels). For some reason they mainly talk about it in terms of the income tax rate or corporation tax rate, but there is of course a Laffer Curve for every individual tax, be it tobacco duty or dog licence.

What interests me is the "Laffer Rainbow" for taxes which are effectively double-taxes on income, such as our Second Worst Tax, Employer's National Insurance. An employer in the UK currently has to pay a tax of 12.8% on top of salaries and wages paid out (above a certain very low weekly level), whether this is economically borne by the employer or the employee is not so important, and currently raises about £40 billion* per annum.

What would happen if the rate were cut to 0%? Would total tax revenues fall by £40 billion? Of course not. In the very short term (the 'static basis'), business income would rise by £40 billion, so corporation tax or income tax/Employee's NI receipts would increase by about 30% of £40 billion, i.e. by £12 billion (the red area).

Next, new businesses would enter the market once they see the great profits to be made, so overall business activity would expand. Sure, this would compete away some of the profits made by existing businesses, but by the same token it would bid up wages in existing businesses, so the additional corporation tax/income tax revenues would increase by at least half as much again, say £6 billion (the green area, the 'dynamic basis').

Finally, even if the 12.8% cut in employment costs only increased business activity by 5%, that would mean an extra million jobs, so assuming a lot of these go to people currently on welfare or in a public sector non-job, and that each person who finds a job claims £5,000 a year less in benefits or £25,000 less in salary, that would be another £15 billion saving (the blue area)

So, scrapping a stupid tax which currently raises £40 billion would not lead to a £40 billion fall in revenues, the overall 'cost to the Exchequer' would be no more than £10 billion, and might even be revenue-neutral, so this is pretty much a win-win.

* I used that figure for illustration, prompted by Neil Craig I've checked the stat's and actually it is probably more like £50 billion, i.e. considerably more than corporation tax, but the principle stands.