The Laffer Rainbow: Increases in net incomes

As we see from the previous two episodes, we could get rid of the two worst taxes of all, VAT and Employer's National Insurance (which currently raise about £110 billion), and because of various knock on effects, post-tax incomes in the productive sector (i.e. returns to employees and shareholders) would go up by £100 billion and state revenues would only fall by about £30 billion. Maybe my estimates are a tad optimistic, but it would seem that net incomes would go up by at least double the amount of the tax cut (let's say plus £80 billion as against a £40 billion fall).

A flat income/corporation tax is far less damaging for the economy than VAT or NIC, so the increase in net incomes relative to the amount of a tax cut would not be as marked, as you can see, total output would increase a bit if the tax were cut from 30% to 20%, a little bit more if the tax were cut from 20% to 10% and almost not at all if the rate were cut from 10% to 0%. Click to enlarge:
OK, I've glossed over the fact that if taxes were cut far enough, people would have to pay for their own healthcare, own education etc. but I am sure the private sector can provide those far cheaper and better than the state, and that overall spending on these items would tend to fall, so I'll ignore that for now.

So far so good. We see that if "the state cuts taxes" (in the narrow sense) wealth creation goes up so net incomes increase by more than the amount of the tax cut.

But to whom would the bulk of that income accrue?

We know that with a fixed supply of housing, rents and house prices tend to rise in line with net incomes. I have assumed that rents would rise by sixty per cent of the increase in net incomes. The lowest plausible figure is thirty per cent (as people in the UK spend thirty per cent of their income on housing) and the highest plausible figure is one hundred per cent (because we observe that although their is a wide disparity of incomes across different regions of the UK, net incomes after housing costs are pretty much the same). Click to enlarge:

For existing home-owners with a job, this split before/after housing costs would not be so apparent, as for them it is not an actual cash item, so their net incomes would increase by the full amount. The split would be very noticeable for everybody who didn't happen to own a home at the time of the tax cut (i.e. every future generation), whose disposable incomes would only increase by forty per cent as much as those of home-owners.

So in the same way as cutting VAT and Employer's National Insurance leads to increases in income or corporation tax, cutting income or corporation tax just leads to an increase in a different kind of tax, i.e. rents (which includes mortgage repayments for people who buy after the tax cut).

"Wot?" I hear you cry "Rents aren't like taxes!" I think you will find that rents are very much like taxes. Rents can only be collected because of land ownership, and the only pre-requisite for land ownership is a state to guarantee title*; and once you have a state you have land ownership (even if the land belongs to 'the state' or is earmarked as common land). Land-ownership and the state are two sides of the same coin. When the Normans invaded, did they take over the government or steal all the land? Did they collect taxes or rents? It's difficult to say, isn't it? It is only over the centuries that the split developed between state/taxes and landowners/rents.

For a further list of similarities, consider:

(1) Taxes are collected by The State under the threat of force; (2) there is no correlation between the work the state does for you and the amount you pay; (3) the amount you pay is unlike a normal commercial deal in that it cannot be competed away.

(1) Rents or mortgage payments are collected by landlords or banks with the force of the state to back them up (if you don't pay your rent, they'll have you evicted), and you can't just build a house anywhere there's some spare land as the local council will knock it down again; (2) there is no correlation between the rent you pay and the work the landlord does (above and beyond running repairs), it all depends on where the house happens to be, and as we see, how high or low income tax rates are; (3) the amount of rent you pay cannot be competed away as people have to live near wherever their job is, and the rent depends largely on how high average incomes are in that area.

Anyway, to sum up, this is why, despite my small-state tax-cutting instincts, I don't think we should just plough on with cutting taxes on incomes and production without thinking about what would happen after that, and whether there is anything we can do about it...

* Unlike any other form of 'property' which can only arise from an individual's efforts and free exchanges with other individuals.