Thursday, 5 April 2012

Why Tax Cuts are a GOOD Thing

So, I've seen a few moans on Twitter about the 50% tax band being cut to 45%.

A tax cut for the rich. Out of touch Tories. Blah, blah, blah.

So, if a rich person benefits by £10,000 as a result of the reduction in Income Tax, and it lands heavily in their pocket, what are they going to do with that money?

Save it? Probably not - they've most likely already got substantial savings and investments.

Which leaves one other choice: they're going to SPEND IT.

Always a bad thing.

And what are they going to spend it on? Non-essential goods and services, which are subject to VAT at 20%. So straight away, almost 1/5th of the tax cut money will go straight back to the Exchequer when it's spent.

The providers of those goods and services will also pay tax. After deduction of costs, the remaining profits will be taxed.

The costs themselves will largely be labour, i.e. payroll. This will be subject to Income Tax and National Insurance.

So, the effect of the tax 'cut' at the upper end is that at least 4 other types of tax revenue - possibly more, because I'm sure some it will be spent on cigarettes, alcohol, fuel or plane tickets - will increase.

Furthermore, when they buy said goods or services, that contributes to the movement of money from one place to another, a concept which economists refer to as 'velocity of money'. As velocity is a measure of economic activity, velocity increasing is a good thing. It creates jobs in the private sector, due to an increased demand for goods and services which the State does not provide. This in turn creates demand for labour, so wages rise, and therefore living standards increase, creating further demand for goods and services.

So, this tax 'cut' will largely result in increased revenue from other taxes, plus a compound effect of rising wages and increasing demand for goods and services. The result of which may actually result in a net higher tax take, as a direct result of reducing the rate. The Laffer Curve in action.