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Reverse Laffer

In 1974, American economist Arthur Laffer published his famous and much misunderstood argument that under some circumstances when a government cuts tax it can result in more tax income.  Early critics pointed out that this was only true in a high tax environment, and only when applied to some taxes.  The argument though, was obscured after the Reagan administration in the USA and the Thatcher government in the UK used it as an excuse to cut the taxes of the big corporations along with influential wealthy friends and donors… both of which pocketed the money and continued tax dodging as if nothing had happened.  Since then, critics simply dismiss the Laffer curve as no more than a cover for posh boy Tories handing out tax breaks to their old Etonian school friends.

There was a degree of truth in the Laffer curve though.  Tax breaks to small and start-up businesses, for example, often lead to more investment which, in turn, creates more employment opportunities and thus more income tax revenue to the state.  And so, there is a strong argument that even in an economic downturn like today’s, government should lower those business taxes which most deter business investment.  In the UK, the most obvious target is the antiquated local business rates system, which taxes businesses according to an arbitrary calculation of the value of the property they trade from rather than something sensible such as their annual profits.

 

The widely misunderstood Laffer Curve

The trouble is that the properties from which businesses trade are one of the few things which can’t be offshored to a convenient tax haven.  And so, state tax officials are extremely reluctant to switch to something more malleable like reported profits – which, for many UK businesses, are in the doldrums after two years of lockdown and an inflationary slump.

Nor is it only businesses which are struggling.  Councils across the UK are issuing so-called “Section 114” notices – the local government equivalent of bankruptcy – with as many as half of all UK councils now at risk as income falls well short of proposed expenditure at a time where investors are reluctant to loan any more cash.  Ultimately, this guarantees that some pretty severe cuts to public services, public sector salaries, and public sector employment are on the way.  But there is a final stage in the cycle before we get to that point.

Within the UK, my home country – Wales – tends to be something like a canary in the mine on economic matters.  Wales is generally the last part of the UK to recover from economic downturns and the first to fail as the economy slows again.  Where Wales goes, the rest of the UK eventually follows… although it is only when London slumps that the political class tends to take notice.

In fact, Wales has been experiencing growing business failures since the end of 2022, with the hospitality sector particularly badly hit having not fully recovered from lockdowns which were more draconian in Wales than in England.  In any sane world, the state response to this would be a combination of deregulation, tax breaks and even public subsidies aimed both at saving the employment we still have, and ideally creating even more employment.  But ours is no longer a sane world.  And so, in an attempt to save the state from making the albeit unpleasant but necessary cuts, businesses in Wales are being hit with both increased regulation and higher taxes.

The difficulty with localised regulation is that few businesses are bound to their current location.  Indeed, as we saw in the early 2000s when the east European states joined the EU, it is possible to dismantle a factory and relocate to the other side of the continent in just a couple of days.  And overly regulated Wales risks seeing the last of its profitable businesses disappearing across the nearby English border… especially if the UK government chooses not to follow the Welsh government in raising business taxes.

It is, of course, nothing short of economic suicide to raise taxes on business sectors which are not just reeling from the lockdowns, but which never fully recovered from the 2008 crash.  Welsh high streets were among the first to experience the now widespread eyesore of boarded up shopfronts where previously thriving businesses had operated.  Meanwhile, Welsh pubs – especially those outside the big cities – have become an endangered species.  At a time when these businesses are facing higher costs and plummeting demand, a reverse Laffer effect is inevitable – far from raising the income the government claims it needs to fix an NHS which it is largely responsible for breaking in the first place, the additional taxes will be the final straw which forces hundreds, and maybe thousands of businesses into insolvency, taking jobs and rental incomes with them – and causing supply businesses to take a big hit too.

Most likely, government officials have been swallowing too much of their own propaganda about “soft landings” and a rapid return to business growth.  Some may even have deluded themselves into believing that the likely change of government next year will somehow magically reverse a process of decline in the UK which has been accelerating since the 1980s.  This is because the expected signs of recession – particularly deflation and unemployment – have yet to put in an appearance.  But recessions don’t unfold in a linear fashion, and only arrive in backward-looking data (like unemployment claims) long after the proverbial has hit the fan.

In this – the final act before depression sets in – the private and public sectors are trapped by the belief that public prosperity is alive and well.  And so, private businesses – big and small – still believe that they can pass their rising costs onto consumers.  And even though the rate at which these higher costs have been passed on is falling (disinflation… albeit somewhat massaged) ordinary people still face higher costs of essentials like food, fuel and – especially – housing.  Nevertheless, state technocrats continue to believe that people have the additional income to fund tax hikes.  The UK government has done this by a sleight of hand – not raising the tax threshold with either inflation or wages so that everyone pays more income tax, more low paid workers have to pay tax, and more high earners tip into the upper tax bracket.  Locally, tax is levied on households via Council Tax and on businesses by the Business Rates.  And, of course, the Bank of England has been increasing the cost of currency itself by raising the overnight interest rate at the highest pace ever, from 0.1 percent to 5.25 percent – where they claim it will remain for months to come… we shall see.

Notice though, that the impact of these costs will be in the future – although I expect retailers have had a disappointing Black Friday sale (judging by the absence of establishment media hype) and are having a less prosperous than needed Christmas.  But for the moment, we mostly have to look beyond the official data for signs that all is not well.  To give one anecdote – in the run up to Christmas 2022, the houses on the estate where I live were festooned in Christmas lights.  This year in contrast, the majority of houses are in darkness… most likely a response to far higher electricity prices this year than last.  Another such anecdote involves the growing number of empty oil tankers sheltering in St Bride’s Bay.  This though, has made an appearance in the latest UK inflation figures:

“Overall prices in the transport division fell by 1.4% in the year to November 2023, compared with a rise of 0.5% in October. The annual rate for transport was most recently negative in June to August 2023. Prices fell by 1.7% between October and November this year, compared with a slight rise of 0.1% between the same two months a year ago. 

“The easing in the annual rate was the result of downward effects from motor fuels and, to a lesser extent, second-hand cars, maintenance and repairs, and air fares. 

“The average price of petrol fell by 4.1 pence per litre between October and November 2023 to stand at 151.0 pence per litre, down from 163.6 pence per litre in November 2022. Diesel prices fell by 3.2 pence per litre this year to stand at 159.0 pence per litre, down from 187.9 pence per litre in November 2022.”

All too predictably, this was reported in establishment media as a good news story.  For example, Michael Race at Pravda reports that:

“A surprise fall in inflation in November has raised hopes that the Bank of England will begin cutting interest rates sooner than expected…  The Bank has repeatedly increased rates to try to control inflation, driving up mortgage repayments for millions.  But some economists think it may start cutting them in the first half of 2024, much earlier than previously forecast.

“The Office for National Statistics (ONS) said that falling petrol prices were largely behind the surprise drop in inflation last month.”

That’s fine until we stop to look at the international context.  Oil prices didn’t slump because our price gouging fuel retailers were visited by the ghosts of Christmases past, present, and future.  Still less because OPEC+ decided to put the wishes of western politicians above their own national interests.  Rather, oil prices have slumped – despite OPEC+ production cuts aimed at raising the price – because consumption across the western economies has collapsed as ordinary people have had to cut non-essential travel as part of their broader attempts to balance household budgets.

There is a good type of disinflation.  It occurs when competitive businesses can optimise energy and resource efficiency to produce more goods and services at a lower cost…  this is not that!  Rather, the disinflation that we are witnessing is a consequence of tapped out consumers no longer having the spare cash to collectively support the system.  And so, as the oil companies are experiencing today, and as the entire private, public, and banking sectors will experience in due course, when there is no longer enough currency to go around, bankruptcies surely follow…  And after the bankruptcies, government itself must surely fail.

As you made it to the end…

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