The Wrong Side of the Right Curve

Written on 29 July 2013

As Britain grinds its way out of a near triple-dip recession, most analysis has focused on the use of monetary policy and quantitative easing (QE) as a means of economic stimulant, rather than the effects of fiscal policy on economic recovery. Eyes will be on Mark Carney, the new Governor of the Bank of England, as he puts an end to Britain’s ever expanding QE stimulus.

During this time, the Government will continue to tighten its fiscal belt by raising taxes and cutting government spending, and many analysts expect further tightening for the next few years. The question now may be, could this level of fiscal scrutiny mean higher taxpayers will actively look for ways to avoid the marginal effects of such tax increases, and is the UK now on the wrong side of the ‘Laffer curve’?

The Laffer curve was initially proposed by the economist Arthur Laffer and popularised under the Reagan administration following substantial tax cuts to top rate taxpayers. The curve portrays the relationship between tax revenue and rates charged by the government. The theory suggests no tax revenue will be collected at a 0% tax rate or at a 100% rate where tax payers have zero incentive to work. Between the two opposing ends of the tax rate spectrum, an optimal tax rate must therefore exist whereby any further tax increase have a detrimental effect on aggregate tax revenue received.

An example of such a relationship could have been the case following the recent proposed hike in the top rate income tax in France, and the exodus of a substantial number of French top earners; most notably, the French actor Gerard Depardeiu’s departure. Beyond a certain point the Laffer curve suggests taxable individuals will start to look for tax avoidance schemes, or, as was the case with Monsier Depardeiu, leave the county entirely as the marginal cost of fiscal tightening exceeds the costs associated with tax avoidance.

Although George Osborne has started to offer some solace for both businesses and households, it is clear the squeeze will continue as the Government tries to fill the fiscal hole. Demand for financial advice will continue to grow and companies offering relief from the squeeze will have to keep on their toes as the economy slides further down the ‘wrong side of the right curve’.

If you feel that you are taxed on the wrong side of the curve, give us a call on 020 8545 7600 to see if we can offer some help from the fiscal strain.