High taxes cause inflation

This isn’t quite what we’re generally told. It’s also not something I’d try to insist is the only thing going on. But it is actually true – high taxes cause, not hinder, inflation:

The Bank of England has warned that a surge in early retirement means more interest rate rises will be needed despite mounting signs of recession.

Data from supermarkets showed that families are delaying buying Christmas food as grocery prices surged by almost 15pc in the past year, adding £682 to the average annual household bill.

Meanwhile, economists warned that the UK is facing a longer recession than previously thought as a result of runaway prices.

Huw Pill, the Bank of England’s chief economist, insisted its interest rate increases are not to blame for the recession, arguing that the downturn is being caused by a sharp drop in the size of the UK’s workforce which is fuelling inflation.

This is the Laffer Curve of course. Or even, Laffer Effects. There’s some level of taxation at which people withdraw their labour from the marketplace. We can have all sorts of lovely speculation about exactly what that tax rate is. Also, whether we’ve got something to do with the substitution effect – people decide to have leisure rather than income – or even some perversity of the income effect. For, in that second, it is actually possible that doing it yourself becomes cheaper. Depends how big the tax wedge is, d’ye see?

In fact, we can detail exactly that. Take a nuclear family, two adults working, add children. For many the second income – usually the distaff but that’s not necessary for the logic here – is less post-tax than the childcare costs of gaining that income. So, stay at home and do the childcare oneself – that’s actually a gain in net income. Sure, there are inefficiencies to this. One Mum might look after two kids, one worker four of others’ kids. But the tax wedge is so great that it becomes cheaper, even if grossly less efficient, to have the one taking care of two instead of one four.

OK, so the tax wedge might – in fact will, because “the cost of childcare makes not working sensible” is not exactly an uncommon observation out there, is it? – mean that higher taxes reduce labour supply.

Now add in this retirement thing from the BoE. We are indeed seeing this in doctors’ pensions. The tax rates on them are such that for those in perhaps the last decade of likely working life it’s not, in fact, worth going to work. So, retire early. That’s a withdrawal of labour from the market in the face of too high taxes – but it’s the substitution effect now. Trading work for leisure given the price on offer for the work.

Laffer is in fact right. There is some tax rate which is too high. We see this at least twice in commonly observed problems in our current society.

There are idiots out there, of course there are. I think of one Associate Professor who thinks that taxing pension assets by 5% of capital value will change nothing except the revenue collected. Then there was that other Triple Professor whose confident prediction was that higher tax rates on second incomes in a family would increase market labour supply. Clearly and obviously the wrong way around, as the literature has been pointing out for about a century.

But our little lesson for the day. Yes, sure, macroeconomic effects, more tax means lower – for any given level of public spending – stimulus to the economy and therefore lower inflation. But there are always countervailing effects as here. We also have microeconomic effects of taxation being so high that labour supply falls and thus inflation rises.

One final observation. Polly et al insist that the British would like Scandi welfare at US tax rates. But the thing is, no one actually does agree with this. No one does agree that the Brits are willing to pay the necessary for Scandi welfare that is. Anyone who did agree that we out here were willing to pay for it would be saying right, simples, 25% VAT on everything – inc. food – and lower tax free allowances on income, and higher income tax rates on the poor to middling. Because that’s where the necessary revenue is. That’s where you gain the vast sums required – 5 pence in the pound on all the 30 million workers, not pissing around with 30p in the pound on the top 1%.

So, who advocates that? No one. Absolutely everyone pisses about with shades of incomprehensible taxes on insurance policies, hidden amounts on inheritance, twatting with corporation tax the workers doesn’t realise they’re paying. Exactly that we have a complicated and hidden tax system is all the proof we need that folk aren’t happy about paying even the current level, let alone one higher. Because why would we have a complex system unless the tax level had to be hidden?

Oh, and just the nail in the coffin of this higher tax would be welcomed by all idea. Why is that idea of higher tax always followed by an insistence that HMRC must have more power to enforce such tax levels? Why does the State need to be able to force people to pay what the argument has already stated people will gladly proffer?