How increasing taxes brings in less money

High taxes can be self-defeating for a government seeking additional revenue.

Peter O’Halloran - Tax advice

When tax rates rise above a certain point, they detrimentally affect rates of production.

This is according to a theory proposed by US economist, Prof Arthur Laffer.

Put another way, if a government increases taxes in an attempt to increase its revenue, it will achieve the opposite effect after a certain point, receiving less revenue in the form of taxes.

Laffer advocates lowering tax rates, as tax cuts actually increase revenue for the state by leading to increased production and hence more taxable income (not to mention more jobs).

It could also be argued that lower tax rates allow people to save, or have more disposable income with which to stimulate business.

Moreover, when tax rates are so high that they threaten the existence of tax activities (businesses), these taxpayers are likely to seek other jurisdictions from which to operate.

At lower rates, small tax increases serve to increase productivity. But the level of productivity flattens out and then begins to drop as the tax rates increase.

The Laffer curve illustrates this theory, showing that there comes a point at which government revenue drops to zero. This happens when government so overburdens taxpayers that virtually all income and business profits are taken by the revenue authorities.

At this stage, there is no more incentive to produce goods or work.

Critics of the theory claim that tax cuts do not always stimulate growth. If conditions in a country are unhealthy for taxpayers who would otherwise benefit (as when the right to their personal property is not guaranteed), they are likely to take their extra cash to jurisdictions where their rights and freedoms are guaranteed.

Whatever the case, for tax reductions to assist with economic growth, the rights and freedoms of the taxpayers that drive the economy must be guaranteed as well.

In short, government activity should be positive for business. Instead of focusing on taxes, government should seek to provide the law and order, political stability and some of the infrastructure that business requires to produce good results.

Advocate Peter O’Halloran is a tax specialist.