Beware the pseudo-science of low-tax zealots

With half the world going to the polls in 2024, and ‘tax’ being a major issue at every single election, The Fair Tax Foundation’s Chief Executive Paul Monaghan sets out why politicians and policymakers need to question the lobbying of the Laffer Curve low-tax zealots.

Tax justice makes solid progress

The world is on the verge of an explosion of corporate tax transparency. The voluntary disclosures of progressive businesses (such as Fair Tax Mark accredited companies) will soon be augmented by new, legally required disclosures from large multinational enterprises operating in the European Union, the United States and Australia.[i]

Moreover, the race to the bottom on corporation tax that has been in play over recent decades shows signs of stalling. The global minimum corporation tax that is advancing in many parts of the world diminishes many of the advantages of tax havens. Even the UK, which had been a G20 laggard for many a year[ii], has recently implemented a welcome moderate increase in its headline rate, and before that instigated a doubling in corporation tax receipts over a decade.[iii] In the United States, the Inflation Reduction Act has provided substantial additional funding to their tax authority, the IRS, much of which is dedicated to enforcing tax compliance.[iv]

All of which is right and proper, given that corporation tax is a crucial source of revenues, uniquely progressive, has a major impact on a country’s tax morale and tax dodgers are a drag on national productivity.[v]

Return of the Laffer Curve pseudo-scientists

But the push back has inevitably begun, and once again we are seeing the pseudo-science of the Laffer Curve being used by partisan ideologues to confuse and mislead.

The US-based Tax Foundation has just established an office in Europe, and is promoting Estonia’s tax system (where profits are not subject to traditional corporation tax[vi]) as a model for the rest of Europe. The Cato and Adam Smith Institutes are doing everything they can to pull the plug on the global minimum tax that was designed by the OECD and which has the support of 140 nations. Laffer Curve theology inspired the precipitous tax cuts announced by the short-lived UK prime minister Liz Truss and her ill-fated ‘mini-budget’ of September 2022, which led to a run on the pound and soaring interest rates – global markets were even said to be adding a “moron premium” to UK bond prices at the time.

Laffer Curve dogma has largely been inspired by the work of Arthur Laffer, a pioneer of modern trickle-down economics and adviser to Donald Trump (who presented him with the Presidential Medal of Freedom in 2019). Adherents to his thinking believe that lowering the rate of corporation tax translates into more cash for business investment, which will in turn automatically lead to so much extra economic activity and profit that the total amount of tax raised will actually increase, not decrease.

Undoubtedly the headline rate of corporation tax has an impact on investment decision making by business. As does the tax reliefs that are allowable against it, be that capital allowances or tax depreciation. But (and this is a big ‘but’), neither is an over-riding determinant of investment decision making as long as effective tax rates are not set at extreme levels (the likes of which is rarely encountered these days). It is as, if not more, important, for government to facilitate and invest in enabling infrastructure, skills and innovation. Certainly, this was the conclusion of Cracking the Productivity Code: An International Comparison of UK productivity, which explored why the UK has such an abysmal productivity record given it has had low headline corporation tax rates until very recently.

Minouche Shafik, Director of the London School of Economics and Political Science and a former deputy governor of the Bank of England, put it succinctly in the Financial Times: “When I was at the World Bank, we did hundreds of investor surveys on what determined their willingness to invest in a country. The top reasons were almost always the same: first came macroeconomic and political stability, high-quality infrastructure and skills. Low taxes and enterprise zones were always near the bottom. The key to growth is to create an environment where there are great commercial opportunities — tax rate differences of a few percentage points are largely unimportant if you are making a lot of money.”

Moreover, and apologies if this is stupefyingly obvious, the Laffer Curve is self-evidently a ‘curve’. So, even if you accept the hypothesis at face value, namely that all points to the right of the apex revenue-maximising rate lead to a lower tax take (i.e. higher tax rates lead to lower tax take), it is equally asserted that all points to the left of the apex also lead to lower tax take (i.e. lower tax rates lead to lower tax take). Laffer enthusiasts don’t seem to grasp this and talk as though the ‘curve’ is actually a fantastical linear line which ‘proves’ that lowering tax rates will magically always lead to higher tax takes. It’s like someone telling you that the key to getting fitter is less exercise.

The counter case

The idea that there is a robust, real-world evidence base to support the Laffer Curve devotees is fanciful. In fact, the evidence for Laffer Curve ideology is either weak or non-existent. Last year, for example, an IMF Working Paper concluded that: “Host countries’ marginal effective tax rates have at best a weak effect on real investment; those elsewhere have none; and, applied to the prospective global minimum tax, inward tangible investment in most sample countries will increase.”

Moreover, in 2022, a meta-analysis in European Economic Review Study found that the impact of corporate tax cuts on economic growth was ambiguous. After correcting for publication selectivity bias, the researchers concluded: “we cannot reject the hypothesis of a zero effect of corporate taxes on growth”.

The recent example of the United States is stark. Following the passage of then-president Donald Trump’s 2017 Tax Cuts and Jobs Act, the headline rates of corporation tax and repatriation tax were slashed and did not lead to a surge in business investment and tax revenues (which rather predictably fell), but instead precipitated record share buybacks.[vii]

Similarly, at a sub-national level, substantial tax cuts in the US state of Kansas in 2012 were touted as a quick fix to the area’s economic stagnation. The state’s governor even called them a “real-live experiment” that would create investment and jobs, but the economic test failed. Legislation was repealed in 2017 after tax revenues fell and public spending was curtailed.

The reason that real life doesn’t tally with the wishful thinking of the Laffer ideologies is that, in most cases, modern economies currently operate to the left of Laffer’s apex revenue-maximising rate – i.e. if you lower the rate of tax then you reduce the total tax take.


Responsible businesses are proud to pay their fair share of tax

Most businesses are not calling for aggressive cuts in corporation tax and are generally happy to pay their fair share. They are not looking for an unfair advantage over international competitors. They trust themselves to win if the playing field is level and square. They are proud to pay their fair share of tax and care about what they receive in return. As the World Bank points out:[viii]

  • quality infrastructure is critical for the sound functioning of an economy;
  • a healthy workforce is vital to an economy’s competitiveness and productivity; and
  • education increases the efficiency of workers and allows economies to move up the value chain.

Tax policy should always be evidence based, and resist ideologies, wherever they come from on the political spectrum.

2024 is an election year like no other – with half of the world going to the polls, including in the European Union, India, the UK and the United States. It is to be hoped that discussions on corporation tax can progress in a sober and rationale manner, and that the Laffer devotees’ policy proposals are subject to rigorous scrutiny.

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[i] For more detail, see our briefing on public country-by-country reporting here.

[ii] In recent years, just Russia and Saudi Arabia had lower headline rates of corporation tax, among the world’s largest 20 economies.

[iii] The UK has seen corporate tax receipts more than double over the last decade to c. £80bn, largely through a broadening of the tax base and the closure of numerous loopholes. Source: Office for National Statistics. Years 2013/14 to 2022/23.

[iv] See Empowering the IRS: Understanding the Full Potential of the Inflation Reduction Act’s Historic Investment in the Internal Revenue Service.

[v] For more detail on why corporation is uniquely important, see here.

[vi] Tax is payable on profits distributed but not profits generated and retained. Couple this with an absence of capital gains tax and you have a tax haven by any other name. Estonia has also recently been the recipient of infringement notices from the European Union concerning failure to move forward: a) a minimum rate of effective taxation of 15% for multinational companies active in EU Member States; b) public country-by-country reporting of the amount of corporate taxes paid by multinationals in each Member State and in non-cooperative jurisdictions.

[vii] The Tax Cuts and Jobs Act (TCJA) was the largest gross tax cut in American history (cutting more than $5.5trn in taxes over 10 years). The TCJA has two key elements: (i) a reduction in the federal corporate income tax rate from 35% to 21%, and (ii) a one-time tax holiday that cuts the tax on cash repatriation from foreign subsidiaries from 35% to 15.5%. See here.

[viii] See