Chancellor, may I introduce Prof. Laffer

This lovely beast is a Laffer curve, it describes how much tax revenue could be raised by taxing a certain item such as beer.

On the far left, where the tax rate is set to zero, you don’t raise any revenue because your tax rate is 0%. In other words you are not taxing a pint.

On the far right where you are taxing something at 100%, the amount of revenue raised is again zero. This is because that although you might be willing to buy a pint taxed at 100% I wouldn’t be prepared to make it – I wouldn’t get any money for the ingredients or labour. So no beer is made, none is sold, and therefore no tax revenue.

Now obviously beer is taxed and the government gets revenue from the duty and the VAT, so we know the curve goes up as you move towards the middle. It follows in a pretty straightforward way that there’s a bit somewhere in the middle that’s at the top. That’s where you get the most tax revenue.

Some chancellors decide to tax things to the left of the peak (for example at point A) because they think that all tax acts as a restraint on trade and trade builds strong happy countries. Unfortunately we haven’t had one of those since Gladstone’s era.

Most chancellors are self interested and tax items at the peak because that’s where they make the most money. Occasionally we get chancellors who are round the twist that tax items to the right of the peak (at point B for example) where they actually gather less money than they could.

Guess what kind we have at the moment ?

In the last year Alistair Darling raised the duty on beer over 20%. A few days ago the British Beer and Pub Association reported that the revenue to the government was down by an estimated £258 million.

£258 million! Enough for a nice new hospital, or some decent equipment for the army. Hell, you could resurface a moat and get a nice new duck house for that kind of money.

Rumour has it that someone once drew Alistair a Laffer Curve on the back of an envelope. He must be holding it upside down.

H/T to Pete Brown for his take on this.