Laffer curve, gdp and the rental value of land

The Laffer Curve, GDP and the
rental value of land
© gmwadsworth@gmail.com

What shape is the Laffer Curve?
• The free-market conservatives insist that the
revenue-maximising income tax rate is about
35% - 40%.
• The left-wingers, to the extent they admit it
even exists, insist that the revenue-maximising
income tax rate is about 80%.
• The most reliable way of estimating the
revenue-maximising income tax is to consider
the price elasticity of the supply of labour.
2(c) gmwadsworth@gmail.com

What shape is the Laffer Curve?
• Estimates for the the price elasticity of the supply
of labour, in a closed economy are between 0.1
(i.e. for a ten per cent increase in wages, the
increase in hours worked is 0.1 x ten per cent =
one per cent) and 0.5
• I have assumed an overall price elasticity of 0.4,
i.e. 0.3 plus an additional 0.1 because the UK is
not a closed economy (a relatively low income tax
rate attracts business from abroad).
• The resulting Laffer Curve is shown on the next
slide.

The Laffer Curve (assuming labour
supply elasticity of 0.4)

But what’s the ‘other half’ of The
Laffer Curve?
• The main reasons why tax revenues fall when
income tax rates are above a certain rate
(whatever that rate may be) are:
• People will evade or avoid taxes
• Most importantly, people will be unwilling to
work or start a business for such low net wages
or profits, and so will remain unemployed or go
abroad (and foreign workers or businesses will
not come to the UK).

But what’s the ‘other half’ of The
Laffer Curve?
• All taxes on output (VAT), labour (income tax and
National Insurance), incomes or profits (income
and corporation tax), hereafter referred to
collectively as ‘income tax’ depress GDP.
• The revenue-maximising tax rate (which may
indeed be as high as 65% - 70%) is an irrelevance,
as the reduction in GDP can be as much again as
the tax raised.
• Assuming labour-elasticity of 0.4%, the impact of
different income tax rates on GDP is shown on
the next slide.

Impact of income taxes on GDP

Impact of income taxes on GDP
• The average marginal income tax rate is about
50% (taking into account income tax, National
Insurance, VAT and corporation tax).
• UK GDP is currently just over £1,400 billion.
• The previous slide shows that if we were to
reduce income tax to zero per cent, GDP
would increase to around £1,900 billion.

Impact of GDP on employment
• Increases in GDP would benefit employees
and potential employees in two ways.
• Employment levels would rise from 32 million
(as at present) to about 40 million, and/or
• Average employment income (total
employment income divided by all adults
capable of working) would increase from
£21,000 (as at present) to £27,000.
• The following two slides illustrate this.

Impact of income tax on employment

GDP and the rental value of land
• It’s fair to assume that people are willing and able
to pay higher rents or mortgages in areas with
higher employment levels and higher wages.
• It’s fair to assume that businesses are willing and
able to pay higher rents or mortgages in areas
where people have higher incomes and in
countries with lower income tax rates
• The following slide shows the impact on the total
rental value of land in the UK if we scrapped
income tax and GDP were to increase as
expected.

• Total land rents in the UK are currently about
£160 billion (£2,000 billion market selling value,
excluding buildings and improvements x 4% yield;
plus Council Tax, Business Rates, Stamp Duty
Land Tax £60 billion; plus £20 billion interest
margin earned by the banks on mortgages on
land).
• This is used as the starting point (where the
income tax rate is 50% and GDP is £1,400 billion).
• The blue line increases to the left, in line with
likely increases in GDP.
(c) gmwadsworth@gmail.com 14

• “That’s a heroic assumption”, the crowd shouts,
“You appear to assume that land rents would
increase by £1 for every £1 increase in GDP!”
• This is in fact the most reasonable assumption
that we can make. Let us ignore GDP and focus
on average earnings per adult capable of
working.
• The following slide is similar to the previous one
and shows the predicted average employment
income per adult capable of work and the land
rental value generated by each employee.

Employment income and the rental
value of land (predicted)

value of land (predicted)
• Average employment income was calculated by
multiplying, for each region of the UK, male full
time salaries from ASHE multiplied by the
employment rates from the Labour Force Survey.
• The overall average (£21,000) is then the average
of the resulting figure for each region.
• The following slide is a scatter graph of average
house prices in each region of the UK, from the
BBC, plotted against average employment income
(calculated as before).

value of land (actual)

• The correlation between average house price and average
employment income in each region is 0.915, so it is not
perfect correlation, but very high.
• The average house price can be converted to a rental value
by deducting £100,000 for the cost/value of the building
itself and all improvements (roads, street lights, drainage,
utilities etc) and multiplying by a 4% assumed return.
• Average employment income per household is after 31%
income tax and NIC, multiplied by 1.5 adults per household.
This was then be plotted against a notional income tax rate
for each region (so as to use the same X-axis in the previous
chart but one) and average rental values were plotted
underneath on the following slide.

• To summarise, it is fair to assume that in the
absence of any taxes on output, labour,
incomes or profits, UK GDP would increase by
about £500 billion per annum.
• It is also fair to assume that the rental value of
land in the UK would increase by about £500
billion to well over £600 billion per annum.
• There are two tiny little problems here…

Two tiny little problems…
• The government would have very little in tax
revenues, so there would be just enough money
for law & order and defence, but none for old age
pensions, ‘free’ healthcare or education, or
welfare payments.
• Bare land values would treble, in line with higher
rental values, and so the selling price of land and
buildings would more than double. Although
people’s net employment income would nearly
double, future generations would find it even
harder to become owner-occupiers.

One simple solution…
• We have seen that income taxes not only reduce the net
income of employees and businesses, they reduce GDP
quite significantly as well.
• Taxes on the rental value of land have no such ‘dead weight
costs’. The rental value of a plot of land is dictated by a
million and one factors, hardly any of which are under the
control of the actual occupier.
• If income tax were scrapped (an average marginal rate of
50%), the rental value of land would increase to £600
billion. A 50% tax on the annual rental value of land would
raise about £300 billion per annum, quite sufficient to
replace all income taxes, as well as Council Tax, Business
Rates and Stamp Duty Land Tax etc, assuming sensible
reductions in government spending.

• It may be that the rental value of land in the
UK ‘only’ doubles to £320 billion, in which
case the tax on land rental values would be
closer to 100%.
• It may be that the rental value of land would
increase to more than £600 billion (depending
on emigration, immigration, inward
investment etc), in which case a tax of £300
billion would be less than 50%.

• If this were the case, total revenues could be
increased to £400 billion or £500 billion and the
‘extra’ used to repay the accrued national debt
over less than ten years.
• Either way, it is a fairly safe bet that the UK
government could finance itself entirely with
taxes on the rental value of land (plus duties on
certain goods, such as petrol, alcohol and
tobacco; and a tax on the banks’ rental income,
being the 2% interest rate spread that they can
earn more or less in their sleep).

Laffer curve, gdp and the rental value of land

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