Jeremy Hunt: How high taxes are killing the ‘animal spirits’ Britain needs

Jeremy Hunt is a former Chancellor, Foreign Secretary and Health Secretary and is the MP for Godalming and Ash.

It is now all but nailed on that taxes will go up in November’s budget.

The consensus is it will be by around £30 billion, about 1 per cent of GDP. Most of the focus has been on who the ‘losers’ are likely to be – pensioners, savers, people who own their own homes and the list goes on. But even more significant will be the drag impact on the economy, leaving us stuck in a low growth trap the last Conservative government worked so hard to get us out of. 

Since leaving government, I have been investigating further the link between overall levels of taxation and economic growth. As Chancellor, my Treasury officials told me that countries with lower taxation do, on average, enjoy higher growth. But they added an important caveat: correlation was not the same as causation. So are low taxes a dividend of high growth, or the driving force behind it?

For many in the business world, it is blindingly obvious that low taxes foster higher growth. In his excellent book Return to Growth, Jon Moynihan gets to the bottom of this with a methodology that shows that between 2010 and 2019, OECD countries with the lowest levels of public spending – such as Australia, the US, and South Korea – all grew on average more than 2 per cent faster per annum than countries with the highest levels, such as Finland and Denmark. 

Why is this so controversial amongst economists? Because there is a very different view, usually from the left. Torsten Bell – now both an MP and a government minister – points to the fact that many countries with higher levels of public spending – Denmark, Sweden and the Netherlands for example – tend to have higher GDP per capita alongside better living standards. But why is that?

The most likely reason is that many of them have been far more successful than us at getting people into work. A quarter of our adult population is out of work and, as the CSJ recently reported, the after tax income of someone out of work claiming UC health, PIP and the local housing allowance will next year be £2,500 higher than someone working full-time on the National Living Wage. That compares to employment rates of over 80 per cent in Scandinavian countries. 

If we had the same proportion of women in work as Denmark, one million more would be employed in the UK. Their welfare state is also tougher: under their system, 600,000 more disabled people would be in work in the UK. And interestingly, at the point when many countries overtook the UK in terms of GDP per head, their levels of public spending as a share of GDP were lower than ours.

What economists do agree on is that taxation – particularly business taxation – discourages investment, which is one of the main drivers of growth. For every pound of tax levied on businesses, the amount of money reinvested into the economy goes down. Public spending crowds out private investment. Large public sector pay rises may boost consumption in the short term, but they have two major drawbacks.

The first is that they are often inflationary, especially if they are funded by increasing employers’ national insurance contributions which then causes companies to raise prices. Worse still if they are funded by borrowing that leads to higher interest rates and more debt interest payments. Rachel Reeves’ decision to increase borrowing by £28 billion a year in her budget means the average household is paying £3,900 annually in tax – not for schools or hospitals but just to cover our debt interest.

But the main reason low tax countries have higher growth is cultural. Capitalism needs what Keynes called “animal spirits”: this is the entrepreneurial drive that pushes people to work hard and take risks, including starting a business. This comes from a culture of personal responsibility and seeking reward for effort. High taxes and cradle-to-grave welfare undermines that culture. That is why there is so much more dynamism in North America and Asia than there is in Europe.

Simply put, people work harder in countries with lower taxes. Between 2010 and 2019, people living in OECD countries with a tax-to-GDP ratio below average worked 260 more hours a year compared with those above. Studies suggest that women and secondary earners in particular tend to work more if marginal tax rates are lower.

Mississippi in the United States is an interesting example of how this works in practice. For the past decade, Mississippi’s legislators have been busy cutting state taxes for both individuals and companies. These cuts have been carefully phased in over several years and have turned Mississippi into the fastest growing state in the US.

Since the first tax bill was passed in 2016, the number of hours worked by each non-farm employee in Mississippi has increased by nearly 6 per cent. By comparison, over the same period, the average amount of hours worked per person per annum in the UK decreased by 2 per cent.

Real median wages in Mississippi have also reached levels not seen in decades, and poverty levels – though still high – are falling rapidly. The state has also seen record amounts of investment from businesses, including billions for new data centres. In 2023, Mississippi’s GDP per capita overtook the UK’s. The poorest state in America now has a higher output per head than we do.

When I became Chancellor, markets were crashing and I had to take difficult decisions – including on tax – to show how we would repay our Covid debt. But for me and Rishi Sunak, raising tax was always a temporary necessity and not a permanent change. We proved that a year later with a business tax cut (worth £11 billion annually) to encourage investment with what is known as ‘full expensing’. President Trump has now adopted the same measure in the US.

To make it easier for businesses to hire, I also cut employee national insurance contributions by 4 per cent – something that was predicted to fill over a quarter of the vacancies in the economy by moving people back into work. Both measures incentivise investment and work – and both were possible because we were tackling inflation alongside restoring stability to the public finances.

Rachel Reeves is taking us on a different path. But the evidence is clear: endlessly raising taxes leads to stagnation and decline. By contrast, countries with lower taxes tend to grow faster. I know which I’d prefer for the UK.