Chart of the Week: Take It To The Limit

Few economists are as synonymous with tax policy as Arthur Laffer, the man behind the famous ‘Laffer Curve’, which is reproduced below. The curve, reportedly drawn on a napkin in a moment of brilliance in 1974, illustrates a simple truth. This is that both zero and 100% tax rates generate zero revenue – one because nothing is taxed, the other because nothing is produced. The real debate lies in what happens in between.

Why this matters now: in the lead-up to the UK Budget and amid uncertainty around the US election, tax policies are again under the microscope. There’s speculation about who will benefit (or suffer) from new fiscal measures. In the UK, as the Treasury gears up for what’s likely to be a highly significant Budget, it's worth revisiting Laffer’s lesson. This is that while raising taxes can boost revenue, there’s a tipping point after which it stifles growth.

The data: while it’s true that under certain circumstances lower taxes have spurred economic activity (think Reaganomics in the '80s), most studies show that reducing tax rates seldom pays for itself in full. It’s all about getting the balance right.

Consider the current situation in Argentina under President Javier Milei, who has just announced plans to close the country’s tax collection agency. His radical approach may be rooted in the belief that dismantling bureaucracy will liberate economic activity. Argentina’s stock market is up 30% since Milei’s election, though time will tell whether this is sustainable growth or a temporary high. Closer to home, the UK’s Labour government is contemplating higher taxes affecting everything from capital gains to employers’ pension contributions. As Brits brace for what are likely to be significant tax increases, it might be worth asking if HM Treasury has remembered the lessons of the Laffer Curve.

It’s a good time to reflect on Laffer’s most basic insight: if you tax too much, you risk killing the very activity that fuels the economy. Whether in the UK, US or even Argentina, it’s the skill of managing a delicate balancing act that governments need to remember – especially in times of economic uncertainty.

Key takeaway: balance is the key to success, whether you’re determining tax policy – or managing a multi-asset investment portfolio.

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This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.