A finance minister’s dream

Tuesday 7 Dec 2021

What is the best way to reduce tax rates and yet still collect more revenue, asks Amr ElMonayer


History is a repository of human experience and expertise. Studying and analysing it will help us benefit from the past. This applies to many areas of activity, including taxation. Studying the history of this field and its actual applications is essential, especially as previous experiences might hold the key that will make the dream of any finance minister achievable.

In the 18th and 19th centuries, Britain was one of the world’s largest importers of tea. Tea had become such a basic part of British life that it was regarded as a national beverage. Yet, the customs duties on tea imports were so exorbitant that smuggling it into the country became a widespread habit. The authorities at the time estimated that around 7.5 million pounds sterling worth of tea a year entered the country illegally to evade taxation.

The tea-smuggling rings employed thousands of people. In 1745, police in the English county of Suffolk were notified about 1,835 wagons carrying smuggled tea protected by more than 70 armed guards. As a result of such practices, tea consumption continued to grow, while customs revenues from its importation declined. A solution was required, and British prime minister Henry Pelham, who served from 1743 to 1754, came up with one: cut the tax on tea in half.

He realised that lowering the tax would be an effective way to stop the smuggling, bring down tea prices, and increase government revenues. After he introduced this measure, legal purchases of tea increased three-fold. The increased consumption of the now taxable product more than compensated for the lower tax rate. The revenues from the tax on imported tea rose to nearly twice the amount of annual revenues during the previous five years.

This story is any finance minister’s dream: to reduce tax rates and yet still collect more revenue. In this way, everyone is happy.

In fact, however, Pelham’s idea of lowering the tax to expand the tax base and increase revenues was not new. In 1377, the famous Arab philosopher and historian Ibn Khaldoun wrote on the subject of “levies and the cause of their scarcity and abundance” in his work the Muqaddima. When taxes on people are low, he wrote, they become more industrious and eager to work. Enterprise and prosperity grow due to people’s contentment at the low taxation.

But when taxation exceeds the bounds of moderation, Ibn Khaldoun adds, people’s interest in enterprise fades because of dwindling hopes of its rewards. When they compare the gains to the losses due to taxation, many shrink from enterprise entirely. As a result, total revenues decline due to the shortage of those who can be taxed.

Ibn Khaldoun has not been alone in this view. It is shared by many contemporary economists, not least the US economist Arthur Laffer, who served as economic adviser to former US president Ronald Reagan. Laffer is best known as the inventor of the “Laffer Curve”, which basically says that if a government imposes a 100 per cent tax rate there will be no economic activity because there will be no incentive to work since the government will take all the fruits of people’s labour. Tax revenues will amount to zero. The lower the tax rate, the greater the incentive to engage in economic activity, Laffer said, which in turn increases tax revenues.

However, this situation does not always hold true. At the other end of the curve, taxation is zero per cent, which also means zero revenues for the government. Therefore, ideally any government will want to find the point on the curve where it can achieve maximum tax revenues before the disincentive factor kicks in, causing revenues to fall.

Reagan took advantage of this idea in the US in the 1980s. He reduced the tax rate to 28 per cent in the framework of a tax-reform programme that simultaneously abolished a number of deductions and exemptions that favoured certain sectors. The reforms also streamlined tax legislation and eliminated loopholes. However, in economic theory there is no such thing as abstract facts. When the more recent Trump administration in the US cut tax rates too sharply, tax revenues fell so much that the national deficit rose to unprecedented levels.

I believe that lowering tax rates while broadening the tax base can significantly increase tax revenues. However, for this to happen, there must be a stable and consistent tax policy, clear loophole-free tax laws, and extensive reform of the tax bureaucracy. Above all, it is important to abolish tax exemptions resulting from the pressures and machinations of certain interest groups.

If these steps are taken, it will be possible to increase revenue while at the same time reducing taxes. In other words, every finance minister’s dream would be realisable, but only on the condition that we learn from history and apply its lessons conscientiously after diligent study of the relevant facts.


The writer is a tax advisor and former deputy minister of finance. An Arabic version of this article appeared in Al-Masry Al-Youm on 4 December.

*A version of this article appears in print in the 9 December, 2021 edition of Al-Ahram Weekly.

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