Margaret Thatcher's Forgotten Tax Increase

British Prime Minister Margaret Thatcher takes a trip on the paddle steamer “Kingswear Castle” in June 1987 Photograph by Tom Stoddart/Getty Images

Strategic tax-raiser. It’s not the usual epithet for British Prime Minister Margaret Thatcher, who’s generally remembered by fans as the Iron Lady and by haters as the Milk Snatcher. But raising taxes to help close a big budget deficit is very much part of the legacy of Thatcher, who died today in London of a stroke at age 87.

For the most part Thatcher cut income taxes aggressively during her 11 years in office, from 1979 to 1990. She also deregulated the financial markets; privatized council housing and the national phone company, airline, and oil company; curbed powerful labor unions; distanced Britain from monetary union with Europe; fought Argentina over the Falkland Islands; and survived an assassination attempt by the Irish Republic Army.

But in 1981, Thatcher pushed through a tax increase at a time when the economy was shrinking and unemployment was around 9 percent. She did it because it seemed to her politically impossible to cut spending any further and yet she felt it was essential to cut the budget deficit. Shrinking the deficit, she felt, would bring down interest rates, which would enable private businesses to borrow and expand, ultimately leading to more growth.

“I was in the flat packing my hats into boxes for my trip to the United States,” Thatcher recalled in her memoirs, which are online at Alan Walters, an adviser, came in and pressed his argument for a smaller deficit. A short time later, as Thatcher was about to leave for America, Geoffrey Howe, her Chancellor of the Exchequer, came to her with a way to increase tax revenue without boosting rates: Postpone the inflation adjustment in tax brackets. That would push more families into the higher bracket—a big deal at a time of 13 percent inflation.

“This was the turning point,” Thatcher remembered.

What’s most striking from today’s perspective is that Thatcher saw her tax increase as a blow to the Keynesian orthodoxy of the day. The Keynesians believed that government should sustain demand by running big deficits when the economy was weak, then pay off the debt by running surpluses when times were good. To Thatcher, the followers of John Maynard Keynes were too fond of meddling in the affairs of the private sector.

Defending her tax hike, she gave a speech to the Conservative Party’s Central Council meeting in Bournemouth that was positively Churchillian:

In the past our people have made sacrifices, only to find at the eleventh hour their Government had lost its nerve and the sacrifice had been in vain. It shall not be in vain this time. This Conservative Government, not yet two years in office, will hold fast until the future of our country is assured. I do not greatly care what people say about me: I do greatly care what people think about our country. Let us, then, keep calm and strong, and let us preserve that mutual friendship in which patriotism consists. This is the road I am resolved to follow. This is the path I must go. I ask all who have the spirit—the bold, the steadfast and the young in heart—to stand and join with me as we go forward. For there is no other company in which I would travel.

The enormous differences between the Britain of 1981 and the U.S. of 2013 make it hard to draw lessons for the U.S. from Thatcher’s experience. Reducing budget deficits was a far more urgent concern for Thatcher than it is for President Barack Obama: Britain was in such sorry financial shape that it had only recently been forced to turn to the International Monetary Fund for a loan. That explains why Thatcher felt it necessary to do something. On the other hand the public sector remained bloated, so she could have balanced the budget with spending cuts instead of tax hikes. She concluded that it wasn’t politically possible to do so—at least not quickly enough to calm the financial markets.

Thatcher’s contemporary, President Ronald Reagan, shared her devotion to shrinking government and cutting taxes. He, too, occasionally raised taxes, including on capital gains and corporate income in 1986. That either shows that even giants have feet of clay—or that once in awhile, there are worse things than raising taxes.

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