The new government's clear mandate to cut spending and tax

May 12, 2015 2:25 PM

In the aftermath of last Thursday's surprise election result, the new Conservative government should reflect on the priorities for taxpayers and what needs to be done both now and over the course of the next five years until elections return in May 2020. These priorities can be categorised into three broad themes: the need for a Spending Plan; the need for comprehensive tax reform; and the need for structural reform to enhance the overall economic competitiveness and effectiveness.

1. Spending Plan

The government now has a clear mandate to bring spending down to below 36 per cent of GDP, the level set out in budget 2015 for 2019-20. The electorate returned the coalition parties to parliament with another majority, a vindication of their record. Of course, the results were much clearer than even that analysis suggests. Not only did they return the coalition parties to power, they also increased the representation of the party with the stronger implied programme on spending, the Conservatives, such that they now have a majority and can govern without their former Liberal Democrat coalition partners.

The increased support for the Conservatives and Ukip is significant, because both parties pre-election promises imply slightly sharper reductions in spending by 2020 than the coalition numbers set out in the budget due to their tax and deficit policies. Ukip and the Conservatives between them attracted 51.7 per cent of the popular vote in Great Britain, a clear indication of the electorate's priorities. Add in the Liberal Democrats to get the three main parties which supported the coalition deficit reduction programme and the combined vote share equates to a resounding 59.9 per cent.

That's a clear mandate to carry out spending reductions but we need a plan to set out how we are going to do it. While it's unfortunate that neither the Conservatives nor Labour spelt out exactly what they would do before the election, detailing what would happen only in the broadest terms of overall spending, we published our Spending Plan back in March. The Government should now either adopt it or set out its own version, telling us in much more detail than they have so far provided what will happen to constrain spending in line with their overall numbers.

2. Tax reform

Our tax system is a complicated mess which continues to do serious damage to our competitiveness. Measures such as bringing down Corporation Tax and increasing investment allowances have had some impact on business and the economy. Meanwhile, rapidly increasing the personal allowance has not only eased the tax burden on many taxpayers but also significantly sharpened incentives for people to take up low income employment, and has been partly responsible for the "jobs miracle" in recent years. But tax reform has been far too piecemeal, with simplifying measures cancelled out by new headline-grabbing initiatives and gimmicks which further complicate the system with new eligibility rules, exemptions, thresholds and rates. 

The IFS's Paul Johnson wrote convincingly a few days ago about the need for an overall tax strategy that can guide tax policy towards a more rational, simpler and coherent system. Our 2020 Tax Commission's Single Income Tax sets out just such a plan. It recommended merging all income taxes including corporation tax, national insurance and capital gains tax into a new single tax on income at a single rate of 30 per cent.  And it called for highly damaging transaction taxes such as stamp duty on shares and property to be abolished altogether. Spending doesn't need to be drastically lower than already planned for 2019-20 to make this possible. Indeed, implementing our Spending Plan in full would be enough.

One area in particular that the government should waste no time in reforming is National Insurance. Our 2012 paper How to abolish National Insurance shows how, albeit with timescales that are now a little out of date. But the case in principle is clear and there is no reason to delay on the first of the three steps: transparency. We need a more honest name for the tax, and more honesty in our pay packets which would be achieved by including all National Insurance, including the so-called "employer" contributions, as well as Income Tax in a single deduction, as well as listed individually.

3. Structural reform

Finally, we need broader structural economic reforms beyond modernising taxation and spending policy. While our labour market regulations are not particularly burdensome relative to other European countries, the trend for competition for jobs that has increasingly come from leaner, less restrictive countries outside the EU shows every sign of continuing for the foreseeable future. We need as few costly barriers as possible in front of employers who are considering taking on new staff.

Planning reform, both in terms of infrastructure questions such as letting airport operators expand their capacity and in terms reforming the green belt and building height restrictions to allow house-builders to build the homes we need would help taxpayers in multiple ways. Not only would they solve the obvious problems such as acute housing and runway shortages, but they would also go some way to improving economic output and productivity, which would in turn feed through to wages.

Studies have shown that much of the difference in retail wages in the UK compared to the higher rates in the US is due to excessively tight planning restrictions, which have the effect of putting built indoor space at a premium, and therefore wages at a discount because it reduces labour productivity. Not only would effective planning reform reduce housing benefit bills but it would also have an impact on other benefit bills by putting downward pressure on consumer prices and upward pressure on wages, leading to higher tax revenues.

Constitutional questions on the future of Britain will cut across these themes, both with respect to how the fiscal settlement operates within the union and regarding renegotiation of EU membership and whether the referendum will result in a yes or no vote. Britain's ability to reform laws that hinder our economic competitiveness, for example, is in some regards constrained by the current obligations of EU membership. And we need to be careful not to restrict the scope for tax reform with insufficiently flexible devolution on questions such as the base for devolved taxes. So politicians should bear them in mind when addressing devolution and the EU.

Many of these point and more were discussed in our post election conference last night, co-hosted with Business for Britain, the Institute for Economic Affairs and ConservativeHome. You can watch the conference here.

Latest Blogs: