Still a long way to go on tax and spend

It’s been a fascinating week.  The Government announces plans to re-write the fiscal rules to allow even more borrowing (like they weren’t ignoring their rules anyway); the Conservatives say hysterically that they may have to raise taxes to sort the economy out (like that works!); and the Liberal Democrats pledge to cut the overall burden of tax by cutting wasteful government spending (although the Lib Dems have for years been the highest taxing of the three main parties). 

It’s time to sort all this out and try and make some sense of what is going on. 

Firstly, the Government.  From today’s FT:

“With the government on course to break the rule limiting net public sector debt to 40 per cent of national income, a new framework would initially be looser. A consequence will be to make it easier to borrow more in the coming downturn, although the principle reason for the change is to restore confidence in the rules, so the medium-term budgetary position might be tighter than currently planned.”

So once again the Government plans to borrow more in the short term, promising us that it really will impose some discipline down the line.  We’ve heard this in each Budget since 2000.  Although it is sensible to borrow more in a downturn, the huge deficits of the earlier part of this decade, when the economy was growing strongly, are inexcusable. 

But let’s look at how the Treasury has consistently got its borrowing forecasts wrong.  Analysing Budget predictions for the financial year immediately following with the outturn numbers two Budgets later (e.g. for 2001-02, Budget 2001 forecast and Budget 2003 outturn; for 2002-03, Budget 2002 forecast and Budget 2004 outturn, etc) shows that tax revenue has consistently been overestimated far more than spending has been underestimated. 

    • Between the financial years 2001-02 and 2005-06, the average overestimate of current receipts was £6.6 billion.
    • Over the same 5-year period, the average underestimate of spending was just £0.7 billion.

This is hardly surprising.  Over the same period taxes were rising, and as you would expect, these tax rises were not generating as much revenue as the Treasury’s static modelling predicted. 

This leads us on to David Cameron on Tuesday and Liam Fox today saying that taxes may have to rise under the Tories to fill a black hole left by Brown.  This is economic lunacy.  The worst thing to do in a downturn is raise taxes, which will only deepen the crisis and prolong the economic misery.  As Fraser Nelson points out today, other countries are taking a very different approach:

"The Irish government decided a few weeks ago that it would tighten its spending this year, because tax receipts were falling. Is this idea so hard for Gordon Brown to grasp? The entire country is cutting back its spending, why can’t government?"

Indeed, it should not be too difficult an idea for the Opposition to grasp either.  And the evidence on Treasury forecasts presented above shows how the Tories will not fill a black hole with tax rises, because they won’t get the revenue they expect.  (See also numerous studies which conclude the same thing – p.15 of the Tax Reform Commission report cites a number of them.)  While only in very rare situations will tax cuts entirely pay for themselves, it cannot be repeated often enough that tax rises generate less extra revenue than expected and tax cuts do not lose as much revenue as expected. 

The logic of the Tories’ own position is to cut spending, rather than increase taxes, to balance the books:

    • Firstly, they have correctly argued against Brown’s tax rises, pointing out the damaging effects of higher taxes on both economic competitiveness and household budgets.  Tax cuts are the logical response. 
    • Secondly, they have made the case that the Government has wasted a colossal amount of taxpayers’ money.  It should not be too difficult, then, to find some savings.  The TPA’s Bumper Book of Government Waste found over £100 billion of wasteful and unnecessary spending.  Save just 10 per cent of that and you can make a big difference to the fiscal position.

Instead the Tories promise to match Labour’s spending plans and even talk about tax increases.  You would be right to feel confused, except for the fact that it’s common knowledge that the Party is terrified of the “spending cuts” charge. 

But public opinion has moved on a long way.  It’s not simply newspaper headlines screaming that we are over-taxed and ripped-off by the Government.  The following polling data is just the tip of the iceberg:

    • A YouGov poll for the TPA in August last year, before the credit crunch, found that 64 per cent thought that “the government spends too much and therefore taxes us too much”, with only 4 per cent thinking that “the government spends too little and therefore taxes us too little”. 
    • A YouGov poll in May this year found that only 2 per cent think they pay too little in taxes; 38 per cent think that “taxes should be cut even if it means some reduction in government services such as health, education and welfare” against 22 per cent who think that “Government services such as health education and welfare should be extended, even if it means some increase in taxes”; and 61 per cent would oppose a policy which required them personally to pay higher taxes in order to increase spending on public services such as health education and welfare, against 21 per cent who would support it.
    • 81 per cent think that at least £10 in every £100 of government spending is wasted, while 53 per cent think at least £20 in every £100 spent by politicians goes down the drain.

This polling evidence suggests that a message along the lines of “Ordinary families are having to tighten their belts and cut back on luxuries; government and politicians should do the same” could be very popular.  Now, in fact, may be the ideal time to carry out a shake-up of the bloated public sector, and get popular support for doing so. 

It is a fact that is not lost on the third main party.  Yesterday the Liberal Democrats pledged to reduce the overall burden of tax by finding £20 billion of spending cuts.  As the party leader, Nick Clegg, said, “Every family is tightening their belt at the moment.  Government must tighten theirs, too.”  Presumably they’ve been looking at the same polling we have. 

This is extremely welcome and significant, whether out of a change in principle, or a sense that votes are up for grabs.  The Liberal Democrats are the only one of the three main parties to pledge to reduce the overall burden of tax.  We wait to see their detailed costings and the specific areas of government spending they will cut, but, as Iain Dale wrote in today’s Telegraph [link], “it’s a damn sight more than any other politician has had the guts to do”.

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