Andrew Haldenby is Director of Reform.
Looking beyond this week’s Budget, a big question is whether the UK is going to emerge from the financial crisis in better shape than when it went in. The country could simply go back to the kind of politics and economy that prevailed in the “boom” years. Much better if some lessons are learned and some fundamental problems are put right. The call for a “permanently smaller state”, made by both the Chancellor and the Prime Minister in recent months, is an important example of the kind of game-changing objective that would make things genuinely different this time.
New research from Reform casts light on exactly why the country should avoid going back to business as usual. George Osborne has spoken of the need to fix the roof when the sun is shining – i.e: repair the public finances in periods of growth after they inevitably suffer in recessions. The Reform research has a number and an idea that show exactly what happens when that job is neglected. The research identifies a “debt ratchet” that has operated over the last 20 years and under successive governments. Under the ratchet, deficits have fallen much more slowly in the good times then they rise in the bad. The estimate is that in this financial year, the national debt is £124 billion higher than it would otherwise be (or 76 per cent of GDP instead of 68 per cent).
That is the kind of sum that changes a Chancellor’s fiscal calculations ahead of a Budget. Just as importantly, the ratchet means higher deficits, higher debt and so higher taxes in the future – unless the UK can step off the escalator.
The debate within the two Coalition parties illustrates how strong is the temptation to ease fiscal discipline at the first hint of green shoots. Of course the long term aim, consistent with the idea of a “permanently smaller state”, is to reduce levels of taxation. The public finances, however, have to be in a position to support this aim. In truth, the calamitous state of the UK public finances argue for greater discipline, rather than a wobble in the Chancellor’s commitment.
Osborne might announce slightly better-than-expected borrowing numbers on Wednesday, but the deficit will remain at around £90 billion for this year. The national debt is heading inexorably up to over 75 per cent of GDP, or its highest level since England last won the World Cup in 1966. The OBR forecasts a rising tax burden for the UK in every decade from now on.
All this suggests that a discussion as to whether to focus tax cuts on low earners or middle earners is, unfortunately, a debate for another day. More important is an antidote to over-confidence. 21 of the 25 official forecasts since 2002-03 have predicted that the public finances would move back into surplus. In fact, they have remained in deficit for all of that time.
This is why George Osborne’s interest in a new framework for tax and spend policy is so important. Last year he suggested that Parliament could take on some kind of oversight role over the public finances, at least for two or three years after the next election. He will bring forward more thinking in this year’s Autumn Statement.
This could and should be another game-changer. It is exactly the kind of self-denying ordinance that acknowledges the temptations that confront politicians and seeks to constrain them.
Today’s Reform research argues that the end-point of this type of reform is a new, stronger role for the Office for Budget Responsibility, which has been one of the undoubted successes of this Parliament. The Reform authors show how the OBR could build greater credibility by taking on wider powers – for example, to monitor Opposition party policy, and other tiers of government (such as local government). Eventually, it would take on a limited ability to vary income tax, corporation tax and VAT in order to maintain the strength of the public finances.
An institution of this kind will be more effective than a new fiscal rule, which both Gordon Brown and Osborne have tried in recent times. Both Chancellors abandoned their fiscal rules in crisis conditions because to have obeyed them would have imposed too great a cost on the economy. Institutions can be more flexible.
Many will object that taxation is quintessentially a job for politicians and should never be under independent control, even if only partly. The problem with that argument is the extremely poor record of political control over the last two decades. The success of Bank of England independence is important here. By freeing interest rates from political control, it has reduced the danger of inappropriate cuts in rates. Taxation is also susceptible to political manipulation, which can also have damaging consequences for the economy.
Some Conservatives, perhaps including the Chancellor, will say that it would be wrong to give the OBR power to scrutinise Opposition party policy, for fear of giving it greater credibility. The bigger game, however, is to entrench good policy on public finances regardless of which party is in government. Other countries, such as Sweden, have been able to sustain fiscal discipline over decades, bringing down their debt from emergency levels to around 20 per cent of GDP. The UK needs to do exactly the same, and pressure on the Opposition parties to have good policy would help a lot.
The goal is greater honesty in the political debate on the public finances. In turn, that will lead to greater realism on public spending, which is the only way to achieve lower tax rates in future. Such a change genuinely would see the UK in stronger shape.