Matthew Sinclair is Director of the TaxPayers' Alliance.
The growth figures showing a contraction at the end of 2010 are certainly worrying. They suggest the economy was really buried in the snow. And if growth was “flattish”, as the ONS suggests it would have been without the snow, even before a VAT hike then that is cause for concern about the underlying strength of the recovery. Even that won’t really be clear for some time once the statisticians have finished revising the data though.
The critical question, which can easily be lost in the immediate headlines, is how well we take advantage of the opportunities that a recovering international economy will create. Not now, but over the next decade. That is what will determine whether or not the fiscal adjustment feels like painful austerity or a gentle squeeze. And it could decide the next election.
Earlier data, which is a bit more reliable and allows us to compare with other countries, shows that Britain’s recovery has been creditable if unspectacular so far. Unemployment is still low by European standards, in September it was less than 8 per cent here compared to over 10 per cent in the eurozone. But inflation is high, consumer prices were up 3.3 per cent in November on a year earlier, against 1.9 per cent in the eurozone. Add those figures together for a back of the envelope Misery Index – a summary statistic for economic pain popularised in American elections in the 1970s – and you get 11.1 for the UK whereas the eurozone registers 12. We aren’t having a particularly miserable time of it compared to our European peers but this is hardly the recovery a thrusting Anglo-Saxon economy benefitting from a weak pound would hope for.
In the coming years we might be buffeted by new storms in the global economy. The fiscal crisis in the eurozone could become unmanageable; China’s long, impressive boom could yet turn to bust. Those kinds of risks are beyond our control.
The vital challenge for British policymakers is how they can create the best kind of environment for a strong relative performance. To ensure that Britain is a source of positive surprises as it was from the end of the last recession to the onset of the financial crisis. Unfortunately the Government are simultaneously loading a lot of pressure on household budgets and sending quite mixed signals to international business. Their strategy for growth isn’t nearly strong enough to deliver the recovery both coalition parties need.
The two big immediate sources of pressure on household budgets are the VAT hike and rising petrol prices. Combined with inflation that was already high last year, those two measures are a recipe for an austere 2011.
The logic of the resuscitated Fuel Duty escalator, increasing the duty by 1p above the rate of inflation each year, is that high inflation will always be accompanied by steep tax hikes on petrol and diesel. It is in effect almost the opposite of the stabiliser that the Conservatives proposed before the election.
It isn’t just this year that families will be facing huge pressure on their finances. To slow the steady accumulation of public sector debt and limit a debt interest bill that will soon eclipse the interest on all the nation’s mortgages put together, the Government are planning a combined, cumulative £438 billion in tax hikes and spending cuts. But that isn’t all. You can add £282 billion of investment required in the energy sector by 2020, which will be passed on in higher energy prices, and £22 billion that the water network needs. All together it adds up to £742 billion, or the best part of £30,000 for every household to find over the next decade, on top of all their own priorities for their money.
Another source of hope for the economy, even if British consumers are feeling miserable and picked on, would be getting the right incentives for investors and entrepreneurs to expand and create new businesses. There is some good news there with cuts in corporation tax from 28 to 24 per cent by 2015. The Government have also promised to tackle red tape with an investigation of health and safety law and an Office to look at Tax Simplification. We’ll see how much that cuts the £76.8 billion cost of new regulations since 1998, according to the British Chambers of Commerce Burdens Barometer.
But so far business seems to be underwhelmed. London First ran a survey that suggests 60 per cent of senior executives at overseas investors in London have not changed their opinion of the city as a business location. Ten members of the OECD already have combined corporate tax rates of 24 per cent or less and rates are being cut around the world. On the other side of the ledger, with the new 50 per cent tax rate we have one of the highest top rates of income tax.
That combination of a heavy burden on the shoulders of families and a tepid environment for business is bad news. What can the Government do about it?
What they absolutely shouldn’t do is reverse course on cutting spending. It is well established in the economic literature that higher spending, as a share of national income, is associated with lower growth over time. High deficits also mean uncertainty for families and businesses who know the Government will have to pay eventually, but don’t know how. If they invest, will they pay the price for today’s spending in higher taxes on the returns tomorrow?
Bizarrely Ed Balls cited Ricardian Equivalence on the Daily Politics. Either he is ignorant of the meaning of the concept or he butchered it in a dishonest attempt to make his point sound credible. The point of Ricardian Equivalence is that people know deficits will have to be paid for and adjust their behaviour in light of that, consuming less so they have the money to cope with the forthcoming spending cuts or tax rises. As a result Keynesian attempts to prop up the economy with deficits tend to fail. To the extent Ricardian Equivalence is correct, spending cuts to reduce a deficit will not weaken the economy ever, let alone ahead of time as he was suggesting.
To ease the pressure on consumers, spending cuts should be focused where they will hit the budgets of ordinary households least. Freezing the International Development budget in cash terms for example, the same kind of settlement the science budget received, would save £3.7 billion a year on current plans by 2014-15.
We should also look to reform other policies imposing major costs on families and businesses. Citigroup Global Markets expect that £282 billion of investment will be needed in the energy sector by 2020, but only £80 billion of that is to keep the lights on. To meet environmental targets we need to invest £202 billion – more than Germany, France and Italy put together – as we have a particularly tough target to increase our use of renewable energy and have to make heavy use of prohibitively expensive offshore wind. Citigroup expect that will mean energy bills rising by 52 per cent in real terms. While it might be possible to save some money with greater energy efficiency, that can only cut the rise to 35 per cent even before you pay for the extra insulation.
The promise is that in return for taking such drastic action, at such a severe cost while the big emitters are refusing to join in, it will help us take the lead in the green markets of the future. The reality can be seen in the German solar industry, which is facing collapse with competition from China and unaffordable tariffs being cut: green jobs are a mirage. Many more jobs will be lost in energy intensive industries like steel and chemicals – manufacturing industries that are currently the ray of light in the growth figures – than are ever created building and installing wind turbines and solar panels.
Finally we need to improve incentives for people to work and invest in Britain. That means taking opportunities to cut taxes that are such an economic disaster they lose money. We can cut corporate tax rates much more sharply and scrap the 50p rate and be confident that the economic returns will be so dramatic there will be more revenue in the till within a few years. With all the challenges facing the economy and the public finances, we can’t afford to leave that kind of opportunity on the table.
The response we get is that it is important the rich pay their share. But companies don’t pay tax; people pay tax whether they are workers or shareholders (i.e. your pension fund). And a hedge fund manager who relocates to Switzerland because of the 50p rate pays a lot less tax. Do we really want to pay more ourselves just for the pleasure of inflicting higher taxes on the rich?
It would be easy to identify a political price tag on any of the policies I’ve recommended, the lobbies who will be outraged or the opportunities for the opposition. All of that pales into insignificance compared to whether or not the economy is growing strongly a few years down the line at the next election. If the Government want political success they need to reduce the burden being imposed on families and businesses and make hard decisions to get the economy growing.