Sunday, November 14, 2004
Tories offer an escape from the tax net
Posted by David Smith at 10:00 AM
Category: David Smith's other articles

IT has been a long time coming. My first reaction, I confess, was to rub my eyes in disbelief. But now it can be said: the Conservatives are producing some good ideas on tax.

The Tory problem — apart from Labour’s 159-seat Commons majority and the enduring electoral appeal of even a tarnished Tony Blair — is that every time the party has even hinted at tax cuts, it has been accused of planning to slash spending on cherished public services.

Whether public services are quite as cherished as the government would have us believe is another story. So is the question whether Oliver Letwin, the shadow chancellor, was wise to sign up to a policy of matching Labour’s future spending on health and education.

But modern Tory wisdom is that any suggestion that the party was intending to trim spending on services would have resurrected unhappy memories of the “slash and burn” era of Margaret Thatcher. (She never actually slashed spending though she talked a lot about doing so, but that’s another story.) The Tories’ strategy is a three-pronged one. The party’s spending review, being carried out by David James, the company doctor, will aim to cut “unpopular” government spending while leaving cherished programmes intact.

The Department of Trade and Industry, sadly for those who work there, counts as unpopular in this context, and so does much of the work of the environment, food and rural affairs department.

The logic is that a party which aims to cut bureaucracy and red tape can legitimately talk of eliminating entire government programmes — and the officials needed to administer them — in a way that Labour, apparently addicted to these things, cannot. But senior Tories concede that voters have to be persuaded that their programme is any different from Gordon Brown’s superficially similar exercise involving some 100,000 fewer civil-service posts.

The second prong of the Tory strategy, touched on here last week, is to emphasise the inevitability of Labour’s third-term tax rises. That is getting easier, with the massed ranks of independent analysts, including the Institute for Fiscal Studies, saying it is all but certain that taxes will need to rise to meet the chancellor’s golden rule.

His response to that, in his pre-budget report on December 2, will be to deny any such thing. The consensus, it should be said, has been wrong before.

Assuming, however, that the Tories can avoid being skewered on these first two prongs, its third prong is quite promising. Letwin has drawn on the advice of Lord Saatchi, the Tory co-chairman, whose polling is revealing what most angers voters about the tax system. The shadow chancellor has a tax- reform panel under the chairmanship of Stephen Dorrell, a former Treasury minister and health secretary.

In the coming months we shall see a “dance of the eight veils” as the shadow chancellor slowly uncovers his ideas in eight areas of taxation: income tax and national insurance thresholds, council tax, inheritance tax, stamp duty, taxes on savings and pensions, small-business taxation, capital-gains tax and environmental taxes.

After Brown’s budget next March Letwin will publish, in detail, what his first budget would be in the event (still unlikely) of a Conservative election victory.

The first options, on income-tax and national-insurance thresholds, came last week. While nothing is set in stone, the direction is clear. Under Brown, record numbers have been drawn into the tax net.

The number of income-tax payers is up from 25.7m to 29.9m since 1997. Only part of this reflects the rise in employment, which stands at 28m. Some workers earn too little to pay tax but plenty of non-workers, mainly pensioners, are taxpayers.

Even more dramatic is the rise in the number paying the top 40% rate of tax, from just over 2m in 1997 to more than 3.4m now. Labour lost an election in 1992 for threatening to hit middle-income earners with higher tax. It has done so by stealth since 1997 and people don’t like it.

We have one of the world’s lowest earnings thresholds for moving into the top rate of tax. The cause of this stealth rise in taxation is fiscal drag. Tax allowances and thresholds have risen in line with inflation while earnings have risen at a faster rate, as they always do. With every budget Brown has created a few hundred thousand more taxpayers and tens of thousands of extra higher-rate taxpayers.

The Tory options, set out in a paper last week, range from the modest — raising tax allowances and thresholds in line with earnings to stabilise the number of taxpayers — to the dramatic. The most expensive, costing nearly £7 billion, would restore allowances to their 1997 level in relation to earnings, taking millions of people out of tax. That is probably not the one that Letwin will be able to choose.

Raising allowances by more than inflation — overindexing — has a good pedigree. It was the strategy used in the first half of the 1980s under Thatcher. Her chancellors, Sir Geoffrey Howe and Nigel Lawson, were able to stand up at budget time and say that they were taking tens of thousands of people out of tax.

This was abandoned in favour of cutting the basic rate only in the late 1980s when the Tories decided that the top rate of tax needed to be reduced (from 60% to 40%) but that this would be impossible without also reducing the basic rate.

Such considerations no longer apply, so the Tories have the makings of a good tax policy. Which may simply mean, of course, that the chancellor will steal it for himself.

PS: The Bank of England is such a much-loved institution that, like the late Queen Mother, you criticise it at your peril. Everybody thinks the Bank is wonderful — except the 13 members of the House of Lords economic affairs committee.

The Lords Peston, Barnett, Oakeshott, Roll, Skidelsky and their colleagues, in their latest report, begin with a swipe at Gordon Brown for switching the Bank’s inflation target to the consumer prices index (CPI) measure. The change, they say, was not thought through. Not only does the target exclude house prices, but it is detached from the rest of the economy.

The CPI is not used for uprating of pensions and other benefits or wage negotiations. The Lords imply it was a silly and unnecessary change and it is hard to disagree. They also criticise recent external appointments to the Bank’s monetary policy committee.

Much of the Lords’ fire is directed straight at the Bank. It thinks the MPC has tied itself up in knots over the housing market, giving a confusing message on the role of house prices in its rate decisions.

Most of all it attacks the Bank’s “systematic and persistent” forecasting errors. The Bank has tended to overestimate inflation and, in recent years, overpredict growth, thus keeping interest rates higher. It should, say the Lords, make its new economic model public to allow better scrutiny.

The report was published a day after the latest inflation report. Perhaps it was coincidence but Mervyn King, the governor, struck an uncertain tone. He predicted a modest fall in house prices but suggested that it would not affect consumer spending very much. While the economy would bump up against capacity limits, it was not clear whether this would push inflation higher.

Does that mean interest rates have peaked? I now think so but the Bank isn’t saying. King said it depended on the data in the coming months. In other words, his guess is as good as yours.

From The Sunday Times, November 14 2004