Sunday, September 10, 2006
Treasury tax squeeze will keep us all in its grip
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

Tax has become an issue again. Some would say it has never gone away. Ahead of the party conference season, and notwithstanding other distractions, the tax debate is simmering away.

For the Conservatives, and David Cameron, the issue is whether he can head off demands from party traditionalists for tax cuts, and stick with the rather feeble formulation that the proceeds of growth will be shared between public spending and lower taxes.

Amid the Labour party’s turmoil, Gordon Brown, who has already got his retaliation in by warning against “unfunded” tax cuts, faces pressure from the so-called Blairite outriders, Stephen Byers and Alan Milburn. Byers called for inheritance tax, one of Brown’s biggest moneyspinners, to be abolished. Milburn said in this newspaper last weekend that the debate over Labour’s future policy should include whether it means higher or lower taxes.

Meanwhile, allies of Sir Menzies Campbell, the Liberal Democrat leader, have been putting it about that at his party conference he could lose the battle to scrap the commitment to a 50% top rate of income tax. His plan is scrap the 50% commitment and cut income tax for the lower paid, making up the lost revenue with higher green taxes and increases in capital gains tax.

On a loftier note, the Institute for Fiscal Studies announced last week that it has launched a major review of British taxation, “Reforming the Tax System for the 21st Century”. The £625,000 review, headed by Sir James Mirrlees, joint winner of the Nobel prize for economics in 1996, will be in the tradition of an influential IFS report led by Sir James Meade, another British Nobel prizewinner, published nearly 30 years ago.

The aim of the new review will be to assess whether a tax system that dates back decades, and in some cases centuries, is appropriate for the modern era, with electronic transactions and movements of capital across borders on a vast scale.

The Mirrlees review will take 18 months. Meanwhile, there will be plenty of political horsetrading over tax. When I met George Osborne last year, after he had been appointed shadow chancellor by Michael Howard but before David Cameron was elected Tory leader, he told me his aim over the parliament would be to develop an intellectual case for lower taxes.

The problem for his predecessors, he suggested, was that they had tended to whip out promises of tax cuts before elections, which lacked credibility. He would avoid that by gradually building the case.

Since then, however, tax cuts have become almost banned words for the Tories. They must not, Cameron insists, come before economic stability. As a policy choice, they will have to compete with higher public spending. A document produced by the party’s Public service Improvement Policy Group last week was headed “Conservatives will support the growth of the public services”.

For the Tory party’s ultras, the No Turning Back Group, that sounds like a provocation. Its pamphlet, The Case for Lower Taxes, introduced by John Redwood, to be launched at the party conference next month, aill make the economic and moral case for tax cuts. “This is a plea for early action to cut our tax rates,” he writes. “If you keep tax rates down, the economy grows much more quickly.”

The pamphlet itself does not have much time for large swathes of public spending, which it rejects as unnecessary and wasteful, though it welcomes payments to the disabled “who need the help of other taxpayers to enjoy some of the benefits of our rich society”.

Redwood, when I spoke to him, seemed surprisingly happy with his leadership’s stance on spending and tax cuts. Promising reductions now, he said, would be irresponsible.

Without going as far as the No Turning Back Group, however, it seems to me that Cameron and Osborne are wrong on a couple of counts. One, as I have pointed out before, is that the relevant choice is not, as they put it, between tax cuts and stability. It is between tax cuts and public spending.

The other is that, if there are indeed dynamic “supply-side” effects on economic growth as a result of tax cuts, and most economists would accept there are some, merely sharing the proceeds of growth between extra public spending and lower taxes will fail to capture them. If there is a growth dividend to be gained from tax cuts, in other words, why not go for it? If high taxes constrain growth, there may not be many proceeds to share out.

The problem for the Tories, and for the chancellor’s other opponents - inside and outside the Labour party - is that he has put an armlock on the tax debate by committing so much to public spending.

Taxes are rising to record levels because they have to to fund a seven-year rise in government spending from 37.4% to 43.1% of gross domestic product. In hard numbers, spending is more than £70 billion higher this year than if its share of GDP had been held down.

Brown is also presiding over an increase in government debt, making a breach of his own 40% (of GDP) limit quite likely, at a time when he not out of the wood in terms of meeting his “golden” rule; only borrowing to fund public investment over the economic cycle. The state of the public finances suggests the debate should not be over cutting taxes but, rather, whether they will need to go up.

In the meantime, the tax burden continues to rise through a combination of deliberate measures, fiscal drag and a more intrusive and aggressive approach from the new combined tax department, HM Revenue & Customs. The effect, apart from a squeeze on households, is that Britain is rapidly losing tax competitiveness, as Richard Lambert, CBI director-general, pointed out last week. No longer is this a low-tax economy for firms or individuals. The tax system has gained hugely in complexity. The annual Tolley’s Tax Handbook now has more than twice the number of pages on direct tax as in 1997.

Is there a way out? Opposition politicians have come to believe that it would be electoral suicide to propose significant “cuts” (more accurately, smaller increases than Brown) in public spending. They and the government focus on cutting waste and inefficiency. But useful polling by the Taxpayers’ Alliance shows that, while voters think it is perfectly possible to reduce waste and thereby cut taxes, they do not believe politicians - Labour, Tory or LibDem - are capable of doing so.

So it looks as though we are stuck with a high-tax, high spending economy, even with the prospect of a significantly tougher public spending round next year. Perhaps, now the tectonic plates are shifting in politics, they will start to shift on this too. But don’t bank on it.

PS Noon on Thursday is becoming a very wobbly time of week, at least when the monetary policy committee (MPC) is meeting. The markets had got used to the Bank of England not doing anything on interest rates each month. Now, after being surprised by the August hike from 4.5% to 4.75%, they fear something every month.

That will calm down, and the MPC sensibly left well alone last Thursday (another surprise would have been pushing it). Realistically, all eyes are on November. There has been a pronounced fall in petrol prices, with unleaded in some places back below 90p a litre, as well as some tentative indications that service-sector growth may be slowing.

But the British Retail Consortium reported that its shop price index last month was 1.4% up on a year earlier (normally it shows a fall) driven by higher food prices and the fact there were heavier non-food discounts last year than this. Some insurance firms are following the Norwich Union with higher motor premiums. There’s just a hint that companies have rediscovered their pricing power, something the MPC won't like.

From The Sunday Times, September 10 2006

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