Sunday, February 04, 2007
Brown's imprudent tax and spend legacy
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

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Events permitting, and they include Scotland Yard’s cash-for-honours investigation, Gordon Brown has a few months left as chancellor. And, while the attention is on Tony Blair’s legacy, it is possible to start piecing together Brown’s. What will he have achieved by the time he hangs up his red box?

Last week two respected research bodies, the Institute for Fiscal Studies (IFS) and the National Institute of Economic and Social Research, offered their thoughts on Brown’s fiscal legacy — tax and spend. Both assessments were fair. Neither went down well in Treasury Towers, and were no doubt regarded by the chancellor as an unwelcome intrusion into his preparations for leadership.

The IFS’s green budget, in conjunction with the Economic and Social Research Council and Morgan Stanley, has for years set the scene for the budget proper in March (this time Brown’s last).

This year’s green budget includes a useful retrospective on the Brown era. It starts encouragingly enough, concluding that the public finances in 2006-7 are healthier than in 1996-7, the year before he took over from Kenneth Clarke. Then, public borrowing was 3.5% of gross domestic product; now it is 2.8%. Then, most borrowing was for current spending (wages and salaries); now most is for capital spending (roads and hospitals).

I said the report was fair, and perhaps that is a bit too fair on Brown. When he took over, the public finances were on a sharply improving trend, Clarke having halved the budget deficit since 1993. Though the Treasury says things will improve sharply over the next few years, it has been saying that for some time. So far this fiscal year public-sector net borrowing is £39.7 billion, against £38.8 billion in the corresponding period of last year.

Even if we let that one lie, the numbers do not look good. The “structural” budget deficit — what is left after cyclical influences are removed — is the fifth largest in the Organisation for Economic Co-operation and Development.

Most countries have reduced their budget deficits. This was true for “prudent” Brown in Labour’s first term but not since 2001, when prudence became extravagance.

There is another comparison, which the IFS rightly says is “not flattering” to the chancellor. Ten years into office after the 1979 election, and having endured the first of their big recessions, the Tories could boast lower government debt and a budget deficit under control.

Brown, despite the advantage of uninterrupted economic growth, has more debt (as a percentage of GDP) than the Tories at this stage, and a bigger underlying budget deficit. If the economy hit the rocks, the public finances do not look robust enough to take it.

That point is emphasised by the National Institute. It thinks government debt will rise to 39.4% of GDP in a couple of years, perilously close to the 40% limit of one of Brown’s fiscal rules, the so-called sustainable investment rule. Like all his rules, there is a get-out clause — the limit only applies over the economic cycle.

But the institute, which has had a long battle with the Treasury over what it calls a moving of the goalposts on the golden rule (borrowing only to fund investment), says that, if properly measured, it has already been broken over this cycle.

Some will regard such matters as esoteric. There is no crisis for the public finances, and the debate over the rules can seem strictly for the nerds. But it is important, because of the tax implications.

Whatever you say about Brown, there is one thing you have to salute him for; he has been an extraordinarily efficient taxer. Each time outside economists have warned that the public finances are in a mess and that taxes will need to go up, the chancellor and his aides have pooh-poohed such talk. But then, after a decent interval, he has gone and raised taxes anyway.

Take a recent example. Labour’s 2005 manifesto promised “targeted tax cuts” for families and “a tax regime that supports business”. The public finances, we were told, were in rude health.

In fact, as the IFS points out, measures announced by Brown during Labour’s third term (so far) mean tax increases of more than £6 billion, including the doubling of air passenger duty that took effect last week. That continues the pattern of his chancellorship.

The tax numbers are staggering. Direct tax measures the chancellor has announced over the past 10 years, combined with inherited Tory tax rises and “fiscal drag”, mean taxes have gone up by £58 billion, or 4.2% of national income.

Brown has “lost” a third of this extra revenue, because of the poor performance of the financial sector during the three-year bear market at the start of this decade. But that still leaves £40 billion of extra taxation on his watch, equivalent to £1,300 per family.

Fiscal drag — uprating tax allowances in line with prices (or not at all) rather than earnings — is pernicious, because it is so easy for the Treasury to do. Fiscal drag on income tax is worth nearly a penny on the basic rate of tax each year, according to Maurice Fitzpatrick of Grant Thornton.

Had the higher-rate threshold increased in line with earnings it would be £6,000 above where it is now, and there would be a million fewer people paying the top rate of tax than the 3.25m who do.

There is more of this to come. The Treasury assumes fiscal drag will persist over its forecast horizon, even though it has previously acknowledged that to raise the tax burden in this way cannot be a sustainable long-term policy.

The trouble is that Brown needs the money — another £10 billion or so in higher taxes over the next five years, with a similar amount achieved by “cuts” in public spending.

Brown, and his chief secretary, Stephen Timms, are gearing up for the 2007 spending round. It will mean a sharp slowdown in both current and capital spending, at a time when the public services are pleading poverty and the infrastructure continues to creak. It isn’t much of a fiscal legacy, and it does not look like great politics. And Brown will have nobody to blame but himself.

PS: Sir Nicholas Stern has been touring the world with his report on the economics of climate change but I have yet to come across an economist who agrees with his “headline” finding that spending 1% of global GDP each year now will save 20% damage to the world economy later. William Nordhaus, an acknowledged expert, disagrees with Stern’s numbers. So does Partha Dasgupta, in the National Institute review, who accuses Stern of tailoring his assumptions to produce the desired conclusions.

Climate change is, excuse the pun, a hot topic; the Intergovernmental Panel on Climate Change’s new report was out last Friday. John Llewellyn of Lehman Brothers has applied his analytical rigour to the issue in an excellent report, The Business of Climate Change.

While also finding it hard to get to Stern’s numbers, Llewellyn is clear on the need to act, and thinks busi- nesses should be at the forefront. The four ways to cut carbon emissions are energy efficiency, cutting non-fossil emissions (agriculture and land-use changes), switching demand from high-emission goods and services, and switching to low-carbon technologies. A strategy to cut emissions — abatement — has to be combined with adaptation to changes in the pipeline.

Abatement could mean setting how much emissions countries and companies are allowed — a worldwide volume-based policy. Or, by ensuring users pay the environmental cost in the market, a global carbon price-based policy. Business tends to favour the second approach. It may end up with a messy combination of the two.

From The Sunday Times, February 4 2007


Comments

The biggest miracle of the miracle economy - it's a miracle Gordon has managed to spend so much and yet deliver so little.

Posted by: FHH at February 4, 2007 01:28 PM

David, you forget that the IFS also pointed out the 'off the books' debts of public sector pensions, PFI and railtrack debts amount to a further £100bn, taking the national debt to a much higher level than the offical one.

Any thoughts?

Posted by: Ash at February 4, 2007 07:57 PM

It is an important issue, though it is not one that the IFS chose to emphasise, and neither did I on this occasion. By the way, public sector pension liabilities, on their own, are many times £100 billion. The latest official figure for the main public sector schemes is £327 billion but one independent estimate puts it above £1,000 billion.

Posted by: David Smith at February 4, 2007 08:13 PM

Without wanting to come across as a complete Gordon fan, the spending spree was started off by Tony Blair making commitments to spending on Health and (later, Education) in the 2001 election campaign at a time when Gordon was still saying Prudence. John Prescott's Department (whatever it was called at the time) also routinely trumpeted spending commitments without any evidence of outcomes. Brownite departments have been rather stronger on evidence-based policy rather than policy-based evidence-making.

Posted by: Paul Bivand at February 5, 2007 10:31 AM

Paul,
The role of the Treasury is always to try to limit the fiscal damage, but I'm not sure your recollection of events is entirely accurate. Tony Blair, it is true, blurted out the NHS commitment (raising spending to the EU average) in a January 2000 interview with Sir David Frost, and Gordon Brown was hopping mad about it. But only because he wanted to announce it himself, in his March 2000 budget.

Posted by: David Smith at February 5, 2007 10:41 AM

Dear David,

Can you tie up the following statement with its origin, are there certain aspects of these that you could apply to the intense "monetization" of the current new world order.

There's no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Bets wishes,

Arik Schickendantz


Posted by: arik schickendantz at February 7, 2007 03:01 PM

Dear David

What advice would you offer a would-be first time buyer contemplating their first purchase? Is the housing market still a safe investment or are we in danger of a downturn. The geographical area being considered is Chichester if that makes a difference.

Best wishes
Cliff Pritchard

Posted by: Cliff Pritchard at February 9, 2007 03:30 PM

Cliff,
I don't know your area, but I've no reason to suppose it will be behave very differently from the national average. I don't expect a fall in house prices but I do expect a slowdown in house-price inflation. That means you can afford to take your time. The other advice is straightforward:
(a) Don't overstretch yourself; leave room to accommodate higher interest rates, or get a decent long-term fixed rate (b) Don't buy something that's been on the market too long - it probably means it will be hard to sell (c) If something seems much too expensive, it probably is.
Good luck. It's tough for first-time buyers.

Posted by: David Smith at February 9, 2007 09:02 PM

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Posted by: blinbo at February 11, 2007 01:40 PM