Sunday, June 12, 2022
With tax cuts, you can't have your cake and eat it
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on www.thetimes.co.uk This is an excerpt. Not to be reproduced without permission

There is a lot of talk of tax around. Boris Johnson, having scraped through a confidence vote among his own MPs, is being urged by some of them to repair relations with his party by pushing through big tax cuts. Tax Freedom Day – the point in the year when according to its inventors we stop working for the government and start working for ourselves – was marked on June 8, a week later than last year, and the highest it has been for 40 years.

The OECD – the Organisation for Economic Co-operation and Development – said in an updated Economic Outlook that the UK will have the slowest growth next year not just in the G7 but in the wider G20 group of countries, except Russia. In fact, the OECD says the UK will have no growth in 2023, which brings to mind the Monty Python election night sketch and the candidate who polls no votes at all and is asked: “Are you disappointed with this performance?” The candidate’s response is a rendition of Climb Every Mountain. I don’t think we will see that from ministers, but you never know.

According to the OECD, UK growth will be a victim of the Russian invasion of Ukraine but also the combination of a monetary and fiscal tightening; higher interest rates and higher taxes. The higher personal taxes this year, increases in both income tax (through freezing allowances and thresholds) and national insurance (NI), will be followed next April by the big rise in corporation tax, from 19 to 25 per cent.

I have described these before as the most ill-timed tax increases in recent history, particularly in the context of the cost-of-living crisis. Some of them are already in place, despite next month’s softening of the NI rise by increasing the threshold at which it starts to be paid. The corporation tax increase next year could be delayed, though I suspect the government would think the optics of that would be terrible against the backdrop of struggling families.

The freeze on income tax allowances and thresholds, which brings more people into paying income tax of paying it at a higher rate, could also be suspended. It is intended to last until 2026. There is a difference, however, between delaying or suspending the planned increases in tax - which will take the tax burden to its highest since the late 1940s - and actively cutting tax. That is the red meat some Tory MPs are pressing for.

The confidence vote revealed that the prime minister is held in low regard by more than two-fifths of Tory MPs. He is not going down a bundle with the public either, 60 per cent of whom wanted Tory MPs to remove him last week, and with a popularity rating plumbing new depths.

In an important respect however, the prime minister and Tory MPs and party members urging tax cuts are at one. They all want to have their cake and eat it. They want the government to recreate the tax-cutting spirit of Margaret Thatcher, but without replicating the conditions which allowed those tax cuts.

Public finance is not that complicated. If you want lower taxes you can either borrow more – which does not look like a sustainable long-term position – or you can spend less. Rishi Sunak, the chancellor, has done us all a favour, though not necessarily his own political prospects, by pointing out that there is no magic money tree here. Tax cuts do not pay for themselves.

Many Tories who know no economics think that the Laffer curve, invented in the 1970s by the American economist Professor Art Laffer, is gospel. It showed that above a certain level raising tax rates will generate lower rather than higher revenue. But real-world examples of this are hard to find, and the downward slope of the curve, when this effect kicks in, is likely to be at much higher tax rates and tax burden than anything in prospect now.

How did the Thatcher government cut tax? The answer is that it did not, at least initially. The first Thatcher term, 1979-83, was characterised by a higher tax burden, and higher public spending. Her government inherited public spending of 41.5 per cent of gross domestic product and fought that 1983 election with that having risen to 43.3 per cent of GDP. My figures are from the Office for Budget Responsibility’s invaluable database.

Then things changed dramatically. Public spending fell from 43.3 per cent of GDP in 1982-83 to just 34.5 per cent by 1988-89, a huge change helped by a booming economy. In real terms, public spending was barely higher in 1988-89 than in 1982-83 and was 2 per cent lower than in 1983-84. This period of tight spending control was tighter, though not by much, than in the austerity years under David Cameron and George Osborne after 2010.

The contrast, and this is where the cake-and-eat-it point comes in, is with now. The current government inherited public spending of 39 per cent of GDP. It surged to a record 51.9 per cent in 2020-21 as the pandemic struck and is expected to be more than 43 per cent this year, eventually settling at over 41 per cent. That assumes the government sticks to its plans and that unwinding some of the support announced this year will be straightforward.

This government has embraced higher public spending, which is intended to be 12 per cent higher in real terms in 2024-25 than in 2019-20. Some of that is higher infrastructure spending. Public sector net investment, which accounts for only about 6 per cent of government spending, is intended to be 44 per cent higher in 2024-25 than in 2019-20. But other government spending is also going up, by 11 per cent in real terms. Unveiling his comprehensive spending review last October, the chancellor hailed “the largest increase this century” in real-terms departmental spending.

You can’t have it both ways and have your cake and eat it. The reality is of a rising tax burden, in which any token tax cuts before the next election will be exactly that, mere flesh wounds to coin a phrase. The differences between this government and Thatcher’s are much greater than the similarities.