The hand-wringing establishment is wrong again about Truss’s tax cuts
Candidates for No 10 are using taxes to shadow box on the economy ... the big battles are yet to be fought
Tax cuts that merely reverse past rises will not bring a performance revolution. We were not doing that well before
So, now we know the final two contestants to be our next prime minister, and tax has come to be the key dividing line between them. But are their differences on this issue really so stark? And aren’t there more important things at stake?
The Left-leaning establishment and media have attacked Liz Truss’s pledge to cut taxes immediately as irresponsible and even ridiculous. Not for the first time, they are well wide of the mark. The apparent purity of the “you mustn’t spend what you don’t have” doctrine is completely at odds with the facts of fiscal policy. We are borrowing huge amounts anyway to fund current spending but no one suggests we should be raising taxes even more to reduce borrowing to zero. Indeed, lest we forget, not that long ago the then-chancellor Rishi Sunak was borrowing in order to subsidise eating out.
How much to borrow and in what circumstances is a judgment call. Everything depends on the amounts, the types of taxes and/or spending and the economic circumstances of the time. We don’t even know what the fiscal position will be over the next year without tax cuts. Forecasts for 2021-22 from the Office for Budget Responsibility (OBR) turned out to be hugely pessimistic. In March 2021, it thought borrowing for the year would be £234bn. As it happens, it was just under £142bn, some £92bn less.
Ms Truss has suggested Covidrelated public debt should be treated differently from other debt and effectively be paid off or whittled away over a long period, mirroring what we have done with war debt. This is an appealing notion but I don’t think it makes much practical difference. It is appropriate to take a long-term perspective on bringing down public debt, whatever its causes.
The two key taxes that Ms Truss wants to cut, namely National Insurance and corporation tax, are worthy candidates for reduction. Indeed, what she is proposing is simply to reverse the recent rise in NI rates and abandon a planned increase in corporation tax. This is hardly the stuff of a tax slasher’s charter.
Both those tax rises, announced by Mr Sunak as chancellor, are damaging. NI is a tax on jobs which discourages employment, raises business costs and squeezes disposable income. Reversing the increases in NI contribution rates, far from being inflationary, would help combat inflationary forces.
The planned increases in corporation tax would harm corporate investment at just the time we need to stimulate it. They make the UK much less competitive and thereby discourage internationally mobile companies from locating or increasing their activities here. It is true, however, that tax cuts would tend to increase aggregate demand and, thereby, put further pressure on the Bank of England to raise interest rates. Some critics would argue that the net result could be no overall boost to demand at the expense of higher public debt.
They may have a point but this isn’t all about aggregate demand. The supply side is crucial. In this regard, there are some features of such a different policy mix that are attractive. The cuts to NI and corporation tax would get us started on the task of structuring the tax system to boost incentives. Meanwhile, it would surely be more helpful for the supply-side of the economy to move interest rates back towards normal, not least as this would put zombie firms under pressure. Higher interest rates would also tend to take the heat out of the housing market while also boosting the incomes of savers who have had an extremely raw deal over recent years.
Yet tax cuts that would merely reverse recent increases will not revolutionise economic performance. After all, we were hardly doing spectacularly well before. So this dispute over whether and when to cut taxes is really a form of shadow boxing.
The big battles are yet to be fought. Ms Truss has said that she would not impose “Austerity: Mark II”. I suppose that what she means is that she would not support the sort of squeeze on public spending that was enacted by George Osborne. Such austerity was indeed unpopular. You could also argue that it was both too intense and badly structured. Yet if we are to get a serious reduction in tax rates over the next two years while also bringing the debt down as a share of GDP, then government spending will have to fall as a share of GDP.
Perhaps the trick is all in the words used to describe this process. “Austerity” certainly doesn’t sound nice and, at least when applied to public spending, the word “cuts” doesn’t seem appealing. Yet a fiscal policy dedicated to lower taxes doesn’t have to mean “cuts” in public spending. It just means very tight control so that the spending numbers don’t rise as fast as GDP. This does not sound too difficult but achieving it will require an iron will and huge political strength and determination.
Yet even radical tax cuts, on their own, will not be enough to transform our economic performance. As I have often argued here, we need really radical policies to boost productivity in both the public and private sectors. These will include measures to rein in trade union power, reform and reshape the education system, reform the NHS, slim down and redesign the Civil Service, and promote competition throughout the economy.
As it happens, achieving these things will require the same qualities as bringing down the tax burden by reducing the share of government spending in GDP. But we still don’t know which of the two candidates is more likely to display these qualities.