It is clear from all the pre-Budget rumours that we are being prepared for another massive increase in taxes. I say another because the previous Tory government had already hiked them.
Now the reason being given is that there is a ‘black hole’ in the public finances – more or less the same reason given by Rishi Sunak.
This is Treasury desperation talking again. Each time, we get the same result: the economy stagnates as the higher tax knocks it back and worsens long-term growth prospects. The problem, then, is that without growth, the outlook for the public finances is grim. So putting in place yet more tax rises leaves it even worse.
Indeed, if matters did not look so grim, we could all be enjoying a good laugh at the procession of rumours of new taxes that have been paraded in the media, only to be disowned in later rounds of leaks.
Early on we were told the aim would be to soak ‘the rich’ with substantially higher capital gains tax and much-reduced non-dom exemptions; however, officials soon explained to Labour ministers that these would reduce tax revenues due to the likely flight of those being targeted. So these ideas have increasingly disappeared from the rumour mill, still leaving live proposals for higher tax, including inheritance tax and capital gains, that threaten growth by raising marginal tax rates on the very entrepreneurs on whom growth depends.
Rachel Reeves has landed on a contradiction: she aims for growth but she wants entrepreneurs, ‘the rich’, whose investments they need for that growth, to ‘pay’ up front for their redistributive policies for ‘working people’. Whichever way she turns, this basic contradiction destroys her calculations.
Yet this destruction of long-term growth prospects by immediate tax-raising springs from a failure to think strategically about the public finances.
For a rich country like the UK, there is no need to balance the books in the short term: borrowing is an instrument of policy that allows flexibility. What matters is the long-term ratio of debt to GDP; if that comes down and is sustainable, then there is no problem.
The best way to achieve this is by keeping tax rates down. This both prevents short-term stagnation and maximises the chances of long-term growth, which then boosts tax revenues and brings down the long-term debt to GDP ratio, while paying for public services.
If you look at British history over the past two centuries, you can see this playing out. The ratio of debt to GDP was brought down twice from well over 200%, once after the Napoleonic wars and the second time after WWII. In each case, it took a long time and there was no panic-stricken dash for balance, as is now being urged on us by the new Treasury orthodoxy embodied in various short-term fiscal rules.
One defence we hear for this Treasury orthodoxy from some is that the market in UK government bonds, ‘gilts’, is worried about future borrowing. They cite the fact that gilt yields are above German equivalents. This is to misunderstand the pricing of long-term bonds which normally reflect expected short-term rates of interest; with the EU facing a slowing economy, the European Central Bank is cutting rates, unlike here and in the US, where long-term rates are similar due to similar ‘higher for longer’ rate policies.
Another defence of the orthodoxy that we hear is that to raise borrowing would repeat the fate of Liz Truss’ mini-budget. Yet again, this misunderstands the problems Liz Truss faced, which were the slowness with which the Bank of England was responding to high inflation, compared with US policy at the time, and the emergence of the pension fund portfolio crisis which Bank regulation had permitted.
In fact, the markets were fairly calm back then about UK government solvency risks, as was shown by the market in Credit Default Swaps which only signalled a 0.7% chance of default, about the same as Canada today. With better market tactics by the Bank, the Truss budget and government would have survived, to our enduring benefit today.
All this implies that in this coming Budget, tax should be kept down.
Yes, in the long-term, it should be raised if there is no alternative because growth falters. There would be no objection to Rachel Reeves announcing such contingency plans, while deferring tax increases today to maximise the chances of renewed growth.
While we can be grateful that the talk of raising taxes on ‘the rich’, targeting the entrepreneurs we rely on for innovation and higher productivity, has been somewhat muted in favour of raising a general tax like NI employer contributions impacting on the country at large, with less damaging effects, the strategy is still flawed by its short-term focus.
The only reason Labour has partly retreated on those taxes aimed at the rich is, as we saw earlier, that the Treasury belatedly realised that they would reduce revenue as entrepreneurs were leaving in droves.
Nevertheless, in their place we now hear that income tax thresholds will indefinitely not be indexed to inflation, pushing up marginal tax rates steadily, while marginal rates on capital gains are set to rise and business exposure in inheritance tax will rise and NI employer charges will be imposed on pension contributions.
All this on top of high corporation tax and already high marginal income tax rates, besides a raft of new labour regulations – precisely the policies that cut entrepreneurial marginal returns.
In effect, the proposed Reeves-Treasury strategy assumes tax and business regulation do not impact growth; it banks on being able to spur growth in the new Labour ‘pro-growth’ agenda by directly stimulating investment from the private sector.
But how does this investment happen? From profit opportunities. These in turn come from rising productivity producing new profit after tax. The higher the tax rate and the more costly the regulation, the smaller this becomes.
The evidence that economies where tax and regulation are low do best on growth is well known and has been around for a long time. Here in the UK, we had the evidence from the Thatcher government reforms in the 1980s that growth could be revived by such policies. We also had the evidence from previous decades that direct government subsidies ‘backing winners’, failed miserably.
How can today’s Treasury and its quango ally, the OBR, back this proposed revival of failed policies, and urge premature tax increases which on the evidence above will ensure low growth? It is an intellectual mystery. The trouble is we will all pay the price through a flatlining economy.
This piece was first published in The Daily Express.
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