19 July 2022

Tweaking taxes won’t do: the next PM needs a sweeping programme of economic reform


The Tory leadership race so far has been characterised by a rather sterile debate on tax policy and its effect on inflation. We could all benefit from some home truths in this area.

For starters, the idea that tax cuts and regulatory reform don’t lead to more private economic activity, more competition and lower prices, thereby putting downward pressure on inflation, is a fantasy. Nor should we continue to parrot the old think that it is simply a question of growth (which means money printing and more government spending) with tax rises to pay for it, or austerity (no spending) and no tax rises.

There is a third and much better way forward.

First, we have to recognise how we got into this mess. When you lock down the global economy and cause supply chains to implode, then the resulting chaos will cause massive increases in the price of things. Container costs have gone from about $3,000.00 per container to $20,000.00 since the lockdown. If transportation costs are spiralling, we should expect prices to rise.

The second impact of the lockdown was a massive tightening of the labour market as people were effectively paid to sit at home. A spike in the number of people retiring early made the labour market tighter still. Environmental levies and all sorts of environmental regulation, including the banning of many types of energy production has led to a massive increases in the cost of energy. Since energy is a key component of pretty much everything, it is unsurprising that prices are going up. Last but not least, the effects of the profligate money printing all governments have been engaged in has added the icing to this inflationary cake.

These are all largely self-inflicted wounds. If we are going to have a meaningful effect on prices, we have to first reverse the mistakes we have made, and that means understanding what they are. 

Most importantly of all, we will need to massively increase our energy production, by removing environmental levies, taxes and bans on needed energy production. We have to stop distorting markets in favour of particular kinds of energy production that we happen to like.

Second, we must remove the grit in the supply chain. This requires us to facilitate trade as much as we can with facilitation at the border, and a hard push on our external trade policy. Programmes like freeports and the single trade window at the border need to be put on steroids. The resulting trade corridors that can be developed between UK freeports and zones in other countries will draw in the global supply chain and accelerate trade. 

Third, we need to do everything in our power to stimulate private sector economic growth. Growth does not mean government spending.  Unfortunately, you do get more of what you measure and since GDP includes government spending as well as genuine private sector economic activity, the easy way to increase GDP is for the state to spend more. My counsel to ministers and officials alike is to stop looking at GDP for the next couple of years and focus instead on policies that stimulate entrepreneurial activity in this country.

This means accelerating the regulatory reform agenda that Jacob Rees-Mogg has started. Too many ministers and officials in government have been resisting reform. They have often been communicating the fears of large incumbents who do not want to change. This is as it has always been, but the new PM will have to break through this and drive everyone to find significant areas of regulation to improve so that competition can become the organising principle for the economy.

The resultant creative destruction will lead to more and better firms, more competition, more products and lower prices. Overcoming incumbent power will not be easy and will require ministers to see past arguments that favour vested interests, often beautifully disguised by prudential, or some other putative national interest concern. 

Of course, a very important element to building this entrepreneurial environment is to reduce and reform taxes. The overall tax burden in the UK is far higher than in more entrepreneurial places, such as the US. We need to simplify the tax code and make it work for business formation and business growth. It is simply not the right choice to claim that taxes must rise to allow monetary policy to continue to be loose or spending on projects to continue. Here again we are in danger of entering fantasy land.

The commentariat who frequently don’t understand economics often suggest tax cuts ‘must be funded’. It sounds reasonable, but is based on fundamentally flawed reasoning. First of all, the government does not have money. People have it. Tax cuts do not need to be funded. It is necessary government services which need to be funded – and that is not the same thing at all. They are funded by the private sector economic activity from which tax is derived.

This is a non-zero sum game, but if the government reaches into areas where it shouldn’t be getting involved, there will be a double hit to the economy. First of all, that extra government activity will require a higher tax take, and secondly it will erode private sector activity if the government is providing services which the private sector can and should provide.

If you are genuinely serious about changing the UK to a more dynamic economy, you need a massive programme of economic reform that includes tax cuts. The regulatory morass – the result of decades of inattention and EU regulatory creep – coupled with the high tax burden is crippling insurgent, smaller firms.

Any leader who grasps the nettle on all of this will have a chance of reversing the current direction of travel and giving the British people a fighting chance in the global economy. The UK has a small window of opportunity to act, and the necessity to do so because of the need to offset disruptions caused by leaving the EU. But this calls for an ambitious and transformative programme, not just a few tweaks around business as usual.

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Shanker Singham is CEO of Competere, a former Advisor to the Secretary of State for International Trade and former cleared advisor to the US Trade Representative and Department of Commerce.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.