Osborne must take axe to tax

There are two big misrepresentations about the current state of the British economy.
The first is that the present government has engaged in savage cuts in public spending that are shrinking the size of the state in the most painful way. The second is that the size of the economy is shrinking and as a result, the nation is heading into a “triple dip” recession.

In fact, public spending is still climbing at a sustained pace, which is among the reasons why the Coalition is constantly on the lookout for new targets to tax. The fact that despite all the headlines, GDP is still rising, albeit at a much slower pace that hoped for, partly explains why, despite all the mischievous reporting, employment continues to rise and a remarkable 580,000 private sector jobs have been added to the British economy in the past 12 months.

This is the real background against which George Osborne will present his third budget on Wednesday (March 20). In many ways it is a last chance saloon for Osborne.

The next general election (on the basis of five year fixed term parliaments) is just two years away so the Chancellor urgently needs to change the narrative if the Tories are to have any chance of staying in office. In the end it is “the economy stupid,” to quote former American President Bill Clinton, that wins elections.
A close looks at what has been happening to the public finances produces some surprises. Despite all the talk of “cuts”, most of the “cuts” promised have never been delivered.

Under the Coalition’s plans to bring the budget under control by 2017 (a balanced budget already has been postponed for a year) some 85 per cent of the savings are destined to come from cuts in spending and 15 per cent from rises in taxation.

Both variables are failing to deliver according to analysis by the independent Institute for Fiscal Studies. On the spending front, the only part being delivered is cuts in investment spending with 67 per cent so far earmarked or delivered.

This in itself is somewhat crazy. Spending on new infrastructure such as roads, rails, university facilities and sewage, such as the Thames Tunnel, are in fact the key to future growth. They should probably not be cut at all. Indeed, record low interest rates offer an opportunity for the government to use its credit ratio (no longer “AAA”) to finance infrastructure.

In contrast, just 32 per cent of the reductions in benefit spending have been delivered and only 21 per cent of the reductions in day to day spending. Indeed, the latest data from the Office for Budget Responsibility, the government’s pay watchdog, shows that central government current spending will actually rise this year by 2.4 per cent, rather than contract as scheduled. As a result, government borrowing is widening rather than narrowing and the nation’s debt levels (the accumulation of borrowing) will reach a record 96 per cent of national wealth by 2016, when it starts to fall again.

It will be argued that this is happening because in times of hardship, welfare bills, including unemployment benefits, tend to rise. But the reality is that employment is the highest it has ever been so there is no reason, other than non-delivery, why welfare cuts should not be falling.
There are taxation problems too. Income tax receipts are rising reflecting the better employment numbers and the decision to freeze some allowances. VAT is also on the rise reflecting the underlying fact that the economy is expanding, if slowly.

But the corporation tax take is shrinking. This reflects a number of factors including foreign takeovers of UK firms, aggressive tax avoidance schemes used by both UK and overseas enterprises and disruption of production from the North Sea. So what should the Chancellor do? He should reject the political noise being made by the LibDems and Ian Duncan-Smith among the Tories and finally take a meat axe to the welfare budget, thereby dealing with the deficit and freeing funds for investment.

On the taxation side of the equation, it is time for Osborne and the government to move towards lower and flatter taxes. The place where there are the potentially richest rewards are in oil and gas exploration. One of the main reasons for Britain’s GDP shortfall is the loss of production from the North Sea that has fallen 40 per cent from its peak and is dropping at six per cent a year. At present, extraction industries are taxed at between 60 per cent and 81 per cent a year. Changes in North Sea oil taxation last year have already led to new projects.

The “fracking” revolution offers all kinds of new opportunities. Reforming the oil and taxation regime would be a great place for the Chancellor to start if he is to reshape his economic legacy.
Clearly, Osborne is determined to get on top of the public finances even if delivery is proving more difficult. But the real path to future growth is through radical tax reform that will kick-start investment and exports.

Alex Brummer is City Editor of the Daily Mail

    Last updated: 9:45am, March 14 2013