Osborne’s last chance

Prospect Magazine

Prospect Blog

Osborne’s last chance

by
/ / 14 Comments

George Osborne holds up the budget box outside 11 Downing Street. When he delivers the budget on 20th March, it will be his last chance to make an impact as chancellor (photo: HM Treasury)

The 2013 budget is George Osborne’s last chance to make an impact as chancellor of the exchequer. Next time he presents a budget, all eyes will be on the general election and everything will be seen through that prism. Fundamentally, Osborne is a managerial chancellor in the highly conservative treasury mould: he could equally have been a civil servant. Indeed, civil servants must be very content with his policies.

His first act, in true treasury style, was to break the first rule in the fiscal consolidation handbook: he ramped up taxes and promised some spending cuts later, hoping that growth would do most of the work in reducing the deficit. Of course, growth has not materialised and total government spending remains uncut. The tax rises—together with other events outside the chancellor’s control such as the euro crisis—have contributed to reducing growth. When you cut a deficit, the rule is to cut spending first—especially if the deficit is caused by high spending.

The government’s efforts to cut spending have been scuppered because they have tied both hands behind their backs. They began by ring-fencing aid and health. However, they have also been reluctant to cut back the other areas that saw huge growth under Gordon Brown: benefits to pensioners and to working-age families with children. There will be real cuts in the benefits of the latter group over the next few years under the proposals of the Autumn Statement, but even these cuts will only restore benefit levels relative to wages to where they were a couple of years ago.

George Osborne needs a fiscal strategy. Perfectly reasonable plans were put forward two years ago by the Institute of Economic Affairs to reduce government spending to 30 per cent of national income. Such a level would raise the UK’s sustainable growth rate by about 2 per cent a year, bringing huge benefits to rich and poor alike. This is not a level of state spending that would mean wiping out the welfare state—we are talking about bringing it to just below Australian levels. Such a level of state spending could be financed realistically by a simple, fair and flat tax system that would reduce avoidance significantly. This reduction in the size of the state should involve all departments. Welfare systems should be radically reformed to bring an end to their appalling effect on incentives to work, save and on family formation, thus reducing spending whilst increasing opportunity for all. Again, much can be learned from Australia.

It is unlikely we will see this. However, if the chancellor cannot aspire to be a Nigel Lawson, he could at least try to be a Geoffrey Howe. He could begin to reform the tax system to make it more economically coherent.

The four worst designed taxes in the UK are probably stamp duty, inheritance tax, capital gains tax and national insurance. Stamp duty is an unjust tax and an impediment to mobility. At the very least Osborne could reform stamp duty to reduce higher rates on owner-occupied domestic property. Inheritance tax is a tax on estates not on inheritances and raises very little money. This could be reformed—probably to Liberal Democrat acclaim—to be a tax on the receipt of inheritances over a very high lifetime allowance that was properly indexed by statute. Conservatives might see this as a step to abolition. Capital gains tax is a Liberal Democrat obsession despite raising very little money and being economically very damaging. However, George Osborne could, at least, reintroduce price indexation allowance so that investors are not taxed on illusory gains that only arise because of inflation. He might be able to sneak that past the Liberal Democrats as there is no serious rational argument against it. National insurance was manipulated by Gordon Brown for purely political reasons. The threshold at which employees and employers pay should be increased and there should be a complete tidying up of the system to return to the relative simplicity of the pre-Brown days.

But, at heart, the chancellor has to decide whether he is a conservative and a politician doing the job of a bureaucrat or whether he has vision and ambition. The static treasury models that do not take account of the way in which taxes destroy growth need to be ditched. Osborne must set out a radical vision of a smaller state in which all areas of spending—especially those that rose most rapidly in the Labour years—are candidates for cuts.

  1. March 1, 2013

    Will Davies

    Assuming this article isn’t a spoof, is there anything vaguely empirical or even anecdotal to accompany the claim that cutting the size of the state by around 25% would raise the level of growth by 2%? Or were these numbers just churned out by a von Mises-bot?

  2. March 2, 2013

    Philip

    yes, that is the average result produced by the empirical studies on the issue. We are talking of a reduction of 20% of national income (from 50% – currently, if you use the proper figures to 30%). Roughly each 10% of national income fall in government spending raises growth by 1%. Could easily be more given our extremely high levels of government spending.

  3. March 2, 2013

    Rhys

    This is pure ideological dribble, followed up with some more half truths to push a poor policy forward; “When you cut a deficit, the rule is to cut spending first -” according to who?

    “but even these cuts will only restore benefit levels relative to wages ” – this is an enormous assumption saying that in 2017 wages will still be below inflation where do you have the evidence for this?

    such a poorly researched article,and I still don’t understand in real numbers and terms what you want Osbourne to do.

  4. March 3, 2013

    Will Davies

    I was wondering if you could refer us to one of the ‘empirical studies’ you mention (not including publications by rightwing think tanks).

  5. March 3, 2013

    philip

    @rhys seems strange that critics just have to resort to abuse rather than reason.
    @Will – there is a list of studies here http://taxfoundation.org/article/what-evidence-taxes-and-growth in the table. I might add that I have no idea if the tax foundation is what you call a “right wing” (by which I assume you mean “free market” think tank). But, if it is, that list of studies in the table is the list that is commonly quoted – I can’t think of any others. It has to be said that there is little dispute about this issue (certainly when government spending is greater than 30% of national income; below that level there is not really much evidence around at all). Opponents of lower levels of government spending normally argue that government spending is desirable for other reasons and that we have to trade off (say) equality with growth. It is unusual for people to argue that higher government spening does not reduce growth. It is worth adding that no government in the UK has consistently been able to raise much more than 40% of national income in tax (and, if they do, tax revenues do not rise so you end up with lower real government spending but higher spending as a proportion of national income) and so the current level of government spending of around 50% would appear not really to be financable without borrowing.

  6. March 4, 2013

    fleche_dor

    The accolytes of Mrs Thatcher have consistently underestimated the scale of the Great Recession and consistently prescribed the same medicine to treat it .1980′s recession solutions to an economic situation more in keeping with the1930′s Great Depression.

    The government has already cut taxes, designed to improve growth prospects such as business tax rates. It has also allowed the rates that banks charge for borrowing such as mortgages to grow to a diffetential of 3-4% – eight times that before the credit crunch.Geoffrey Howe measures. Where is the evidence of growth in the last 30 months?- 7 albeit mildly recessionary quarters from ten.

    The evidence cited for cutting taxes creating “more” growth usually or always ignores the long term costs of measures such as privatisation. For example customers of Centrica are currently paying for returns to shareholders and executive pay; costs, which they bare to forgo current expenditure, which could contribute to consumer expenditure growth.

    The US Sec of Finance followed Austrian School thinking in letting Lehman Bros go bust in 2008 and then global governments intervened to prevent market meltdown by part-nationalisation of banks and insurance co’s and quantitative easing.
    Keynes 2 v FA Hayek 0.

    Until the advocates of von Mises have acknowledged both the extent of the current economic situation and the long term costs of the short-term fixes their can be little credibility in their claims.

  7. March 4, 2013

    Tom B

    It’s hard to know where to start criticising this article with the right wing dogma that I suppose you have to expect from an IEA lackey.

    Firstly, the idea that civil servants must be “very content” with Osborne’s policies does sort of ignore the fact that the number of permanent secretaries throughout the civil service have left since the 2010 general election, with a ridiculously high level of turn over: http://www.instituteforgovernment.org.uk/blog/5204/permanent-secretaries/
    Booth contends that the deficit is caused by high spending. But where is the evidence that it is just high spending? Surely the fact that the vast majority of the deficit originated in 2008 illustrates that it was the collapse of a growth model that caused the deficit. The evidence of the years since 2010 is that austerity does nothing to restore growth. The fault lies with the model of growth still not replaced by the present government. The massive global economic recession showed how unsustainable that model of growth was – a model which labour had continued essentially unchanged from the Conservatives before them. It was capital unleashed, labour smashed, ever greater leverage and a faith in self-correcting markets. The crash showed the bankruptcy of the ideology Booth espouses. It was a crash that many economists, raised in part on an IEA style unquestioning faith in free markets, assumed impossible – see Greenspan’s mea culpa after the crash. It was not social spending that wrecked our economy. Yet, time and time again, it is that part of the economy which comes under Booth’s fire.

    What about the lessons of history? Booth ignores the good example of the post early 1990s recovery – one where austerity was slow, and only took effect after growth was established, as Jonathan Portes has explained elsewhere.
    http://notthetreasuryview.blogspot.co.uk/2012/05/how-chancellor-made-right-decision.html

    I agree with him that tax rises were a bad idea as part of front loaded austerity. But, front loaded austerity was the problem. Given his opposition to raising taxes, why does Booth claim that another form of austerity, cutting state spending, is part of the solution? State investment has essentially halved under this Government. This gets no mention though… The fiscal consolidation handbook is not to simply cut state spending irrespective of context, as the 1990s example shows. Instead, you have to look at the context. The greatest debt is in the private sector and there is a deficit in demand. Given that simultaneous deleveraging by private and public alongside each other will not work, it is by maintaining state spending, allowing growth to return and then raising taxes that we can tackle the deficit.

    Booth is like a broken record, repeating old right wing demands for lower taxes, less Government as the panacea for growth. It wasn’t nurses or teachers who screwed the economy; it was the rich banksters who fund the opaque organisations like his and laid the way for the neoliberal mess we now find ourselves in. How about, rather than writing such guff, he apologise for his institution’s own role for the state we’re in? Or, like deluded communists after the fall of the Soviet Union, does he claim that the problem is true capitalism has never been tried?

  8. March 4, 2013

    Philip

    Taxes have been increased – very dramatically, in fact; I think that bears out my point really. But your oddest statement is about the Austrian school. Problems from letting Lehmans go had nothing to do with Austrian thinking and everything to do with inadequate legal systems to deal with the problem (letting Barings go wasn’t a problem was it because the market and the associated legal systems could deal with its failure?). It is, in fact, Austrians who are arguing that this is a really serious recession that cannot be resolved simply by printing money or government borrowing. Very much the reverse of what you suggest, it is we who understand the long-term costs and there is growing evidence to suggest that they are very real long-term costs from the misallocation of capital in the boom which has been sustained by low interest rates since. Indeed, the consensus seems to be coming round to the Austrian way of thinking about this matter (see the Bank of England’s latest Financial Stability Report for example).

  9. March 4, 2013

    fleche_dor

    George Osborne, even as Shadow Chancellor set out his stall to reduce the budget deficit and government debt pile. Taxes were increased in certain areas to achieve this aim, but 80% of the pain was due to be taken by public spending cuts.

    Apart from corporation tax, the government has also increased the individual personal allowance, which has reduced income tax paid on earnings. This is another tax measure typical of the Thatcher governments.

    Above you suggest that the Chancellor try to be a Geoffrey Howe. Osborne took measures straight from the Howe orthodox text book and his famous, or infamous 1981 budget. He not only allowed the temporary VAT reduction to expire, but increased it to 20%. As described in my post above, he has allowed the real rate of interest charged for mortgages to proportionately increase by 8 fold. This is another Howe measure in spades, as Howe increased interest rates from 12% to 14% to deal with an inflation rate of nearly 20%, caused principally by high wage increase demands; a factor absent since the 1970′s. The real rate of interest charged by financial institutions is much higher proportionately now, due to higher differentials between the Bank of England and commercial lending rates and is having a depressive effect on the volume, velocity and vivacity of money circulation. Inflation is c3%. In 1981 the UK was in current account surplus, with exports having exceeded imports since 1975, yet the UK has been in deficit solidly for nearly fifteen years, since 1998, a brief respite since the balance dipped below zero in 1985, a decline which began in the year of Howe’s 1981 budget. 2013 is a very different situation indeed to the time of Geoffrey Howe, particularly at his 1981 budget. Howe’s budget measures were aimed at reducing high long term interest rates. Not even Gordon Brown’s government had a problem with high long-term interest rates. It was a problem that did not exist in 2010 and still does not exist now, despite the loss of the much cherished AAA status; a deeply misguided 1980′s solution to a different economic problem. Far be it from me to remind you of all people of the nature of the 1981 budget measures.

    The President, US Government and the Fed were able to provide bailouts for the financial services sector companies that they chose in 2008. They picked the winners and in Lehman’s case the loser, by refusing a bailout. Both bailouts and picking winners are counter to Austrian School thinking.

    The evidence about reduced spending on public capital projects, i.e. investment since 2010 has been well publicised. The Chancellor has cut this substantially since coming into office, particularly in the 2010 budget. The only major capital state-funded project that had already been committed, before the 2010 election was the 2012 Olympic Games. The only quarter of growth (1%) in the last year was due to the Games. Building the Olympic Park will have off-set the worst effects of recession in the construction sector between 2008-2012.

    There are other ways of securing capital investment beyond government spending. However, government usually has a role in promoting, letting contracts, or providing legal permissions, through planning, etc for these, for example road, rail, bridge building, housing, power facilities, etc. Private sector capital has been brought in to achieve major projects in the past, e.g. Channel Tunnel Rail Link, Channel Tunnel, and particularly Queen Elizabeth II Bridge, Dartford.

    There are not any Keynesians that have been heard to proffer that simply printing money or government borrowing will end the recession. Indeed they have been arguing harder and for longer that such solutions alone are doomed to failure.

    Individual consumers would be hard-pressed to mis-allocate capital, since the credit crunch, as it has been in very short supply indeed and that which has been available has become proportionately much more expensive due to deteriorating living standards and substantial cost of living increases. This is not necessarily the case in the corporate sector.

    There is little doubt that there was a misallocation of capital during the boom, especially through commercial real estate, though this has also continued into the recession in commercial capital creation. Some would argue that the large bonuses and salaries of senior executives in certain companies and banks, such as utilities, highlighted above is gross misallocation of capital. This is money that should be returned to shareholders, or used to generate future returns through reinvestment. The historical malinvestments made during the boom are in the past, unless the argument posited is that capital values were distorted and have not yet corrected, such as in commercial real estate valuations, or supermarket land bank holdings.

    Osborne’s next budget will be his third since coming to power. In 1981, the government had not yet been in power two years. Time will tell whether Mr Osborne has done too little too late to save his own skin, or that of the country’s economy.

  10. March 5, 2013

    philip

    @tomb – I am afraid it was not just the banking crisis, there was a huge rise in public spending (including on non-age-related welfare) when employment was rising rapidly in the early twenty-first century. And it is, I am afraid, not very sensible to say that teh article is arguing like the ex-communists who say that communism has never been tried. Only a couple of times in our history has public spending reached current levels as a proportion of national income – we are at an extreme position regarding the role of the state in income provision (two thirds of families with children receive means-tested welfare benefits). Regarding the cuts in investment spending, I take your point. It is always investment spending that is cut first. Indeed, that is part of the point of the article – those items of spending that rose rapidly in the Brown years remain untouched. The Portes viewpoint, I am afraid is just not credible. On current projections it will be 10 years after the crash that the structural deficit is removed! How slow do you want the reversal to be? There is also little evidence, i am afraid, that countries with floating exchange rates and high indebtedness gain anything from greater fiscal deficits – quite the reverse.
    @flechedor – I will not go through everything you said ,but I just wanted to point out that when I referred to Howe, I was referring only to his ability to at least simplify and make more coherent the tax system in very difficult circumstances.

    It is interesting that the voice of left wing reason seems to have disappeared altogether and any comment on this blog is just mixed up with gratuitous insult or rudeness. In many ways, that is a very sad feature of public life in Britain today. Your last point is very wide of the mark, Tom B, – see the letters I helped organise to the FT in 2006 about the impending problems developing (which had little to do with free markets and much to do with lots of other things).

  11. March 6, 2013

    fleche_dor

    Philip

    I am very sorry to read that you think that you have been the victim of “gratuitous insult or rudeness”. Certainly most responders have provided healthy and robust challenge to your article, perhaps some of those contributions are cutting, worded curtly and clumsily, but rude, or insulting? They have usually cited evidence, or economic theorists, whom the IEA has regularly promoted to support their arguments.

    “Cutting red tape,” “Supply side reforms,” “Cutting taxes” and “Simplifying tax system” are favourite mantras of the right, yet attempts to achieve them rely on political and financial reality. The Poll Tax was an attempt at tax simplification, but had disastrous political consequences. The current government has the constraint of an electoral pledge from its Chancellor to reduce the budget deficit. Consideration of tax cuts has to be seen through the prisms of political reality and fiscal impact.

    It is difficult to discern from the article how cuts to, or abolition of inheritance tax, capital gains tax and stamp duty will simplify the tax system, though combining National Insurance with Income Tax has intellectual coherence, in that sense. The former three, without any explanation above of their simplification benefits sound like measures that will proportionately benefit the property owning wealthy the most.

    One off property transaction taxes are not a significant impediment to economic growth currently. A majority of consumers, particularly those with a greater propensity to spend are attempting to pay down debts, or save up the hefty deposits required just now. High borrowing costs, barriers to access to finance, such as income insecurity and lack of housing supply are greater impediments to growth in the property market currently. There is no evidence provided to suggest that the property transaction taxes cited are the real barrier to economic growth through providing stimulus to the property market currently.

    Surely, the Chancellor’s budget has to focus on the policy measures that are most likely to stimulate economic growth, rather than some intellectually sound tax simplification, which has questionable impact on growth and unknown fiscal cost, or benefit.

    Mostly, the contributors have engaged with the article through their comments and responses on specifics from its built in assumptions to its evidence base and policy recommendations. From the author’s interactions, it is unclear whether the substance of challenge has yet, or even can be answered with the necessary intellectual, or independent academic rigour.

  12. March 6, 2013

    philip

    @fleche-dor – thank you for taking the trouble to reply. It is certainly not clear to me though that the challenge has been made with intellectual rigour though many good points have been made. Both making points with intellectual rigour and rebutting them is not really very easy in a clunky comments function. However, i don’t feel that when phrases such as: “This is pure ideological dribble, IEA lackey” etc are used people are necessarily looking for civil debate or intellectual rigour. You see, the thing is that issues such as “supply side reforms”, “cutting taxes” are not just mantras. It is easy to dismiss the evidence about the rise in government spending before the crash and the benefits of lower government spending but the evidence is real (and certainly there is no evidence in the opposite direction). Nobody has really demonstrated how current levels of government spending (which, I repeat, are still as high as in 2010) can be financed even if they were desirable and the main valid points that people have made about goverment spending is that capital spending has been cut (which is true – it always is, government seems never able to cut current spending). By ring -fencing health, aid and all the apsects of government spending (by and large) that Gordon Brown increased so rapidly there is not much left to cut. Do we really want over two-thirds of families with children on means-tested benefits? Regarding your specific points at the end, i was very careful when making the points I did about the minor tax changes that would be possible. I did not use the word simplification at all (that is in the Lawson world, not the Howe world) i said that an inheritance tax rather than an estate duty (also proposed by left wing think tank IPPR) would be more coherent. It might or might not help people wiht property depending on the rates and thresholdsI did not say the stamp duty would lead to more growth but that it was unjust and an impediment to mobility (an academic on a salary of say £50K who got offered a job who had just happened to have bought a house in Reading or Cambridge 20 years ago might have to spend over half his net salary on stamp duty if he changes jobs!). It may not be a priority but it is a problem. I feel that the reasoning is more robust than you give credit for and I am not sure that the critics are not falling into the same trap of which they accuse me of falling in.

  13. March 9, 2013

    Tom B

    You say that there was a huge rise in public spending under Labour. Yet it was not exploding past our capacity to pay for it at the time, remaining in line with past % of GDP spending as under the last 18 years of Conservative Government. What are the facts?

    Look at the detail in the 2010 budget, page 105.

    http://cdn.hm-treasury.gov.uk/junebudget_complete.pdf

    Public sector current expenditure fell from 37.5% of GDP in 96-97 to 34.5% in 1999-2000 before rising again to 37.8% on the eve of the crash in 07-08. Hardly a “huge rise”!

    The greatest increase was in Government capital investment, the section of public spending you seem to agree is more valuable to growth. It was that that increased from 0.7% of GDP in 96/97 to 2% by 07/08.

    Government spending was higher than 37.8% for 14 of the 18 years of the Thatcher Governments according to that table (it’s the same for TME too).

    If there was a rise, it was only in line with what income was coming in at the time.
    It only became a problem once the model of growth failed.

    TME did jump as a % of GDP to 46.5% in 201-11, according to the 2012 budget

    http://cdn.hm-treasury.gov.uk/budget2012_complete.pdf

    But, given the extent of the recession, that is unsurprising! This was similar in previous recessions – see the graph on page 2 here:

    http://www.ifs.org.uk/bns/bn25.pdf

    And note the subsequent fall with a return to growth after each of those recessions. It is now a high level of Government spending relative to the private sector but that is obviously the result of the collapse in the private sector which was far too dependent on a housing bubble and financial credit expansion – again, the model that Governments have followed over the last 3 decades since the neoliberal turn. We need a new model, one that is not so unstable and reliant on the financial sector. If the Government has to run a deficit in the meantime to help that be made possible – be it by funding tax cuts or state investment – then we should do it at a time of extremely low interest rates when the private sector needs to deleverage.

    I would agree with a lot of Colin Hay’s assessment of the crisis

    http://speri.dept.shef.ac.uk/wp-content/uploads/2013/01/SPERI-Paper-No.-1-%E2%80%93-The-British-Growth-Crisis-FINAL1.pdf

    I agree that there was a problem with spending being reliant on unsteady growth – see my previous comments on the growth model – but the prime problem was the private sector indebtedness. Let me point you back to the 2010 budget. Page 7 has a graph showing how growth was based on ever expanding levels of private sector debt, rising to about 450% of GDP in 2010.

    Note that public sector debt is NOT included in the Treasury graph – no doubt because public sector debt as a % of GDP is tiny in comparison and shrank over the same period. Why do you fail to comment on private sector indebtedness and how 450% indebtedness in the private sector is a check on growth? Against that, state debt is far smaller. It was the financial sector that was especially out of control.
    Unwinding the huge debt in the private sector will require public sector deficits. I don’t know why a decade of state deficits is seen as a disaster but decades of unsustainable private sector deficits do not get a mention from you. I’d rather not have public deficits, but I don’t see the alternative to that if the private sector is to deleverage.

    You say you wrote letters to the FT at the time. What were they on? Did you argue that we faced a huge imminent crash? Other people, academics like Wynne Godley and Steve Keen, did, hence why I respect their analysis and prescriptions far more than the IEA, CPS or almost any politician in the UK on this!

    You complain about gratuitous rudeness. Fine, my last post was blunt and pretty short at best. I’m sorry, it was quite unnecessary. However, it is hard not to get annoyed with thinktanks, whose staff get put on a pedestal in public debates. The media never asks who pays for people like you from thinktanks, left wing or right wing, to spend their time propagating certain views and policies. Politicians, union members and businesses are all rightly treated with scepticism when they appear in the media – they have their incentives questioned. Whenever Mark Littlewood turns up or someone from the IPPR on the other side, no one asks who is paying the bill. But they should. It is a reasonable assumption that the people who pay for the IEA think their investment worthwhile for themselves. I hardly think your organisation is funded by the poor who seem to have suffered the most from the neoliberal policies of the last three decades.

Leave a comment





Author

Philip Booth

Philip Booth is Editorial and Programme Director at the Institute of Economic Affairs 




Most Read