Osborne's last chance

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.