Both of the tax increases announced by Sunak as chancellor are damaging. National Insurance is a tax on jobs which discourages employment and raises business costs, as well as reducing disposable income. Reversing the recent rate hikes in National Insurance contributions, which are far from inflationary, would help combat inflationary forces.
Planned corporate tax increases would hurt corporate investment at the very time we need to boost it. They make the UK much less competitive internationally and thus discourage international mobile companies from locating or expanding their operations here.
It is true, however, that a tax cut will increase aggregate demand and thus, other things being equal, put additional pressure on the Bank of England to raise interest rates. Some critics argue that the net result may not be an overall boost to demand at the expense of higher public debt.
They might make sense. But that’s not all about aggregate demand. The supply side is critical. In this regard, there are some features of such a different political mix that are attractive. Cutting National Insurance and Corporation Tax will help us begin the task of structuring the tax system to increase incentives.
In the meantime, it would certainly be more beneficial to the supply side of the economy to return interest rates back to normal, not least because this would put zombie firms under financial pressure. Higher interest rates will also take the heat out of the housing market while boosting incomes for savers who have had an extremely harsh deal in recent years.
Yet a tax cut that would simply reverse recent tax increases will not revolutionize our economic performance. After all, we were hardly doing impressively well before these tax increases were announced. So this argument about whether and when to cut taxes is really a form of shadow fighting.
The big battles are yet to be fought. Liz Truss said she would not impose Mark Two Austerity. I guess what he means is that she would not support the kind of squeeze on public spending introduced by George Osborne. Such austerity was indeed unpopular. You could also argue that it is both too intense and poorly structured.
Still, if we want to achieve a serious reduction in tax rates in the coming years while reducing debt as a share of GDP, then government spending will have to decline as a share of GDP.
Perhaps the trick is in the words used to describe this process. “Austerity” definitely doesn’t sound good. And at least when applied to public spending, the word “cuts” doesn’t look appealing either. Yet a fiscal policy dedicated to the cause of lower taxes need not mean “cuts” in public spending. It just means very tight controls so that spending doesn’t grow as fast as GDP. This does not sound too difficult, but achieving it will require an iron will and enormous political strength and determination.
Yet even sweeping tax cuts alone will not be enough to change our economic performance. As I have often argued here, we need truly radical policies to boost productivity in both the public and private sectors. These will include measures to curb the power of trade unions, reform and reshape the education system, reform the NHS, cut and reshape the civil service and promote competition across the economy.
As it happens, achieving these things will require the same qualities as reducing the tax burden by reducing the share of government spending in GDP. But we don’t yet know which of the two candidates is more likely to display these qualities.
Roger Bootle is chairman of Capital Economics
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