It’s not hard to sketch out the scene on 22 June when the new chancellor, George Osborne, delivers his emergency budget on behalf of the coalition government. He clears his throat, looks around the house, and announces: “Cripes! What a mess. We resign – one of those Milliband brothers can clear it up if they are so smart.”
Amusing, but unlikely. In reality, Osborne will have to deliver a set of measures that will define the new government. There are four priorities he should focus on: restoring honesty to the public finances; simplifying the tax system; making deep structural reforms to the way the British economy operates; and kick-starting growth – even if that means taking some risks in the short-term.
The last Conservative chancellor to deliver the first budget of a new government was Geoffrey Howe. That was in June 1979, just after Margaret Thatcher was elected prime minister. It was genuinely radical. VAT rose from 12.5% on luxuries and 8% on most other items, to a standard rate of 15%. The basic rate of income tax was cut from 33% to 30%. The top rate fell from 83% to 60%. Exchange controls were relaxed and big public-spending cuts announced. Later budgets by both Howe and his successor, Nigel Lawson, were just as radical. But the main thrust of the Thatcherite reconstruction of Britain’s economy was laid out in the first speech. It was a clear break with the past.
Osborne should be no less bold. Britain can still escape from the near-bankrupt state that 13 years of Gordon Brown has left it in. But it requires swift, decisive action. First, we need complete honesty about the state of the public finances. The UK doesn’t just have one of the highest budget deficits in the world. It has hidden much of the waste and debt of the Brown years. What turned the markets against Greece was not just the scale of borrowing. It was the fact it had fiddled its figures for so long. A 10%-plus deficit might be sustainable, given how bad debt figures are everywhere else. But if the bond markets get the sense they are being lied to, they will move in for the kill.
The first task of the new Office for Budget Responsibility will be to root through all the quangos, private finance initiatives (see page 16), and pension obligations, and come up with a meaningful analysis of what bills the British taxpayers will have to meet over the next decade. Nothing less than brutal honesty will do.
Next, the tax system must be simplified. Over the past 13 years it has turned into a Byzantine mess that does more to destroy wealth than collect or redistribute it. A few basic principles should be established. All taxes should be low, fair, and simple to collect. All taxes should be standardised, whether on income, capital gains, or inheritances, to reduce the incentive to shift assets around. People and companies should be exempted from taxes instead of given allowances or benefits. It will be virtually impossible to reform the current tax system along those lines. Instead, repeal the entire thing, and create a new, simpler tax system from scratch.
Third, make structural reforms now. Changes to the tax system can have a big impact on the way the economy works. But it takes time – at least five years, possibly longer. A falling pound alone won’t revive British manufacturing. But creating tax-free zones for factories would work, particularly if placed in the regions that will be hardest hit by spending cuts (Wales, Scotland, Northern Ireland and the northeast). Encourage saving, with tax breaks if necessary, and make sure debt isn’t subsidised through the tax system. The UK needs to rebalance its economy from financial engineering towards industry, science, technology, media and manufacturing. A start has to be made on that now if any of the results are to be seen before the next election.
Finally, make a wager on growth. Howe’s budgets were deliberately deflationary. He had to beat inflation out of the system, as well as restructuring the economy. Osborne doesn’t have that unenviable task. Inflation, though creeping higher, isn’t yet a big problem. Instead, the coalition can borrow a trick from Ronald Reagan in the early 1980s. He pushed for radical, pro-enterprise tax cuts, even when he didn’t have the money to pay for them. The gamble was that growth would come through swiftly enough to keep the deficit under control. And he was proved right.
Osborne should try something similar. The UK can’t just cut its way out of this deficit – not without imposing pain on public services, for which there will be little political support. It can’t tax its way out either. Taxes are already at the upper limit of what can be raised: push them any higher, and you’ll just collect less revenue. Instead, Britain has to grow its way out of trouble. Big cuts in corporation tax – say to the 12.5% levied in Ireland – would be the best way to do that. Global firms would flock back to the UK. Follow that with cuts to the top-rate of tax, and entrepreneurs would be re-motivated too.
It would be risky. But as Howe showed in 1979, this is no moment for caution. Osborne is only going to get one shot at radical change. On its current path the UK economy faces years of austerity and decline. We’ve little to lose, and much to gain, from trying to turn that around.