The Pin Factory Blog

Think back to George Osborne’s budget. Do you remember how often he used the word fair? Do you remember how often he used the word progressive? More importantly do you remember how he added an additional £2 billion to the child tax credit to make sure all those graphs looked the way he wanted?

I wonder if Mr Osborne realises how much of an intellectual concession this is. The terms ‘progressive’ and ‘fair’ are becoming increasingly common in our political vernacular. This wouldn’t be a problem if the words true meanings hadn’t been distorted out of all recognition. For progressive, read statist. For fair, read redistribution.

The corpse of Brownism still haunts the political debate. The 50p tax rate will stay, not because of any tangible benefit it brings, but because of ‘fairness’. Taxes will have to rise to plug the deficit, not cut to ensure growth and greater tax takes in time. Free school milk is to remain despite having no discernable health benefits because of the long shadow that Thatcher has cast over the Conservative party.

Everywhere we look we are told about the terrible cuts to come. These cuts, as we have already outlined on this blog, are practically non-existent. Public spending continues to rise, year on year. What’s more worrying is that no intellectual case is being put forward that cuts are a good thing in and of themselves. The idea that ever higher public spending is an unquestionably good thing is rarely even challenged.

I would like to see the government send a clear message; a message that shatters assumptions. I would cut the top rate of income tax, not to 40%, but to 35%, and I would also lower the bottom rate to 17.5% so it remains half the top rate. This would send the message that the fruits of your labour are yours to keep. It would strike a blow to the politics of class warfare and envy. It would be a rallying cry for economic liberalism, and it would show that the coalition government is not bound by the intellectual chains of the left.

Well, we can all dream, can’t we?

The reforming New Zealand Finance Minister, Ruth Richardson, was in London giving a lecture for Reform, and I went along. It was a refreshing call for honest and limited government, and why the benefits of that are worth the pain of the inevitable pruning back. Government has grown too big, too intrusive and too bureaucratic, she believes, and it has smothered personal freedom and responsibility. But electors are getting angry at working hard to create wealth, only to see the political elites making all the decisions on how to spend it.

Changing this requires radicalism, says Richardson. You need a team of leaders with a clear view of the proper role and limits of the state. You need to work out practical ways of devolving decision-making down to localities and families. You need to start early. And you need to show results. You won't get a second chance: "You can only use your political capital once," she says.

So what is on her agenda for reform? All those universal and middle-class benefits must go. The resources of the welfare state should be targeted on those it is supposed to help – the poor, not the middle classes who do so nicely out of it. You need to identify what the core functions of government are, and eliminate the clutter of all the rest. And for those core functions, you need to use market principles. There should be no easy presumption that schools, hospitals and the like can only be provided by governments. Let private suppliers compete with public suppliers, contract out functions to private and voluntary groups, and give users the budgetary and decision-making power.

Richardson is also famous for insisting on honest government finances – such as complete disclosure of the economic situation before elections: no more governments trying to pretend things are better than they are, no more oppositions smooth-talking us when they know they will have to make brutal cuts after an election. It needs an Office of Budget Responsibility, right enough: but, says Richardson, that body must ruthlessly safeguard its independence. Citizens, she thinks, should control the limits to the tax burden through referenda. Income from work or capital should be treated equally, and the tax system must be simple. Social benefits must not just be targeted, but should be time-limited, so that relying on state support is not a long-term option. Regulation should be based on principle and the rule of law, not the arbitrary rule of officials, however well-intentioned.

The Spending Review on 20 October will be the test of whether the UK government has understood these lessons of experience.

Today has seen announcements by two praiseworthy councils that, dare I say it, strike of innovative cost cutting.

Birmingham City council has shown that “I can reduce redundancies and cut costs” need not be a contradiction. The plan is simple, as Conservative Home explains:

Suppose you have person A in a necessary job retires and person B who wishes to continue in employment but is in a post that is being scrapped. Rather than recruit a new person for the necessary job and make the person redundant for the post being scrapped you redeploy person B to take over from person B.

Not only are there fewer redundancies, the costs of hiring from outside and making person B redundant are eliminated altogether. Taxpayers and council workers both win.

Hammersmith and Fulham’s efficiencies are somewhat different, gained by scrapping unnecessarily burdensome regulation. The council estimates that simplifying the planning system, removing the licence needed to pierce an ear and shredding the 10-page form requiring filing by any school wishing to hold events featuring music, amongst others, would save £200 million were they implemented across the country.

These innovations, good in themselves, are important for two further reasons. First, they lend support to one of the strongest arguments for localism and the breaking up of our centralised state; that smaller bodies are generally better at generating good ideas than sluggish monoliths. Second, they suggest that those busy thrusting bleeding stumps into the face of anyone suggesting ‘cuts’ doth protest too much. If one council can locate £200 million of efficiencies in the small, £4bn Local Government budget, just think of the savings a diligent Treasury official could find. Contrary to what the some in the media might think, nothing like 100% of the impending budget cuts need come from frontline services.

Despite the views of the Business Secretary, Vince Cable, the prospects of banks being compulsorily split up between their retail and investment/’casino’ operations are receding.

Two years ago, the UK banking sector was close to complete collapse. The then Labour Government decided that the stricken Royal Bank of Scotland (RBS) could not be allowed to fail.

The cost has been enormous. Around £45 billion of public money has been injected into RBS alone. Neither should the vast contingent public liabilities of RBS’ asset protection scheme be overlooked.

Many eminent authorities have proposed that, to avoid any recurrence of the 2008 collapse, the UK’s leading banks should be legally split up. Indeed, the independent Banking Commission, due to present its report next September, may advocate a split, possibly with caveats.

Even so, it is increasingly unlikely that the Coalition Government would pursue this route. Threats of HSBC – the owners of the former Midland - relocating to Hong Kong and Barclays, whose earnings are dominated by its investment bank operations, settling in New York are focussing minds: far lower tax receipts would accrue. Given the UK’s dire fiscal position, would it be surprising if this fact proves decisive?

The 2020 Commission on Public Services, chaired by Sir Andrew Foster, the former Audit Commission chief executive, has apparently said (this is according to the Today Programme report this morning) that the post-war settlement is over, and that the welfare state, as we know it today, is living on borrowed time. 2020's findings deserve a fuller analysis, but for now, here's a graph that shows why the Commission is right:

What this graph from the Bank of International Settlements (BIS) shows is how public debt as a percentage of GDP is going to change over the next thirty years, assuming we stick with current policies. The red line is the baseline scenario, the green line shows what would happen with a small gradual adjustment (a fiscal consolidation of 1% of GDP each year from 2012), and the blue line shows what would happen with a small gradual adjustment in which age-related spending was held constant (as a percentage of GDP).

Whichever way you cut, current policies are quite plainly not going to be affordable in the future. It is worth pointing out, for anyone who thinks that the debt can just be rolled over forever and the day of reckoning delayed indefinitely, that BIS also projected future debt interest payments. Based on the baseline scenario, the UK's debt interest payments would reach c.27% of GDP per year by 2040. That would account for pretty much all the revenue from income tax, national insurance, corporation tax, council tax, and business rates, and wouldn't leave much for anything else.

BIS also points out that the UK would have to run a budget surplus of 10.6 percent of GDP for the next five years if we wanted to stabilize public debt/GDP at 2007 levels. That the coalition government's 'savage cuts' would still leave us with a budget deficit at the end of the current parliament just goes to show how serious the situation is.

Bank of International Settlements: The future of public debt: prospects and implications, March 2010 (PDF)

Given the fuss the unions are making, you would be forgiven for thinking that the coalition government's planned public spending cuts are every bit as swingeing as the BBC would have us believe. But the actual figures from the emergency budget do not bear this out. Let's look at Total Managed Expenditure (TME) first:

As this table shows, the government's proposed cuts are pretty small beer. In nominal terms, spending will rise every year. In real terms (assuming 2 percent a year price inflation) this equates to small cuts in 2011-12, 2012-13 and 2013-14, followed by small rises in 2014-15 and 2015-16. Compared to the c.60% real terms public spending rise that took place under the previous government, this is, frankly, insignificant.

It is also fair to say that capital spending will bear the brunt of what little cuts do in fact take place:

Current spending meanwhile (and almost all 'vital, front-line public services' fall into this category) will rise every year between now and 2015-16, even in real terms:

Now, OK, these are not exactly big rises - but nor are they swingeing cuts that will (a) have any significant effect on the economy or (b) on the public services-using population at large. What the coalition's spending plans really amount to is a five-year, real terms freeze of current expenditure, combined with three years of significant falls in capital expenditure. The overall impact of that is a a very small, real terms drop in TME (roundabout 1.5%) between now and 2015-16.

I guess I can see why this would upset the public sector unions, who have grown used to the endless bread and circuses delivered by Gordon Brown's shameless profligacy. But everyone else needs to take a deep breath, look at the numbers, and then calm down.

Via James Delingpole, I see that the last vestige of the BBC’s non-partisan façade has finally slipped:

"Behold the spending review slider! Pay attention, my vicious right-wing audience. You know those 144,625 new affordable homes you want to never see built? Well, cut the Housing Budget by 25% and they never will be! Want to lower the basic pension by £30 a week? Drag that slider to a 30% Welfare cut and watch those poor retirees squirm. Efficiency savings? Cuts to needless bureaucracy? Don’t talk such rot! My viscous free-market perspective necessitates that every penny of my cuts contribute to the great cause of crippling front line services. Up for some poor bashing anyone? I’ll go fetch my golf clubs. Oh I’m salivating just thinking of the devastation my swingeing cuts could achieve were only I at the Treasury!"

Today the Coalition has announced its ‘EU referendum lock’ bill. The legislation is designed to prevent any more power being transferred to the EU without first having a referendum on the transfer of said powers. While this may be the intention of the legislation it already seems to be falling apart under scrutiny.

The first point to note is that since the passing of the Lisbon treaty the EU has no further need of any treaties (which would trigger a referendum under the bill) due to it’s self amending clause. This makes the bill all but worthless. However the bill will still cover the so-called ‘ratchet clauses’ which allow the EU to erode national veto’s and steadily gain more powers.

Douglas Carswell, Roger Helmer and Bill Cash have all attacked the bill for being largely worthless, and it will be interesting to see what amendments Eurosceptic’s put down later in the bill’s passage.

Carswell has blogged that the Coalition has already failed to stop numerous important powers being ceded to the EU, “since we promised this “lock”, the EU has 1) established a diplomatic corps, which we voted through the Commons, 2) given Eurocrats control over the City, 3) extended the EU arrest warrant, and 4) agreed to an inflation-busting EU budget increase. We've hardly stopped giving the EU more powers since May, have we?”

This is the real point of the matter, that if powers are to stop being given away ministers must learn to say “No”, “Non” and “Nein”. The successive ‘give away’ of money, power and sovereignty to Europe can only be stopped if ministers have the backbone to pick a fight, and none do. Cameron has always been keen to avoid confronting the European ‘issue’ and the presence of the Europhile Lib Dem’s in the coalition will only solidify this position.

Ultimately Carswell asks “Do ministers take us for fools?” The answer is clearly “yes”. 

In today's Times (no link, £) we're told that tax evasion costs the Treasury £100 billion in lost revenue. We're told the same thing in The Guardian as well: and these numbers come from the research of Richard Murphy, of Tax Research.

There's a couple of minor points we might make about this. Whether the numbers are reliable for example (evidence from Mr. Murphy's estimation of the losses from tax avoidance by companies doesn't inspire confidence). Whether we can actually do very much about it all and still remain a free society: there will be some level of grey, untaxed, economy whatever we do and there's a trade off between the size of it and how repressive we wish the government to be. Finally, whether closing said tax gap at present would be a good idea: which for most of those proposing we do it wouldn't be. For those who complain the most about the tax gap are also those shouting the loudest for Keynesian demand expansion. And collecting more taxes is just as much fiscal contraction, the opposite of what they're shouting for, as cutting spending is. At least it is according to the Keynesian theories they say inspires their economic pronouncements.

But let's leave aside those minor points and look to the major one. For I too am worried about the size of the tax gap, just as you should be. And just to be entirely fair, let's draw on more of Mr. Murphy's research as we express that concern. Here is his chart of the size of the grey (ie, legal but untaxed) economy:

As you can see, as the tax burden rose, as marginal tax rates rose, as the tax system became more complex, over the years of Gordon Brown, the size of that grey or shadow economy rose. And of course there is more than mere correlation here: incentives matter in economics after all and as the rewards of dodging taxes rise then so do the temptations to do so.

Which is why we here at the Adam Smith Institute have always argued for a low tax burden, low marginal tax rates and a simple taxation system. For we too are worried about the tax gap: it's just that we put forward solid plans to reduce it rather than just worrying about it, by having low, light and simple taxes.

"Tax simplification in Britain should set a threshold of £12,000 and a standard rate of 20% on everything earned above that level...this is precisely the right time to undertake the one reform that could set Britain's growth (and future revenues) firmly on an upward road."

Read his article in full in the Sunday Times here.