What Alistair Darling should have done

In this think piece ASI policy director Tom Clougherty outlines his reaction to the Chancellor’s pre-budget report of November 2008, arguing that Alistair Darling’s so-called ‘stimulus package’ is really a manifesto for wasteful spending, record levels of government borrowing and public debt, and higher taxes in the long term. He argues Darling should instead have announced a substantial rise in the personal allowance balanced by public spending restraint.

Alistair Darling was widely expected to announce a package of tax cuts in his pre-budget report this week, in an effort to stimulate the economy. And a few people actually seem to think he did. In reality though, the Chancellor’s so-called tax cuts were little more than a political smokescreen, a ploy designed to wrong-foot his Conservative opponents and obscure his real agenda – more spending, more borrowing and more tax.

Look at what he proposed. First up, we’re going to get a temporary reduction in VAT to 15 percent. Isn’t that fantastic? A whopping 2.5 percent off! No doubt it will accomplish what high streets full of half-price sales and buy-one-get-one-free offers couldn’t, and get people spending again. Of course, it has also been reported that the Treasury’s figures depend on VAT rising to 18.5 percent in 2011, to pay off all the debt Darling plans to rack up. Thanks, Chancellor, but no thanks.

At least that was an actual tax cut though, if only a temporary one. Most of the measures the government is spinning as tax reductions are nothing of the sort. So the retrospective vehicle excise duty rise is going to be phased in now? Let’s call it a tax cut. No increase in the corporation tax rate for small businesses? Sounds like a tax cut to me. Oh, and the low-income households hit by the 10p tax debacle are going to continue getting their rebate? A tax cut if ever I saw one!

That’s still more than I can say for Darling’s plan to create a new higher-rate tax of 45 percent for those earning more than £150,000. I suppose it’s about time someone tried taxing the rich until their pips squeaked again, but we already know what the outcome is going to be. Most wealthy people will call their accountants and work out how to avoid the increase, while others will just move offshore. Either way, the Exchequer is more likely to lose out than see any increase in revenues.

Then there is the 0.5 percent rise in National Insurance Contributions for both employees and employers, which the Institute of Fiscal Studies has already confirmed will make anyone earning more than £19,000 per annum worse off. For the employee, this is an income tax rise in all but name. And as for the employer, their National Insurance Contributions are a perverse tax on jobs even at the best of times. Making it moreexpensive to employ people is precisely the opposite of what the government should be doing, especially with unemployment predicted to reach 2.9 million by 2010.

But like I said, that’s all just window-dressing. The real story here is that the government’s budget deficit will hit 8-9 percent of GDP over the next couple of years, as the government borrows up to £120bn per annum to fund its profligacy. Public sector debt is likely to top 60 percent of national income (so much for the long-cherished 40 percent ceiling), and even that figure excludes obligations incurred under the public finance initiative (£180bn and counting) and unfunded public sector pensions liabilities (now in excess of £1tn). The taxpayer already shells out £30bn a year servicing government debt, but that’s nothing compared with what’s to come.

And to what end? Are we really meant to believe that public spending is going to stimulate the economy? We’ve tried it before and it doesn’t work. ‘Priming the pump’ simply creates temporary and artificially high demand in certain sectors (generally the inefficient ones), at the expense of others (typically, the ones that actually create wealth). This is followed – as night follows day – by dislocation and unemployment when the artificial demand ceases.

You think borrowing money to renovate schools and hospitals is going to boost the economy, Chancellor? Dream on. Japan spent the nineties trying to kick-start their economy with infrastructure spending and it accomplished nothing except running up debts amounting to 180 per cent of GDP. In the US, massive spending hikes in the 1930s, 1960s and 1970s all failed to increase economic growth rates. And let’s not forget 1970s Britain.

Instead of resurrecting Keynes, Darling should have taken the pre-budget report as an opportunity to put some money back into the struggling private sector economy, where it actually stands a chance of being productive. He could have done this very easily by raising the personal allowance – which currently stands at £6,035 – to £12,000 for every taxpayer. At a stroke that would take 7 million low-paid workers out of income tax altogether, and ensure that no one earning the minimum wage or less would pay income tax at all.

To the average worker, this would be like getting an extra £1,730 a year in gross pay, leaving them £100 per month better off and reversing the substantial falls in disposable income that have occurred over the last 12 months. Indeed, had the Chancellor been feeling prematurely festive he could even have given this measure retrospective effect for the current tax year, which would have meant a one-off ‘Christmas rebate’ of £1,800 for a typical dual-earner family, and another £200 per month thereafter.

Assuming that the higher-rate threshold was kept where it is, and not raised in line with the personal allowance, such a measure would cost the Exchequer around £18.9bn a year in lost revenue – not an inconsiderable sum, but not an overwhelming one either. There would certainly be no need to increase government borrowing to do it: simply forcing government departments to stick to their budgets would save £14bn a year, while cutting quango budgets by 10 percent would save a further £6bn.

Needless to say, that analysis ignores the dynamic effects such a tax cut could have. By freeing up an extra £19bn to be spent or invested in the private sector economy, it could boost growth (or prevent contraction) and therefore increase revenues (or prevent them falling). Raising the personal allowance would also strengthen incentives to work, help to eliminate the ‘benefits trap’ and make low-paid jobs more economic – greatly increasing opportunities for the unemployed.

Of course, even if it didn’t do any of those things, raising the personal allowance would still be worth it, just because it would make everyone’s day-to-day lives that little bit easier. In the face of a recession, isn’t that what government should be aiming for?

Click here to download the ASI’s briefing paper on why the personal allowance should be raised and how to do it.