With tax cuts pledges galore, the Tories are out of touch with economic reality

Imagine for a second that it was Labour rather than the Tories choosing the next prime minister. Consider what the response would be if the hopefuls said it would be no problem to find an extra £30bn to tackle poverty or an additional £40bn for the NHS, and vied with each other to come up with the most ambitious spending pledges.

Larry Elliott, Guardian’s economics editor www.theguardian.com 

It doesn’t take a genius to work out what the response from the Conservatives and the Conservative-supporting papers would be. At the very least, there would be questions asked about how the plans would be financed. More likely there would be warnings of a run on the pound and imminent economic meltdown. The headlines would read something like: “Loony left plans to bankrupt Britain”.

Funnily enough, a different view is taken of the deep and immediate tax cuts now being promised by almost all those bidding to replace Boris Johnson. To those egging on the candidates, these are not reckless fiscal incontinence that will give the City the jitters. They do not represent voodoo economics, in which tax cuts pay for themselves. If you think the Tories in the summer of 2022 are in a similar place to where Labour was in the 2019 general election campaign, you could not be more wrong. As far as the right is concerned, tax cuts are the only way to grow the economy and make Britain great again.

This is wrong on many levels, but let’s begin with the idea that there is something wildly dangerous about the level of taxes in the UK. International comparisons produced by the Organisation for Economic Cooperation and Development show that last year tax revenues as a share of national income across its rich-country members stood at 32.9%. The figure for the UK was 32.8%.

To be sure, the UK’s tax take is rising and is on course to be the highest since Clement Attlee was prime minister, but this is to cover two developments: a pandemic and upward pressures on spending caused by an ageing population. The baby boomers are getting on a bit, and this has implications for spending.

A quick glance at the OECD international tax table shows the range of options. Countries that have generous welfare states are high-tax. Countries that have rudimentary welfare states can be low-tax. No countries have Swedish levels of public spending and US levels of tax.

There are those on the right who know this and are honest enough to spell out that the logic of lower taxes is a smaller state, with people expected to contribute more to their own welfare, whether through payments for healthcare or less generous state pensions.

The rank outsider Kemi Badenoch is really the only one of the candidates for Johnson’s job prepared to argue that trade-offs between tax and spending might need to be made. Even Rishi Sunak, who has billed himself as the fiscally prudent choice, says tax cuts are a matter of when not if.

To the extent that there is an economic strategy, it is that cutting taxes will pay for themselves because they will lead to faster growth and higher revenues for the Treasury. This, supposedly, is what worked for Margaret Thatcher in the 1980s, but it is simply untrue.

Cuts in income tax made by the incoming Thatcher government in 1979 were offset by higher VAT. Taxes were raised when the economy was deep in recession in 1981. It was only after several years of growth and a marked improvement in the public finances that income tax rates were cut. Until 1988, the top rate of income tax was 60%.

The idea that personal tax cuts are a magic bullet that will give the economy its mojo back and solve the cost of living crisis also represents a serious misdiagnosis. Britain has serious economic problems, but they are mostly long-term and structural rather than short-term and fixable through an injection of consumer spending power.

The reason inflation is heading for 10% and the trade deficit is ballooning is that supply is failing to keep up with demand, and the only way to deal with that is to address the UK’s chronic deficiencies in skills, investment and infrastructure. Tony Danker, the director-general of the CBI, is quite right when he says personal tax cuts would only make inflation worse, and that if there are to be any they should be designed to boost investment and be part of an overall growth plan. Lower taxes would almost certainly lead to the Bank of England becoming more aggressive with interest-rate increases.

There are, of course, other ways of spending more while taxing less. One option would be to borrow more – something that could just about be done while sticking to the government’s own rules, but which leaves little wriggle room should the economy continue to struggle.

Another option would be to print more money. According to the advocates of modern monetary theory (MMT), governments that issue their own currency do not need to rely on taxes or borrowing to cover their spending because they can print all they need up until the point when inflation becomes a problem.

It is reasonable to assume that in the current circumstances, with inflation already standing at 9.1%, none of the wannabe prime ministers is going to come out in favour of MMT. That, though, means they need to come up with a coherent explanation of why tax cuts are needed and how they would be paid for. So far there has been plenty of magical thinking and not much else.