The politics of today versus the economics of tomorrow

March 22, 2012

–Sheila Lawler is Director of Politeia. The opinions expressed are her own.–

The 2012 Budget seemed to have something for everyone. For low earners there are tax cuts; for business there are cuts in corporation tax; for well-off families fearing the loss of child benefit, a reprieve; and for all who recognise that the public finances and public spending must be brought under control, there is the comfort of a ‘fiscally neutral’ budget.

But the Chancellor, in seeing off some of the demands of today, may be stacking up difficulties for the future. For instance, the way in which ‘neutrality’ has been achieved will bring its own problems as the threshold for paying tax has gone up as well as down.

Pensioners on modest incomes will see personal allowances cut, and the threshold for higher rate tax at 40% has been lowered (kicking in at earnings of £41,450 and over, not £42,750 as now). These tax rises augur ill for a country which is now racing against time to make the changes needed for its economy to survive and succeed against stiff global competition.

If the UK is to compete and to sell its goods to the emerging markets of Brazil and Asia, on which the Chancellor has set his sights, it will need to change. People will have to work harder (not just longer) and earn more in a labour market which is flexible and open, not stifled by anachronistic regulation. They are not going to do that under current penal policies. Moreover, business will have to grow, not be driven elsewhere by the current tax and employment costs levied on business and employers. If Germany can cut corporation tax from 25% to 15%, so can we!

So instead of penalising people who work harder by juggling the thresholds at which income tax is applied, more ambitious plans are needed, short and long term, for cutting levels of public spending – the real problem for any Budget is not the politics of today, but the economics of tomorrow.

Levels of public spending proportionate to GDP must continue to fall. Efficiency savings are often mentioned here. They should not fall on frontline services – as is already the case, with the most able doctors and specialist research hospitals being squeezed out by Whitehall’s henchmen. Rather the squeeze should be on those very officials whose number and kind exploded in the decade to 2010.

However, to sustain affordable public spending at levels which encourage growth and protect the services such as healthcare that people want, markets are needed with equal opportunities for market participants to provide essential public goods and services. That view is increasingly taken by economists the world over (see for example Ludger Schuknecht’s Booms, Busts and Fiscal Policy: Public Finance for the Future (Politeia 2009).

For change, survival and growth, spending ratios must be brought down, initially to pre-crisis levels and in the longer term to around 35% of GDP. To do that – and provide people with the social goods western countries want.


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