The budget is likely to be another platform from which the chancellor tells us that slashing red tape and cutting business taxes offer the best route to economic recovery – but it is becoming increasingly clear that this approach is not creating the stimulus needed to kick start growth.
Instead the UK is currently ranked as having the second slowest recovery of the G8 (with only Japan doing worse following the Tohoku earthquake).
One important explanation for our sluggish growth is the fact the government has been putting all its eggs in the wrong basket. Cutting corporation tax seems to be the weapon of choice for the chancellor – it has been falling and by April 2014 the rate is set to have fallen to 23 per cent from its original 28 per cent in 2010.
This might seem like an effective way to support businesses in tough economic times but it is a less effective tool than it seems.
This is because cutting tax does not create the same amount of demand that is created by government spending. Tax cuts for businesses lead to a far greater proportion leaking out of the economy in the form of imports of goods and services which does nothing for stimulating growth.
This is why the Office for Budget Responsibility (OBR) concluded (pdf) in June 2010 that government spending will be the main contributor to future UK growth, something that can have up to twice the impact of tax giveaways.
The chancellor should take notice of President Obama’s conclusion that “we can’t just cut our way into growth”. The US approach has seen more success than our own. Last year, US consumer spending increased by 2.2 per cent whereas in the UK it shrank by 0.8 per cent; in February, the US brought its unemployment level down to a three-year low, having created 227,000 jobs.
The IMF are increasingly likely to raise their US growth prediction while the UK’s projections have been reduced and are accompanied by a warning that economies such as ours should be careful not to cut spending too deeply or too quickly.
If the chancellor is going to allocate our precious resources anywhere then surely it should be where it will make the most impact. Unfortunately, the chancellor is allergic to any direct government investment in growth reflected in the steps taken by Obama.
But there are other options available to him. Most importantly he has the ability to increase the purchasing power of individuals in the UK, which would in turn help to stimulate demand and boost employment.
Increasing the personal allowance or reducing VAT are two alternatives that could help achieve this. Today, US economist Eric Beinhocker has put forward a solution based on one of Obama’s stimulus measures. His analysis shows that a 2p cut in employees’ National Insurance contributions (NICs) over the next two years would result in an additional £7 billion per year of household income and between £2-4 billion in additional related growth.
For any stimulus measure to work, it would have to be paid for by increased taxes rather than additional government cuts. Cutting NICs would cost £5.5 billion for each year – but the cost could be made up within six years through increased revenues generated from higher growth along with the proposed mansion tax (£) would pay for the policy.
This is a win-win situation for the government and would add weight to the claim that we are “all in this together”.