The Government plans to "tackle Labour's legacy of debt" yet they are also proposing a number of tax cuts. But there is an alternative way to reducing the deficit.
An email from David Cameron to Conservative supporters on Monday evening promised that the new Government would “tackle Labour’s legacy of debt”. No mention, of course, that the Conservative party were complicit in calls for light touch regulation and had been calling for years for an end to “burdensome” and “unnecessary” regulation. They will do this by focusing on “benefits, tax credits, and public sector pensions“. But there is an alternative to “Osborne’s bombshell“.
The graph below from the Institute for Fiscal Studies shows how Government revenue and spending has widened since the recession started. It shows clearly that before the crash, current spending excluding capital projects and revenues were virtually in balance. The deficit has been caused by increased spending – primarily due to automatic stabilisers such as unemployment benefits and the financial sector bail outs – but also by falling tax receipts.
In this public finance environment, it is extraordinary that the Coalition Agreement argues for several tax cuts including:
• an increase in the personal allowance for income tax – a Lib Dem priority which does nothing for the poorest families;
• a freeze to Council Tax in England for at least a year; and
• the introduction of a transferable tax allowances for married couples to “recognise marriage in the tax system” – a policy which will discriminates against single parents, widows, and married couples where both couples are in full-time work.
Recent research by Stan Greenberg shows that tw0-thirds of voters believe that “it is not the time to cut taxes” (p.44). Some spending cuts will, of course, be necessary (who really mourns the loss of ID cards?) while the overall level of spending will fall if the recovery is secured. But the Government’s planned attacks on the solidarity and redistributive impact of the welfare state is only one approach to deficit reduction. The alternative is to abandon these tax cuts and push ahead with many of the progressive tax raising proposals in the Compass report, ‘In place of cuts‘.
Paul Krugman has an excellent blog outlining why the “fiscal austerity” of Cameron, Merkel and others is affecting the rest of the world:
We do have a framework for thinking about this issue: the Mundell-Fleming model. And according to that model (does anyone still learn this stuff?), fiscal contraction in one country under floating exchange rates is in fact contractionary for the world as a hole. The reason is that fiscal contraction leads to lower interest rates, which leads to currency depreciation, which improves the trade balance of the contracting country — partly offsetting the fiscal contraction, but also imposing a contraction on the rest of the world. (Rudi Dornbusch’s 1976 Brookings Paper went through all this.)
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