Taxes are at a record high. Here's why they need to go up even further – John McLaren

Those calling for radical tax cuts need to realise that Liz Truss was brought down not by some mythical ‘deep state’ but because the market deemed her proposals to be dangerous, given the economic conditions

The latest International Monetary Fund (IMF) economic outlook reports were a grim reminder of the low-growth straitjacket that most advanced economies find themselves in, reinforcing the view that tax rises and limited government spending are the order of the day and for some time to come.

Not that you’d think this was the case from the relatively cheery overviews on economic prospects from various political parties of late. The Chancellor thinks he can carry on cutting national insurance. His opposite number in Labour, Rachel Reeves, sees a bright future, courtesy of an obscure Treasury body called the ‘Enterprise and Growth Unit’. And Humza Yousaf thinks that, were independence to happen soon (I could stop there), then his industrial policy would do the trick. Good luck with all of those.

Of course, politicians are always going to look on the bright side of things, and there is an election looming, but facing up to reality has its virtues too. At present, the reality is how to deal with a docile economy, high national debt levels and poorly performing public services.

Liz Truss-style tax cuts would be a serious mistake for a second time (Picture: Leon Neal/Getty Images)

World economy risks ‘tepid ’20s’

The IMF report was another wake-up call to governments to set responsible policies, not wish-fulfilling ones. However, it recognises that in 2024 – or “The Great Election Year” as the IMF dubs it, the chances of such an approach are slim. All this on the back of its gloomy prognosis for global growth, with a warning that the world economy is at risk of a “tepid ’20s” if policymaking does not change.

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The return of Liz Truss to the fray reminds us what can happen when ‘optimism’ and ‘radical solutions’ are taken to the extreme. Disaster awaits, not because of some mythical ‘deep state’ but because rational players – ie, the market – deem the proposals unhinged and dangerous, given the underlying economic and fiscal conditions.

In an interview with the Financial Times, Truss stated: “Did we have the support from within the organisation to actually do what we set out to do? No we didn’t.” OK, when you start by sacking the head of the Treasury and not talking to the Office for Budget Responsibility or the Bank of England, how is that support supposed to arise? Second, the role of such bodies is to give advice on whether proposed policies are good, bad, or insane. That is their primary responsibility, not to help provide a souped-up engine to allow you to hurtle over the cliff edge all the faster. Self-belief is one thing, raging monomania is quite another.

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This is where politics and economics can end up if hard-won knowledge is thrown out the window. What we have now, across political parties, is a much milder form of myopia but it still has repercussions if the truth is denied.

High government debts

Back to the IMF. Its forecast for the UK is for an average GDP growth rate of one per cent over this year and next, and not much better in the four years thereafter. Meanwhile, it forecasts the UK’s fiscal balance to be at, or over, 3.4 per cent of GDP up to 2029, resulting in a net government debt ratio that keeps climbing, up to 98 per cent of GDP by then. It could be worse, the US’s annual government deficit is over six per cent in coming years and the debt ratios of the USA, France and Japan by 2029 are forecast to be 108, 107 and 153 per cent respectively.

As the IMF points out, you can survive in such an environment until you can’t, or until a fiscal ‘accident’ – like the 2022 mini-budget – happens along. Even the US, with its built-in currency advantage may be pushing its luck.

If such a turning point comes around, then the costs of servicing such elevated debt levels become even greater than the £90 billion seen at present, which is around £30 billion more than the entire UK defence budget. That is why the IMF strongly suggests that “fiscal consolidation is needed in most countries to strengthen debt sustainability and financial stability”. And so, in the case of the UK, the recent national insurance cut is maybe not such a great idea.

The ultimate saviour, if it can be found, will be a return to the sort of productivity growth rates seen in the past, although the impact of good policies would still take some time to arrive. The IMF believes that governments need to find new drivers of growth, not revert to old ones with patchy records, like interventionist industrial policies. Instead, they should be looking at making jobs more attractive for workers, more immigration and harnessing artificial intelligence.

Election bribes, then hard choices

The catch is that policies which help with such a reignition of innovation and growth require long-term investments. However, such policies currently have to fight their corner against more immediate spending pressures stemming from the pandemic and the war in the Ukraine, as well as fending off the tax-cut hallelujah-ists.

In the Great Election Year, we are likely to go backwards, as election bribes dominate, but by next year hard choices will need to be made. At present, UK fiscal plans are akin to another period of austerity for most public services, while at the same time raising the tax burden to a post-war record high – and this under a Tory led government.

There is only one realistic, if hopefully temporary, approach – even higher taxes. As the Institute of Fiscal Studies, in response to the IMF analysis, puts it: “Public spending in the UK is now close to international comparators, but the relative increase in revenues has been smaller. If we want to spend similarly to other countries, we will need to tax similarly too.”

John McLaren is a political economist who has worked in the Treasury, the Scottish Office and for a variety of economic think tanks