Bill Jamieson: Tax cut would show UK means business

George Osborne seems determined to see through his deficit reduction programme and is adamant nothing should dislodge this priority. Photograph: PA
George Osborne seems determined to see through his deficit reduction programme and is adamant nothing should dislodge this priority. Photograph: PA
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SO WHERE are you on the big national question? It looks like a two-choice affair and timing is of the essence. I refer, of course, not to “indyref” but to George Osborne’s Budget on 21 March.

There is intensifying pressure on him to produce a package that will at once quell the criticism that the coalition is doing little to address our moribund economy and at the same time dispel the impression that the UK, deeply angered by the bank bonus controversies, has gone anti-business.

The dilemma the Chancellor faces is stark. So far his previous Budget measures to boost recovery have been dwarfed by a deterioration in the economic outlook and a growing despair that the government is helpless in the face of an epochal change in outlook. If the aim is to catalyse a genuine change of mood and lift our recovery prospects, then here is the choice: should he slash the rate of Corporation Tax paid by business from 26 per cent down to 20 per cent? Or raise the threshold at which people start to pay income tax to £10,000?

Both would be headline grabbers. And both have economic merits. However, left to his own devices, one suspects Mr Osborne would prefer to do neither. He is determined to see through the programme of deficit reduction and he is adamant nothing should dislodge this priority. The deficit target has already slipped once since his emergency Budget in the summer of 2010 and he would be loathe to concede further slippage. Not only would this expose him to political attack from Labour but it might also further loosen the mortar that is holding up Britain’s continued Triple A credit rating. If this goes, there will be a storm of criticism that his grand plan for the UK has manifestly failed.

Now the economy has shown flickers of life in recent weeks. There’s a pulse of sorts. There was a bigger than expected fall in the trade deficit from £2.8 billion to £1.1bn, the smallest such deficit since 2003. There was a modest improvement in industrial output in December. And there was a stronger than forecast Purchasing Managers Index reading for services, accounting for some 65 per cent of the economy.

But the omens further out are not good. Real GDP is still 3.8 per cent below the pre-recession peak of January-March 2008. GDP growth estimates have been widely cut to below 1 per cent. UK bank lending to the business sector remains weak. And a Grant Thornton Business Monitor covering just over 1,000 businesses revealed that business confidence continues to be deeply depressed.

The Eurozone crisis continues to be a drag on business confidence. And arguably more worrying, a report on debt and deleveraging from McKinsey last month showed the UK to have a debt to GDP ratio of 507 per cent of GDP – the second highest of all the large economies and behind only Japan. UK household debt has continued to increase in absolute terms.

This debt overhang will cast a black cloud over growth for years. And the big worry for the coalition is that with tax revenues likely to be much lower than previously forecast because of lower growth, those projections of a tumbling budget deficit will not be borne out. The critique, already strongly advanced both within and outside parliament, is that the coalition has no countervailing policy measures that address the slowdown to near recession that settled in last summer. Mr Osborne’s raft of business friendly measures in the last Budget have had little evident success but have also mostly been forgotten. As for the Scottish Budget agreed last week, Cabinet Secretary John Swinney made much of capital spending plans. But it may be a year or more yet before many of the infrastructure projects will be truly “shovel ready”.

Such are the headwinds now facing the economy that to make an impact, the Chancellor must unveil a Budget measure that will big and bold enough to inject some confidence and get business investing and consumers spending. Pressure is growing for an immediate rise in the threshold for basic income tax. This was raised in April last year by £1,000 to £7,475. It will be raised further to £8,105 this year, and Mr Osborne has set himself a target of raising this to £10,000 by the next election, due in 2015. But last month Nick Clegg, the Liberal Democrat leader, stepped up the pressure with a call for the government to go “further and faster” with a rise to £10,000 straight away.

His rationale was clearly more political than economic. With families facing what he described as a “state of emergency” in their finances, ministers needed to respond more rapidly and that more should be done to ensure the tax burden was more evenly shared. The cost of a rise straight away is reckoned at £9bn. Clegg suggested that some of this cost could be met by addressing inequalities in the current system and by introducing a “mansion tax” on property, aimed at homes worth £2 million as a way of tackling “serious, unearned” wealth. A surer way to drive the high net worth offshore could not be found.

The economic benefit of a sharp raising of the starter rate of tax is that lower income groups would benefit most, and as these groups tend to spent most of their income the effect would quickly flow through to extra domestic demand. This in turn would raise tax revenues by more than would otherwise be the case. The demand uplift would also feed through to business investment and expansion, more jobs being created and a fall in the government’s unemployment and welfare bills.

However, this approach is open to objections. First, it may well be seen in the markets as a surrender of the government’s deficit reduction ambitions and put our Triple A rating at risk. Second, times have changed dramatically since the banking debacle of 2008. In a deeply apprehensive and debt-laden world the old patterns are unlikely to be repeated. Many lower income households might use any tax windfall to pay down their debts at a faster pace. The uplift might not be as strong as hoped. And such a move would do nothing to rebalance the economy away from domestic consumption to exports.

A faster than planned reduction in Corporation Tax may be economically the more efficacious choice. The rate has been falling from 52 per cent in 1982 to 26 per cent currently. But this has been accompanied by an increase in the tax revenue it has generated for the Treasury. In 1982-3 it yielded revenues equivalent to 2 per cent of GDP. Today it is expected to yield £43bn or 2.8 per cent of GDP.

Economist David Martin, author of a paper advocating a Corporation Tax cut published by the Centre for Policy Studies, says: “A cut in the rate to 20 per cent would be a quantum leap towards encouraging the enterprise economy... It would be a wake-up call to business, both domestic and international.”

And it would, he adds, be a significant simplification of the tax system. The initial £8bn cost would be made good in time by higher tax revenues. As well as encouraging inward investment, it would also dispel any doubt over the cabinet’s determination to ensure Britain is open for business.