Patrick Nolan: Cutting the deficit is no excuse for bad tax policy

LAST week's Budget illustrated the painful truth facing the UK. With a deficit of £167 billion for this year alone, spending cuts and tax increases will be required. Yet while some rises are inevitable, the approach taken in the Budget will hold back economic recovery and make rescuing the public finances harder.

Cutting the deficit is no excuse for bad tax policy, but that is what the electorate is being offered.

The proposed increase in National Insurance (NI) contributions is a prime example of bad tax policy. Supporting jobs and small businesses was a stated priority in last week's Budget. But while Mr Darling's speech contained temporary measures to address unemployment, it did not make it easier and less expensive for businesses to take on staff. In fact, the Budget did the opposite and confirmed the 1p increase in NI contributions from April next year. This tax increase will kill jobs – it is already leading employers to consider recruiting fewer staff and letting workers go.

This increase also undermines claims that only higher-income earners will face the burden of higher taxes. Research by think-tank Reform has shown that increases in NI, along with the freezing of personal tax allowances, means that by 2011 someone earning just above the minimum wage (currently 5.80 per hour) will have faced an increase in personal taxes and NI contributions of 1,130 since the beginning of this century.

These tax rises have largely occurred by stealth – freezing tax thresholds and allowances means more people slip into higher tax brackets when their incomes increase over time. The plan to freeze the higher rate income tax threshold will mean, for example, an additional 70,000 people facing the higher rate of tax and the overall tax burden being 400 million higher.

George Osborne was right to pledge to reverse the increase in NI for the majority of earners. His pledge, however, did not go far enough: these taxes should be lowered further to encourage more job growth.

The Opposition may argue that it cannot go further on cutting NI contributions because of the need to reduce the deficit. But there are much better candidates for increasing revenue, such as removing the exemptions to VAT.

Reform along these lines would help rescue the public finances and set the conditions for future economic growth.

• Patrick Nolan is chief economist at think-tank Reform.