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Leading article

The great creep forward

8 December 2012

9:00 AM

8 December 2012

9:00 AM

It took Tony Blair about five years to work out what he wanted to do with his government and George Osborne appears to be on a similar, depressingly slow learning curve. It’s not that he lacks ideas. There were plenty of good ones in his mini-budget this week, including tax cuts for the low paid, and for companies. But none of this will speed the recovery. ‘It’s taking time, but the British economy is healing,’ the Chancellor said, to laughter in the house. We are not even halfway through the recovery.

To go through the small print of the budget was to grasp just how vile the outlook is. At election time, voters tend to ask themselves: are you better off than you were at the last election? According to Osborne’s new forecasts, most will answer ‘no’. To make it worse, far from having abolished the deficit by 2015, Britain is now on course to shoulder the worst deficit of any major western country.

Mr Osborne’s strategy has been to talk tough on cuts, while making very few of them. This has meant taking all the political pain while making little economic progress. It suits neither Labour nor the Tories to admit that, after all this fuss, state spending has fallen by about 1.6 per cent from its peak. Even Barack Obama has made more progress, cutting by 2 per cent. The Spanish have managed 9 per cent, the Greeks 20 per cent, and Irish spending is 33 per cent down from its peak. In taking the slow road to economic recovery, Mr Osborne has simply dragged out the agony.

Waiting until 2018 for a balanced budget is bad enough. But on current trends, the average worker will have to wait until 2020 to see their standard of living back to where it was before the crash. Osborne’s plans for cutting tax on shale gas are welcome, but they are not much use while the shale exploration ban still exists. Money for new schools is welcome, but the main barrier to these schools is the lack of planning permission. Bureaucracy, not state spending, remains the constraint on both of these crucial issues.

There are two ways of responding to the crash. The classic Keynesian way is to borrow masses of cash to support the economy, and spend it — then wait for better times. The other way is being pioneered by Sweden, whose response to the crash was a permanent tax cut for the low paid. It worked, and the extra workers paid for the tax cut. Sweden is now focusing on companies, with a deficit-financed cut in corporation tax from 26 per cent to 22 per cent. Osborne is cutting it from 24 per cent to 21 per cent — but by 2014/15. It’s a welcome boost to business, but one that companies could do with a little sooner.

The principle applied in Sweden is simple: the economic problem is not demand, but supply of willing workers. So to pull out of the slump, more tax cuts are required — especially for the low paid. There’s no point borrowing money, and paying immigrants to build bridges. The purpose of growth is to relieve poverty and cut dole queues. If you cut taxes, and make work pay more, then people will work more. It has until recently been possible to dismiss the Swedish experiment as one that only works in countries where the sun sets at 2 p.m. and commuters ice-skate to work.

But fresh research from America is also proving the extent to which work is linked to tax and welfare. Casey Mulligan, Professor of Economics at Chicago University, has published a book called The Redistribution Recession which draws a near-perfect correlation between an increase in welfare and unemployment. His extensive research indicates that the link between tax, benefits and labour is more sensitive than economists hitherto realised. In Britain, the response to the 50p top rate of tax has also proved sharper than anyone predicted. For every three people who paid more than £1 million in income tax under the 40p rate, just one did so under the 50p rate a year later. This suggests high earners either moved, or moved their money, elsewhere.

On Monday, Sir Mervyn King addresses the Economic Club of New York. The Bank of England Governor takes the lecture slot given to John F. Kennedy in 1962, when he rejected as false the choice between deficits and tax cuts. ‘It is a paradoxical truth,’ JFK declared, ‘that the soundest way to raise the revenue in the long run is to cut the rates now… An economy hampered by restrictive tax rates will never produce enough revenue to balance our budget, just as it will never produce enough jobs or enough profits.’ Five decades later, this basic truth is being discovered anew — and in Britain, far too slowly.

To curb welfare payments in coming years is a tough decision, but one which sits well alongside cutting tax (a little) for the lowest-paid. The government must do what it can to make work pay. The Chancellor’s decision to fund this with a £1 billion tax on middle-class earners will be politically unpopular, but is also horribly necessary in order to address our appalling levels of youth unemployment. It has taken some time, but finally Osborne appears to be carving out a growth agenda.

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