Osborne and tax cuts

“Top Conservative despairs of Cameron growth plan,” says The Times’ front page today. While The Daily Telegraph’s reads: “No tax cuts before the next election, says Osborne”. The two stories are related. British economic growth is evaporating, and more than a few Tory MPs are worried that the Chancellor doesn’t have a coherent growth strategy and that he doesn’t seem to care. Osborne’s cheery interview with Robert Winnett and Ben Brogan will do nothing to allay such fears. He repeats his position on tax cuts: that, while desirable, they are likedessert once the nation has eaten its main course of cuts and tax rises. He appears to rule out using tax cuts as a tool to stimulate growth.

I suspect that tax and growth will be a theme of this coming Tory conference, so Osborne’s position is worth exploring in a little more detail. He tells the Telegraph: “I’m a fiscal conservative with a small ‘c’ who believes in lower taxes, but who believes in paying for lower taxes. My first priority is to deal with the deficit…. I’m not somebody who believes you can fund lower taxes by borrowing more money because that is a deceit and the public are smart enough to see straight through it.”

So: no tax cuts, for as long as there is a deficit. It is a rejection of the JFK theory of deficit-financed tax cuts (here). Osborne doesn’t seem to have a problem with extra debt to finance extra billions spent on overseas aid. Debt-financed spending boosts are okay, debt-financed tax cuts are not.  Fair enough: he’s made himself clear. But he does not even discuss the option of tax cuts, funded by greater savings in the gargantuan government budget. Why not?

The answer can be traced back to the 2005 leadership debate. The frontrunner, David Davis was positioning himself as a low-tax Tory, proposing that growth in the economy should be used to reduce the tax burden. He was backed by most small-state Conservatives. The Cameroons, then a minority faction, needed their own economic message. It was Letwin, not Osborne, who constructed it. They would talk as if Davis would finance his lower taxes with extra borrowing. During the leadership battle and the months that followed, a new phrase was adopted: “unfunded tax cuts”. This was what the Bad People wanted. Later, Letwin expanded the vocabulary further: tax cuts would threaten “stability” because they meant greater deficits, ergo a weaker pound, etc.  So their mantra, from January 2006, was “stability before tax cuts”. It was a baffling stance, implying that all tax cuts are inherently destabilizing. To add a little spice, anyone who spoke about cuts could be disparaged as a swivel-eyed ideologue, a “punk tax cutter” – the type who cost the Tories the last election etc.

Even to suggest that Brown’s spending might bankrupt us was seen as being, well, a bit weird. As David Cameron put it, “I don’t suppose anyone gets up in the morning thinking ‘I wish the state were smaller.” So the mission was to disarm the small state conservatives economically, accept Brownite levels of tax-and-spend and follow Labour’s plans: not the best idea in retrospect.

I’ve never been a Conservative member and have always found its tribal warfare rather bizarre. But the history of Tories and tax helps to explain the debate now. It indicates why Osborne automatically associates tax cuts with extra borrowing: it’s a reflex learned during the 2005 Tory Wars and their aftermath.

It would be a shame if the politics of the 2005 leadership clouded thinking now. This recession is unlike any other, and its trajectory is teaching us plenty about what works and what doesn’t. Obama tried a $1 trillion stimulus which failed. Sweden, by contrast, tried cutting income taxes to encourage more people to work and create wealth: it is now celebrating the elimination of its deficit. Other factors were at play in both countries. The Obama administration is learning and adapting. Last month, Obama proposed a $245bn income tax cut which even Professor Casey Mulligan, who is normally critical of Obama, calculates will create 2 million jobs.

We cannot afford to dismiss the lessons of other countries for ideological or political reasons – or, even worse, because they are still seen in the context of an internal party battle that ended six years ago.

I have faith in Osborne, however, and I’m sure he will deliver a supply-side package. He is smart enough to know that he is not doing enough and that he must be versatile. From the corner of his eye, he’ll note that Ireland – which frontloaded its fiscal pain – is growing twice as fast as Britain this year, with borrowing costs back down to pre-crisis levels. Osborne will know that low UK bond yields is not the equivalent of a standing ovation from the markets – although it can (and will) be spun this way. His seven-year deficit reduction plan is credible, and he deserves credit for that. But low yields are explained by many factors: chief amongst them the freak phenomena of the bond bubble, explained by Allister Heath in a recent cover story. Expectation of a titanic £400 billion of QE also pushes yields down. And if low borrowing costs were a precursor to economic success, Japan would have been booming long ago. Low yields can be the prelude to a lost decade.

Labour’s slow-mo intellectual collapse has left Osborne with a great deal of political breathing space, but the economy will leave him with none. He’s not in the position to discard tools that will help the recovery.