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Is the promise of “tax cuts” credible in today’s British politics? The succinct answer is “no”. The long answer is: It depends on what the tax cuts mean. It is certainly possible to cut some taxes and raise others overtly or (more likely) covertly. But cutting the overall tax burden will be much harder. To be minimally credible, any commitment to a permanent, substantial reduction in the tax-to-GDP ratio would need to be accompanied by a commitment to lower spending levels or growth rates. In theory, this is possible. For example, political parties could promise cuts Health care spending. But can it be elected?
In July 2023, the Office for Budget Responsibility released an excellent report titled Fiscal risks and sustainability, This clarifies the situation with frustrating clarity.
First, the UK suffered a series of shocks that, in the words of the OBR, “brought the worst recession in three centuries, the largest rise in energy prices since the 1970s, and the largest sustained increase in borrowing costs since the 1990s. up.” They have also pushed government borrowing to levels not seen since the 1940s, the stock of government debt to levels not seen since the early 1960s, and debt-servicing costs to levels not seen since the late 1980s. Note also that a quarter of UK sovereign debt (excluding the foreign official sector) is held by foreigners. As the Liz Truss episode proves, Britain cannot escape casual irresponsibility.
Second, economic vitality has been weak since the international financial crisis. This is not surprising. Back in 2009, I argued that the UK would suffer not only a permanent loss of output but also a permanent reduction in the trend rate of economic growth. That’s because the financial sector has transformed it into what economists call a “single-crop” economy. No other sector generates comparable wealth.
Third, China faces challenges such as an aging society, deteriorating economic and security environment, and climate change. Just controlling the cost of senior care will be a huge battle. Defense spending must increase. The need to protect the country from the impacts of climate change is unavoidable: the OBR notes that by 2030, “public investment needed to support the decarbonisation of electricity, buildings and industry could reach £17 billion per year”.
It’s no surprise, then, that public finances look far from sound. To be sure, the recent crisis-driven high spending is likely to decline, with non-interest spending falling as a share of GDP from 41% in 2022-23 to 39% in 2027-28, according to the OBR. But the underlying pressure will then push it back into place. It also ignores the reality that pressure to increase spending is already enormous, especially on health. All in all, the situation is fragile in the short term and unsustainable in the long term. Taxes will rise.
Therefore, any attempt to cut taxes significantly relative to GDP, without the promise of concurrent (and even larger) spending cuts, is a sham. Politicians who make such promises without revealing how they plan to pay for them undermine the legitimacy of an already fragile democracy.
Of course, that doesn’t stop politicians from explaining how they can offset some tax cuts with increases elsewhere. The current tax system is a mess. It has to become simpler and more coherent. It can also be made more equitable and efficient by shifting taxes away from jobs and investments and towards land and other forms of wealth, as well as various polluting activities. Smart tax reform might even spur much-needed growth.
At the same time, Britons must not become hysterical about their current tax levels. Yes, taxes are higher than in the US. But British values are different from American values. In fact, they are more European. The Netherlands is a wealthier country than the UK, with a tax rate of 44% in 2022, compared to 39% in the UK.as oliver wendell holmes jr. explain: “Taxes are what we pay for a civilized society.”
Nor should we assume that faster economic growth will solve this dilemma. As the economy becomes wealthier and wages rise, the relative cost of public services tends to rise, as does the demand for them.
Taxes are ultimately driven by spending. How much (and where) a country spends, and how it pays, is a political decision. It defines the kind of country it wants to be. That’s the problem, not the fantasy that cutting spending will pay for itself or magically lead to growth.
martin.wolf@ft.com
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