Prime real estate in Dorset: to avoid some of the most painful cuts, the government should bring in a “new property tax based on market values”
Economic recoveries tend to be feeble after financial crises. This is certainly the case in Britain, where the economy has come to a near standstill, unemployment remains high and inflation is running at more than twice the Bank of England’s target. With government debt above 80 per cent of GDP and rising, and the budget deficit above 10 per cent, the country’s financial position is very weak. Economic recovery will eliminate part of the deficit, but far from all of it. To bring down government debt, ambitious cuts are certainly needed. The only questions are: how much, how fast—and how?
Any plan needs to weigh the costs of cutting too late versus too early. On the one hand, waiting increases two inter-related risks: loss of political support and loss of Britain’s fiscal credibility. The chief concern here is that investors may lose confidence in the government, pushing up borrowing costs. On the other hand, front-loaded spending cuts may harm the economy unduly.
Although large uncertainties still surround estimates of the scale of cuts needed, OECD analysis suggests that the government’s plans over this parliament seem appropriate. For a start, if current deficit levels were allowed to continue, this would risk a loss of confidence among investors. Early and decisive action has helped to diminish these risks; backtracking prematurely would merely increase them again. Second, it would be difficult to muster political support for resuming cuts after a temporary respite. Countries that successfully pursued similar-scale austerity plans—like Canada, Finland and Sweden in the 1990s—put in place broad, front-loaded programmes and stuck to them. There is also an advantage of early action on deficits, when the government has the political capital and momentum to see them through.
Third, although the cuts will impact growth, they are not likely to derail the recovery. The OECD estimates that the government’s austerity plans will cut growth by only about 0.7 percentage points this year. But continued growth in demand for British goods and services abroad, a depreciated pound and low interest rates all support the economy, which the OECD projects to grow by 1.4 per cent this year, notwithstanding the cuts.
This does not mean that nothing needs to (or can) be done to improve Britain’s economic prospects. The government could avoid some of the cuts by instead broadening the standard VAT rate: ending VAT exemptions for certain goods and services, and reducing the number of goods currently eligible for the reduced VAT rate of 5 per cent. The current exemptions and lowered rates on food, passenger transport and domestic fuel makes Britain’s VAT structure less efficient than that of most other OECD countries.
The government should accompany the broadening of VAT with additional financial support to poorer households, and by addressing high youth and long-term unemployment by offering better access to high-quality training. The announcement of an increase in apprenticeships was a step in the right direction, but more needs to be done. Now that the education maintenance allowance has been abolished, the coalition must find alternative ways of improving incentives for children from low-income families to carry on with their education.
The government must also pursue policies to increase long-term growth, in order to improve living standards and put the country in a more sustainable financial position. Recent OECD studies have pointed to the need to link tax more closely with property values. The council tax and stamp duty, for instance, should be replaced by a property tax, based on market values. Such a move would also dampen fluctuations in house prices. Other structural reforms, including improved ways of funding schools and universities, introducing a more flexible planning system and further increases in the retirement age, would also support growth.
By creating the office for budget responsibility, the government has introduced a powerful spending watchdog, but further improvements—such as imposing debt targets and introducing rolling five-year spending caps that reach across parliamentary periods—should also be pursued to support sustainable public finances. Wide-ranging, structural reforms will help Britain achieve stronger growth—and support the necessary rebalancing of the economy.
Economic recoveries tend to be feeble after financial crises. This is certainly the case in Britain, where the economy has come to a near standstill, unemployment remains high and inflation is running at more than twice the Bank of England’s target. With government debt above 80 per cent of GDP and rising, and the budget deficit above 10 per cent, the country’s financial position is very weak. Economic recovery will eliminate part of the deficit, but far from all of it. To bring down government debt, ambitious cuts are certainly needed. The only questions are: how much, how fast—and how?
Any plan needs to weigh the costs of cutting too late versus too early. On the one hand, waiting increases two inter-related risks: loss of political support and loss of Britain’s fiscal credibility. The chief concern here is that investors may lose confidence in the government, pushing up borrowing costs. On the other hand, front-loaded spending cuts may harm the economy unduly.
Although large uncertainties still surround estimates of the scale of cuts needed, OECD analysis suggests that the government’s plans over this parliament seem appropriate. For a start, if current deficit levels were allowed to continue, this would risk a loss of confidence among investors. Early and decisive action has helped to diminish these risks; backtracking prematurely would merely increase them again. Second, it would be difficult to muster political support for resuming cuts after a temporary respite. Countries that successfully pursued similar-scale austerity plans—like Canada, Finland and Sweden in the 1990s—put in place broad, front-loaded programmes and stuck to them. There is also an advantage of early action on deficits, when the government has the political capital and momentum to see them through.
Third, although the cuts will impact growth, they are not likely to derail the recovery. The OECD estimates that the government’s austerity plans will cut growth by only about 0.7 percentage points this year. But continued growth in demand for British goods and services abroad, a depreciated pound and low interest rates all support the economy, which the OECD projects to grow by 1.4 per cent this year, notwithstanding the cuts.
This does not mean that nothing needs to (or can) be done to improve Britain’s economic prospects. The government could avoid some of the cuts by instead broadening the standard VAT rate: ending VAT exemptions for certain goods and services, and reducing the number of goods currently eligible for the reduced VAT rate of 5 per cent. The current exemptions and lowered rates on food, passenger transport and domestic fuel makes Britain’s VAT structure less efficient than that of most other OECD countries.
The government should accompany the broadening of VAT with additional financial support to poorer households, and by addressing high youth and long-term unemployment by offering better access to high-quality training. The announcement of an increase in apprenticeships was a step in the right direction, but more needs to be done. Now that the education maintenance allowance has been abolished, the coalition must find alternative ways of improving incentives for children from low-income families to carry on with their education.
The government must also pursue policies to increase long-term growth, in order to improve living standards and put the country in a more sustainable financial position. Recent OECD studies have pointed to the need to link tax more closely with property values. The council tax and stamp duty, for instance, should be replaced by a property tax, based on market values. Such a move would also dampen fluctuations in house prices. Other structural reforms, including improved ways of funding schools and universities, introducing a more flexible planning system and further increases in the retirement age, would also support growth.
By creating the office for budget responsibility, the government has introduced a powerful spending watchdog, but further improvements—such as imposing debt targets and introducing rolling five-year spending caps that reach across parliamentary periods—should also be pursued to support sustainable public finances. Wide-ranging, structural reforms will help Britain achieve stronger growth—and support the necessary rebalancing of the economy.
