In my last post, I looked at Gordon Brown’s terrible legacy of debt. While the financial crisis is indeed global, it is clear that we are spectacularly badly positioned to weather the storm, as Gordon Brown has borrowed too much. The position with taxes is just as bad. Today the tax burden is 38% after tax credits are treated as the benefit payments they really are. Before the financial crisis struck, Labour’s plan was to increase this to around 39%. It may now have to go up rather more.
Why would taxes need to go up? In a downturn, the ideal is to cut taxes in order to stimulate growth. The 1990s downturn is a classic example. Taxes were cut quite dramatically as can been seen from the chart below. Yet in the early 1980s, taxes went up, not down. A key reason in both cases was the state of the public finances. In the 1990s downturn, the public finances were a lot stronger and hence there was something in the cupboard for bad times. In the early 1980s, the public finances were in disarray and the cupboard was bare.
Any downturn this time would see a backdrop similar to the early 1980s. With the public finances in a terrible state thanks to Gordon Brown’s economic mismanagement, the scope for stimulation by tax cut looks limited. Indeed it looks like taxes might have to go up - perhaps over 40% of GDP, which would be very painful. You can see why David Cameron and George Osborne are warning that a Conservative Government may have to raise taxes, as Thatcher did, because . . . Labour have done it again.
One last point to note. The dog that is not yet barking is cutting public spending . . . there may be little choice. Today’s YouGov poll suggests that the public understand this issue and are stating a preference for cutting spending over tax rises. I'd be really interested to know what Centre Right readers think.