Try your hand at being Chancellor of the Exchequer

By Dr Patrick Nolan, Chief Economist, Reform.

The Chancellor of the Exchequer faces a difficult task in putting together a Budget next week. Questions that the Budget will need to address include:

·         How can we convince the markets that there is a credible plan to reduce the deficit?

·         When should spending cuts begin – and what cuts can be made quickly (e.g., to the Child Trust Fund) and which ones will take time (e.g., some departmental budgets)?

·         How do we shore up revenues without damaging growth or weakening incentives to cut spending?

·         Is it possible to ring fence the largest areas of spending which have consumed the bulk of the increase in spending this century – or will ring fencing require cuts to non-ring fenced budgets (such as defence) that are too deep?

·         How do we avoid the temptation to use any reduction in the forecast levels of borrowing (which, to be fair, is at a dangerously high level) for vote buying measures, rather than doing the responsible thing and repaying debt?

·         How do we deal with interest groups who are already mobilising against reforms (such as to public service redundancy payments and education cuts) even though no real programme of cuts across government has begun?

So how would you approach the Budget if you were Chancellor? And do you think you could develop a plan that is better than those on offer from the political parties?

To help you to think through the revenue-raising side of this – how to shore up revenues without damaging growth or weakening incentives to cut spending – Reform has developed two calculators. One allows you to analyse how income taxes and National Insurance Contributions have increased so far this century and the other allows you to analyse what would happen if these taxes were reformed.

The first calculator allows people to enter their own personal income and see the changes in their total personal tax bill in 2000-01, 2009-10 and 2011-12. The calculator shows that a voter on around average earnings of £23,300 would have faced a tax bill of only £5,400 on an equivalent income in 2000-01, but in 2011-12 would face a bill of £8,500.

The calculator also shows how punishing national insurance contributions can be. The Government’s plans are for National Insurance Contributions to increase. This is the wrong approach. As CIPD identified in their recent Labour Market Outlook:

The 1% increase in employers’ National Insurance Contributions (NICs) scheduled for April 2011 is likely to have a bigger impact on organisations than the end to the temporary VAT cut or the new 50% top rate of income tax for those earning over £150,000. One in eight (12%) employers responding to the survey expects to recruit fewer staff, while 6% will make more redundancies due to the NICs increase.

The increase in National Insurance is a job killing tax increase.

The second, more complex, calculator allows people to design their own personal tax system. Voters can change the thresholds where income taxes begin and the rates of income tax and National Insurance Contribution rates. The calculator shows the changes to their own tax bill and the effect of these changes on government revenue (both static and behavioural changes are estimated, although it is important to emphasise that data limitations mean that these estimates are indicative only).

Reform argues that spending cuts must play the major role in restoring the public finances. However, as Reform’s recent report Reality check found, tax rises are a regrettable necessity. In California, under Governor Schwarzenegger, including revenue options has been identified a one of the keys to balancing the budget. Reform argues, however, that the political parties in the UK are all planning to increase taxes too far (Reform recommended tax rises of £12 billion over the next three years, compared to increases of £22 billion planned by the Labour Party, £16 billion by the Conservatives and £12 billion by the Liberal Democrats) and are focussing on the wrong taxes. Indeed, job killing taxes must be cut.

There is a need for a detailed plan on how to restore the public finances. One lesson from international reforms, like those in the 1995 Canadian Budget, is that getting the public to support tough measures requires them to feel part of the process. The public must have a say on the public finances.

By launching these calculators Reform hopes to support and encourage public debate on the design of the tax system. Over the next few weeks Reform will be releasing a range of other materials to help support debate on restoring the public finances and reforming public services. This debate needs to take place before the general election as the next government will have to take difficult decisions and these decisions will require a mandate. Receiving the strongest mandate requires political parties to more explicitly set out their stalls before the public go to the polls.