Howard Flight: There is little scope for tax rises if Britain is to remain economically competitive

Howard Flight is a former Shadow Chief Secretary to the Treasury and chairman of Flight & Partners Recovery Fund. Here he reflects on the state of the economy in the wake of last month's Budget.

Above all, the Government’s projected borrowing requirements through to 2113/14 reveal the enormity of Labour’s failure as managers of the economy. Including borrowing for the year just ended, the total is approximately £800bn which would double the national debt.

The first point to note is that all of the trouble has arisen since Gordon Brown started on his mad public spending spree in 2001. While he adhered to Conservative spending plans, there was actually a budget surplus of £18bn in 2000/01.

The second point is that the public spending crisis has been seriously worsened by public sector inflation running at over twice the level of overall inflation and nearly three times the level of private sector inflation over the last decade. This has been, particularly, the result of the political power yielded by the public sector trade unions – where most of the public sector costs are pay.

Average pay in the public sector has risen by between 5% and 10% per annum more than in the private sector. If public sector inflation had been the same as private sector inflation, the public finances would now be approximately £70bn per annum better and so considerably more manageable. This is in essence also why so little improvement in services has been achieved, notwithstanding the increase public spending in cash terms, from £375bn per annum to £635bn per annum.

I doubt that an increase in UK government borrowing of the magnitude announced would be financeable.  During and after the Second World War there was a very high savings rate, largely as there was little on which people could spend their money; and, like Italy today, a high Savings Rate in the private sector enabled the financing of a large government deficit.

Howard Flight is a former Shadow Chief Secretary to the Treasury and chairman of Flight & Partners Recovery Fund. Here he reflects on the state of the economy in the wake of last month's Budget.

Above all, the Government’s projected borrowing requirements through to 2113/14 reveal the enormity of Labour’s failure as managers of the economy. Including borrowing for the year just ended, the total is approximately £800bn which would double the national debt.

The first point to note is that all of the trouble has arisen since Gordon Brown started on his mad public spending spree in 2001. While he adhered to Conservative spending plans, there was actually a budget surplus of £18bn in 2000/01.

The second point is that the public spending crisis has been seriously worsened by public sector inflation running at over twice the level of overall inflation and nearly three times the level of private sector inflation over the last decade. This has been, particularly, the result of the political power yielded by the public sector trade unions – where most of the public sector costs are pay.

Average pay in the public sector has risen by between 5% and 10% per annum more than in the private sector. If public sector inflation had been the same as private sector inflation, the public finances would now be approximately £70bn per annum better and so considerably more manageable. This is in essence also why so little improvement in services has been achieved, notwithstanding the increase public spending in cash terms, from £375bn per annum to £635bn per annum.

I doubt that an increase in UK government borrowing of the magnitude announced would be financeable.  During and after the Second World War there was a very high savings rate, largely as there was little on which people could spend their money; and, like Italy today, a high Savings Rate in the private sector enabled the financing of a large government deficit.

But the UK Savings Rate has only recovered to around 5% of National Income – nowhere near enough to finance government borrowing of the order announced. The implication is, therefore, that much of the borrowing would have to be financed internationally, where we would be competing with the USA and other economies for the world’s savings.

Meanwhile quantitative easing is necessary to replenish destroyed money supply in the short term, and, in effect, results in the UK banks financing much of the deficit; on any on-going basis this would be a recipe for escalating inflation. As the Conservative leadership has recognised, the borrowing requirement, and more particularly government spending, will have to be reined back significantly, once the economy has turned.

Put another way, Gordon Brown has left the public finances on an unsustainable basis, by assuming, wrongly, that the windfall increase in the tax take, which resulted from the financial bubble of 2003 to 2007, constituted permanent and sustainable additional tax revenues. There is no clear empirical measure of the size of these illusory tax revenues, which relate largely both directly and indirectly to the financial sector; but my own estimate is of the order of £75bn per annum. This is, in effect, the extent of the regular reduction in government spending which will need to be effected.

Tony Blair’s economic adviser has suggested a 20% cut in public spending across the board – referring to past Canadian experience. It must make more sense to assess what are and are not priority areas.  Given the extent of public sector pay inflation over the last eight years, there is clearly a case for restraining, if not freezing, public sector pay increases. The territory which I suggest needs particular investigation is Brown’s massive increase in the several areas of social expenditure, beyond established, welfare safety-net provisions.

Here the “books have been cooked”; Brown’s tax credits are not treated as an expenditure, but netted off tax income: substantial social expenditure is also hidden within the aggregate spending for Scotland, Wales and Northern Ireland. The financing of the rising deficit on pay-as-you-go public sector pensions is equally obscured. Much of Brown’s new social spending is, moreover, trapping people into welfare dependency and removing the incentive for people to increase their skills in order to increase their take home pay.  In work fiscal subsidies are also now distorting wider economic efficiency.

What is also clear is that if the productive economy is to recover and to produce real growth for the future, there is little or no scope to increase taxation - where the UK has again become uncompetitive internationally in terms of both personal and corporate taxation.