Lord Forsyth of Drumlean: We must cut taxes to get growth to cut the deficit

Lord Forsyth of Drumlean was Secretary of State of Scotland between 1995 and 1997. He chaired the Conservative Party's Tax Reform Commission and is a member of the House of Lords Select Committee on Economic Affairs. He is also on the Board of the Centre for Policy Studies which today publishes his new paper (co-authored with Corin Taylor), Go for Growth: Cut taxes now to cut debt, which can be downloaded here.

Whoever wins the next election will be faced with unprecedented challenges. The UK economy is in dire straits. For too long we have living on our seed corn, and now we must consume less, tighten our belts and plant for growth in the spring. Public expenditure is close to half of national income, while tax revenue barely exceeds a third. This is not sustainable.

The Tax Reform Commission report, which was published in 2006, argued that public expenditure and taxation were too high and damaging the economy. It set out a programme over a Parliament to achieve lower, simpler and fairer taxes and stimulate growth.

I remember Ed Balls, then a Treasury minister, rushing round the TV studios denouncing the report as irresponsible and unaffordable. Its £20 billion price tag over the whole of a Parliament would shatter economic stability and put at risk spending on the public services, we were told. His words rang hollow then, but three years on the Government has doubled the national debt and has a deficit this year of at least £175 billion. It is clear that a great opportunity was missed.

The Chancellor’s deficit now has to be tackled if we are to avoid a vicious cycle of higher gilt yields and inexorably rising debt servicing costs.

Lord Forsyth of Drumlean was Secretary of State of Scotland between 1995 and 1997. He chaired the Conservative Party's Tax Reform Commission and is a member of the House of Lords Select Committee on Economic Affairs. He is also on the Board of the Centre for Policy Studies which today publishes his new paper (co-authored with Corin Taylor), Go for Growth: Cut taxes now to cut debt, which can be downloaded here.

There is a wealth of academic and practical evidence, from the IMF, the EU Commission and others, that the best way to reduce deficits is to cut public spending. Countries that restrain public expenditure tend to succeed while those which try to repair their finances with tax rises fare less well.

Living standards will fall, unemployment will rise and public services will decline unless we can create new wealth and get our economy growing again. That means curbing the growth of government, attracting international capital and nurturing businesses, entrepreneurs, investors and wealth creators. Last week’s figures showing that manufacturing’s share of the economy has halved under this Government made depressing reading and underlines the enormous challenge ahead.

If the UK didn’t enjoy a competitive tax system when the Tax Reform Commission carried out its work, it's not even on the pitch today. As KPMG’s authoritative surveys show, the main rate of corporation tax was the fifth lowest in the OECD in 1996. Now it is one of the higher rates in both the OECD and the EU. Incredibly, the UK is now ranked 84th out of 133 countries on the extent and effect of taxation by the World Economic Forum – 83 countries around the world have tax systems that are less burdensome and create fewer disincentives to work and invest than we do.

It may make good headlines but the Prime Minister’s plans to hammer entrepreneurs, investors and businesses with higher taxes will kill the golden goose. The Chancellor would be wiser to listen to his backbench colleague, Greg Pope MP, who said last month: “If Gordon really wants to find a dividing line with the Tories here’s one – cut taxes”.

George Osborne has already promised to cut corporation tax to 25% on a revenue neutral basis, by abolishing capital allowances, and to cancel the proposed increases in National insurance rates. These are welcome steps but we need to go much further.

Corporation tax should be cut to 20% to restore Britain’s competitive position and the Government should abandon its foolish plans to raise income tax to 50%. It beggars believe that the Chancellor is reported as considering lowering the threshold at which people begin to pay the top rate of income tax when everyone knows that this is a tawdry piece of political theatre that will do enormous damage to tax revenues and  investment. 

High marginal rates on income tax will result in leakage as clever accountants and investment managers enable people to convert income into capital gains. Capital gains should be taxed at the same rates as income tax with a ten-year taper to a zero rate to encourage long term investment. Stamp duty on share transactions should be abolished. This would boost the stock market and cut the cost of capital to UK companies. (The Tax Reform Commission report contains the arguments for these measures)

Taken together, these proposals reduce revenues by around £4.7 billion, which is around 1p on the standard VAT rate and a small fraction of the cost of supporting the banking system. The German Government is planning tax cuts of 24 billion euros. One silver lining is that because revenues have fallen, the costs of cutting rates are lower and will in time generate additional revenue because of the supply side effects.

Some people say that reducing tax revenues today will undermine efforts to cut the deficit. That’s like saying planting seed corn will leave us with not enough to eat.  We cannot afford to take resources out of the productive part of the economy through higher taxes any more. We need to cut taxes to get growth to cut the deficit and get Britain working again.