Lord Flight: The Treasury needs to be more imaginative when it comes to tax

Lord Flight is a former Shadow Chief Secretary to the Treasury who is now chairman of Flight & Partners Recovery Fund.

Most of the contributions I have seen so far on how to raise economic growth have been either more political than economic or offered little.  The Chancellor’s/Government initiatives so far have been less than successful.  While it is true that many SMEs would like more money, often what they need is equity finance and not loans, for which they are not credit worthy.  Moreover, many businesses large and small are, understandably, in a mode to build up cash reserves against difficult times.  I observe from case studies that some of the large banks have behaved unhelpfully to SME clients, but others are making a real effort to help.

In arriving at a diagnosis of what measures might be helpful to increase growth I suggest the following points are axiomatic:

• Time will tell to what extent, if any, the UK economy has contracted this year – but my own observation is that the Government figures are likely to have an inbuilt negative bias and I suspect the eventual corrections, e.g. in 2 years’ time – will show no double dip recession and marginal growth this year.

• The continuing level of budget deficit of £128bn per annum is unsustainable and unless brought under control in due course will risk encountering problems similar to those of Greece and other Southern European economies.  The Treasury expects the national debt to increase by 40% by 2016, to nearly £1.5 trillion.  Simply, borrowing and spending more is not an option.

• Recent excellent research from Harvard has demonstrated that tax increases, rather than spending cuts, plunge economies into deeper and more long lasting recessions.  Experience about the world shows that adjustments based on Government spending cuts are much less costly in terms of output losses than those based on tax increases.  The Krudman/Stiglitz assertions that spending cuts have a more damaging effect on growth than tax rises, are simply, empirically, wrong.  Spending based adjustments have been associated with mild and short lived recessions where tax increases have been associated with prolonged and deep recessions.  Essentially, business and investor confidence recovers much sooner after a spending based adjustment than after a tax based one.

• There is little or no scope for economic growth based on debt financed, increased consumer spending.  This was pushed beyond prudent limits for 10 years under the Labour Government resulting in massive increases in personal indebtedness.  Household debt rose from 90% to 160% of disposable income over the decade to 2007.  Moreover, with Government also borrowing too much at the same time (effectively Labour created a structural deficit of £100bn at the top of a long, economic cycle), unless there were a major reduction in public sector spending and public sector consumption, permitting tax reductions, growth has to come from either rising exports, capital investment or self-financing, supply side reforms.

• There is a self-evident case for greater capital spending on infrastructure, where it is demonstrably needed.  From my days as MP for Arundel I continue to sight the A27.  This should be at least a Dual Carriageway from Dover to Bournemouth as the main East-West artery of Southern England.  Yet it continues to have terrible bottlenecks through Worthing and around Arundel causing unnecessary and major queues and congestion.  I tried to get the Labour Government to address this problem and it is a great shame that the Conservative-led Government has not done so.  But in the main, where infrastructure investments make good economic sense, the private sector should be willing to finance them.  For road investment, a more imaginative approach is needed which could involve privatising some established motorways to raise the funds for other road improvements, like the A27, which are not practical for private financing.  Thought should also be given to arrangements such as apply in Switzerland, where to use Motorways all vehicles, including those from overseas, have to buy annual user tickets, displayed in their cars, - or are fined!  This would be a new source of revenue for pressing investment needed in our road infrastructure.

• I do not think the case for much greater house building is analogous to the 1930s and 1950s situations when there was real mass demand for more family homes.  Today, projections for growth in the number of new houses needed depend substantially on the number of people per housing unit falling further, to little more than one.  But it looks as if this trend has stopped and, is if anything, reversing.  Younger people now need to continue to live in their family home for longer in order to accumulate the down payment for a property.  There may be a case for constructing more accommodation for rental, particularly in London and the South East, but it is clear from the market that the demand, on a sensible commercial basis (i.e. not borrowing too much) for much more housing is not there.

• Many economists bang on about supply side measures, but rarely give any good examples of what they mean by this.   It strikes me, forcibly, that what the Chancellor and Treasury should be looking at, is tax changes/reductions which will demonstrably increase economic activity and pay for themselves – what I call “Laffer measures”.  By way of example, it has been demonstrable that the tax cost of EIS investment incentives has been more than offset by the Corporation Tax, Income Tax and VAT tax revenues, generated from the businesses which EIS investments have achieved or boosted.  Reflecting this, it was unwise of the Government to “give with one hand” in terms of sensibly widening the company size and parameters qualifying for EIS incentives, but, “with the other hand” discourage EIS investment by limiting EIS loss relief to £50,000 p.a.  This has changed, materially, the risk-reward ratio for EIS investment; and, not surprisingly, already led to a reduction in the volume of EIS issues.  Other measures which Government might sensibly address are the lowering or abolition of capital gains tax on gains achieved beyond a 2-year holding period.  It is demonstrable that the misallocation of resources caused by Capital Gains Tax costs approximately 0.5% p.a. of economic growth.  The lost CGT revenues, if CGT were abolished on gains on assets held for over 2 years, would be more than offset by the tax revenues resulting from the boost this would give to economic growth. My business partner at Guinness Flight in the 1980s and 1990s, came up recently with a fully worked plan for boosting growth by offering home owners tax relief on repairs and improvements for 3 years.  This was his entry for David Smith’s Competition for a new edition of his book “Free Lunch:  Easily Digestible Economics”.  Here again, Tim was able to demonstrate that the tax revenues from increased building activity and employment would more than offset the costs of the tax relief – in particular black economy operators would not be able to qualify for the scheme.

The Treasury needs to be much more imaginative in focusing on specific areas where tax changes and tax reductions would work to stimulate increases in economic activity and, quickly, more than pay for themselves.  When I was Shadow Chief Secretary to the Treasury such thinking was anathema – the impact on economic activity and employment resulting from given tax changes was not to be taken into account in assessing the cost of the tax reductions.  Although there is a point that the changes in economic activity and resulting fiscal revenues can only be estimated and not known for certain – this is the area where I suggest it would be correct for the Treasury to be bolder and more imaginative.  There are other specific territories, beyond those I have described above, where there is scope for both simplification of the tax system and tax reductions to be more than self- financing.  This is what I understand by supply side reform.