Andrew Lilico: Half a dozen thoughts in advance of the Budget

1) Forget Plans B.  The UK does not face a demand problem that fiscal policy can usefully respond to.  Nominal GDP was growing about 5 per cent a year for much of 2010-11 - about the same as its 2000-2007 average (i.e. about the same as in the boom years).  That growth rate shrank to about 3% in the final three months of 2010 as the economy shrank, but the Bank of England is responding to that through additional QE.  There is nothing further for fiscal policy to do.

The fundamental problem is not that there is not enough demand.  It is that the underlying capacity for the economy to grow is very limited. The sustainable rate of growth is only around 1% per year (versus around 2.5% historically), so more rapid Nominal GDP growth just turns into inflation (the key reason inflation has been higher than forecast by many over the past four years).

Attempting some fiscal injection at this stage might be interpreted by financial markets as going soft on spending cuts plans, and would bring the political deliverability of those plans into even further doubt.  That could risk drawing the UK into the sovereign debt crisis.

It is very doubtful whether it is even technically possible to induce a growth spurt if one wanted to at the very high levels of government deficit the UK has.

Even if there were no risk of sovereign indebtedness concerns, and even if a growth spurt were technically possible, it would still be pointless, because all that fiscal policy can ever do is to borrow some growth from the future to provide for today.  Macroeconomic demand management can make the economy grow slower, over the medium-term, than its sustainable rate, if it is volatile, unpredictable, and imprudent.  It can never make the economy grow faster than its sustainable growth rate over the medium term.  Our problem is not that we are growing unnecessarily slowly at present.  It is that our capacity to grow is low.

2) The key macroeconomic priorities should be (a) do whatever can be done to raise the sustainable growth rate of the economy; (b) disentangle the government from the banking sector as much and as quickly as possible, so that if the sustainable growth rate does not increase and consequently the banks go bust, they do not take down the sovereign with them.

3) The key ways the government could raise the sustainable growth rate are as follows:

• Cut government spending relative to GDP.  The government is already committed to cutting spending below 40% of GDP.  If it succeeds, that could add 0.5% to annual GDP growth.
• Raise the efficiency of government spending.  If public sector productivity grew as fast as private sector productivity, that could add 0.5% to annual GDP growth.  Matching private sector productivity growth should be a modest target, since there is considerable scope for catch-up, with public sector productivity growth having dropped one third behind over the decade to 2007.  To achieve private sector levels of productivity growth, use private sector methods - surplus/profit motives; competition; private sector management methods and cultures, etc..  These things will be desperately unpopular, politically.  But they won't be as unpopular as having the banks go bust again and the economy collapsing into another massive recession.

There are three other less important measures:

• Control government debt, avoiding being drawn into the sovereign debt crisis.
• Address demographic pressures.  There could be further pension reforms, raising pension ages farther and faster.
• Encourage households to deleverage faster.  The economy cannot grow sustainably until the debt overhang is worked off.  If interest rates were raised back towards their natural rate, that would induce more rapid household deleveraging and more rapid medium-term growth.  The idea that economies benefit from having the lowest possible interest rate is wrong.  The economy will grow faster in the medium-term if interest rates are at their natural equilibrium rate than if they are below that rate.

4) The 50p rate may well cost money in the medium term and be economically damaging in its own terms.  That is irrelevant.  It serves a political purpose (as do all the tax rises of this consolidation), giving a sense that we are all in this together and so making the spending cuts more likely to be deliverable.  Nothing must happen that undermines the deliverability of the spending cuts programme.

5) Wealth taxes are fundamentally un-Conservative.  The government should not be taxing property.  One of the most fundamental reasons government exists at all is to protect property.  Confiscating property undermines that purpose.  The government should tax the fruits of those exchanges which society makes possible.  In other words, tax should takes a share of the gains trade - of value added.  Taxing wealth means taxing where no value is added, and so exhausting the treasury.

6) The income tax threshold should be raised, to remove people from tax at the bottom.  The most natural way to fund that is by raising the basic rate of income tax.  A rate of 20p is too low.  Lawson's 25p rate was better for the basic rate.  The government should announce a phased rise in the basic rate back to 25p.  What better way to show that we are all in this together?