Tomorrow will see the announcement of the so-called Comprehensive Spending Review. If you believe the propaganda emanating from The Guardian and the BBC you are no doubt expecting massive cuts to public spending. If so, you will be disappointed.
Government spending in 2009-10 was £669bn and is expected to reach £697bn this year. George Osborne’s emergency Budget, which this spending review is intended to implement, aims to “cut” this to £757bn by 2015-16.
This doesn’t sound like much of a cut to me. Of course, it is argued it is a cut in real terms, because spending is planned to rise more slowly than inflation, but it hardly seems to justify the protests emanating from those who have grown comfortable on the enlargement of the public sector over the past 13 years.
The cuts may feel worse than they are because of a couple of factors.
One is the exclusion of the health service from the cuts. It is impossible to make cuts of the amount required while ignoring such a large portion of public spending. Moreover, cuts in health spending may actually improve the service insofar as they remove bloated layers of “management”, monitoring, community engagement, quangos and other nonsense which hampers clinical efficiency, or as the US pundit PJ O’Rourke put it: “If you think healthcare is expensive now, wait until you see what it costs when it’s free.”
Then there is the utterly insane refusal to make any cuts in the overseas aid budget. We may be in danger of inflicting injury through excessive laughter on Singaporeans with the prospect of continuing to send them aid when their GDP per capita is nearly 50pc higher than ours.
It is enough to make you wonder whether the Chancellor has looked at the definition of the word “comprehensive” in a dictionary.
Add to that the escalating cost of interest on our burgeoning national debt and you can see why the cuts may feel heavier than they are effective. But whether or not the cuts are sufficient or even real, we are certainly getting increased taxes. Capital Gains Tax (CGT) and income tax have already been increased and VAT will rise in the New Year.
Try not to regard what I am about to say as special pleading designed to reduce my personal tax bill. As well as a need to implement meaningful expenditure cuts in an effort to reduce the deficit and restore some semblance of efficiency and common sense to public services and welfare budgets, government probably needs to raise tax revenues. The problem is that it is by no means clear that this will result from raising tax rates.
The Laffer Curve is named after the work of Arthur Laffer and was popularised in the 1980s. It is about the relationship between tax rates and tax revenues. It postulates that there is a revenue-maximising rate of taxation and increases beyond that rate may have the effect of decreasing tax revenues. The Laffer Curve has some foundations in common sense. It is the rich and professional classes on whom higher rates of tax fall – not many poor people pay the highest rates of income tax or CGT. Higher taxes may produce lower tax revenues because these individuals may choose not to do additional work or set up or expand their business activities when faced with a higher tax rate. They can take avoiding action, including postponing realisation of investments or even leave the country.
Some are already arguing that the UK has not seen the exodus of financiers which was predicted when the bankers’ bonus tax and the income tax and CGT increases were mooted. HMRC has certainly made it much harder for UK-based workers to relocate abroad and escape UK taxes if they have any family or business ties to the UK. But the longer-term effects may be more subtle.
Last week Peter Sands, chief executive of Standard Chartered, said that it was proving harder to get executives to move to London because of the impact of tax and regulatory changes.
There is also evidence to support the Laffer Curve in practice. During Reagan’s presidency, in which the Laffer Curve was embraced, tax revenues increased even though the top marginal rate of tax in the US was reduced from 70pc to 28pc. Similar effects were observed in the UK under Margaret Thatcher. Of course you cannot do a controlled experiment to eliminate all other factors in a real economy but I will leave you (and George Osborne) with a quote from Winston Churchill: “I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.”
This article appears in today's Daily Telegraph.