The Times - Cut taxes, cut spending. That's the only way

Today, The Times published my views on how the UK can extract itself from the economic bind in which it currently finds itself with zero growth. I outline the key messages that George Osborne and Vince Cable need to take on-board. In short we need to stop the notion of pretend austerity and make noticeable reductions in public spending whilst stimulating the economy through a programme of tax cuts.

Here is my comment in full:
 
Cut spending and taxes. That should be the message that George Osborne and Vince Cable hear today from the business people attending The Times CEO Summit. You cannot borrow and spend your way out of a debt crisis.
 
So-called Keynesian solutions will not work in these circumstances - the bond markets limit your scope for spending, as the eurozone has discovered. Just because the UK has so far retained its triple-A status and low borrowing costs does not mean that we are immune from this. The market takes a benign view of the UK because we are outside the train wreck going on in the eurozone and because of government rhetoric about cutting spending. But there are almost no cuts: public spending in 2011-12 was £681 billion against £689 billion in 2009-10, Labour's last year in power. Our debt is rising significantly at more than £100 billion a year. As a percentage of GDP we are more indebted than Spain.
 
The only solution is to cut the size of the public sector, which is 50 per cent bigger now in real terms than a decade ago. What did we not have from the Government ten years ago that we cannot live without now? Nothing. Get it back to where it was then.
 
Having made the markets supportive as a result of that policy of spending cuts, the economy can be stimulated by cutting taxes. Money is spent more effectively by those who earn it than it is by governments.
 
Nothing can be sacred in these cuts, and that includes the health service. Two reforms are required: first, the proportion of non-clinical staff to clinical staff needs to be cut to less than 1:2; and, second, the NHS should be restricted to covering, for example, just oncology, pregnancy and genuine A&E - all of which might be difficult to insure privately or inhumane to refuse to supply. Everything else will have to be purchased privately.
 
Pensions cannot be ignored. The first social security system was implemented by Bismarck and he set the retirement age about six months short of the average life expectancy. This was not a coincidence.
Pensions are merely claims by those no longer in work on those still working. We cannot support an ever-growing non-working proportion of the population as people live longer.
 
The statutory retirement age for public sector workers and state pensions needs to be raised significantly - by more than ten years; most of the population's pension provision must be provided from their own savings. (These reforms are not impossible - the President of Brazil, a former Marxist, has just implemented something very similar.) Then the Government should establish a fund with investments that will insure all future state pension entitlements.
 
This should be part of a general move by the Government to accrual accounting; government accounts are at present produced on a basis that would attract criminal legal sanctions in the private sector. This will bring "on balance sheet" future benefits, healthcare and pension liabilities and, let's hope, would stop politicians making promises for which the bill only falls due long after they have left office.
 
You can tell this is the right way to go as the Government is moving in the opposite direction, having recently announced that it would transfer the Royal Mail fund, which has £28 billion of assets and £37.5 billion of liabilities, to the Exchequer. The assets will be used to reduce the figures for government debt and the liabilities will simply disappear from view.
 
Mr Osborne should make it clear that we will not contribute to any rescue of the eurozone, directly or indirectly. In particular, we will not increase our International Monetary Fund contribution unless this is explicitly and irrevocably excluded. We should renegotiate our relationship with the EU with a requirement that our contribution to the EU budget (currently £50 million a day) is reduced by at least 90 per cent. If necessary we should leave the EU to achieve this.
 
We should not be worried about leaving. The EU is the least competitive trading bloc in the world as it sinks into a morass of regulation and social spending. The EU will still need to trade with us: count the number of Audis, Citroëns, BMWs, Fiats, Mercedes, Peugeots, Porsches, Renaults, Skodas and VWs on our streets. Do you think they can afford to cut that off? The EU has a positive trade balance with the UK that it cannot afford to lose. Once we have renegotiated our position, we should hold a referendum on continued membership on those terms.
 
Overseas aid should be stopped immediately to any country that has GDP per capita higher than the UK; or a nuclear weapons programme; or more billionaires than the UK.
 
Cease all measures to support or "rescue" the housing market. The obsession with home ownership and house prices is part of the UK's problem, not the solution. We cannot become wealthier by selling each other more and more expensive houses. Houses cannot be exported. It is no coincidence that in the most successful economy in Europe, Germany, less than half of people own their home.
 
Stop subsidies for all alternative energy sources. Wind power does not work - full back-up capacity needs to be built to cope with cold and still conditions in winter. Solar power is not economic in the UK for obvious reasons.
 
To quote M&S: there is no Plan B.

 

Comments

[Dermot Driscoll]

Great ideas but politically impossible to action with a coalition government or by a single party with re-election in mind!
So further national decline seems the only future.

[Colin Mckenzie]

I agree 100% with these proposals. But if they were used as the basis of a political party's manifesto they would be totally rejected in a General Election. Not enough people will vote to remove 'free beer for the workers'. So have we reached the position where we know what we should do but the democratic process prevents us from doing it?

[prohyp]

"This was not a coincidence.
Pensions are merely claims by those no longer in work on those still working. We cannot support an ever-growing non-working proportion of the population as people live longer."

I would take issue with you on that point Terry, if only because you fail to acknowledge that those of us who had to start work at 14 or 15 had no choice other than to pay into a scheme devised by the Government for provision of a pension in our so called old age. In many cases individuals did not recover the amount paid in due to premature death, or worse still payments were suspended during periods of hospitalisation, a situation that remains unaltered today.

As you aware the second state pension was an optional scheme, which many of us opted into. Is the fact that the actuaries got it wrong a reason why pensioners should be penalised?

[Alan Butterworth]

There is much I agree with in the article and I look forward to your views on areas for cutting government spending. I would have cut the Olympics (a huge fraud), the Royal Jubilee (I know the Queen does a worthy job but in what other situation do you have to pay for the entire extended family and 700 servants), a few un-winnable foreign wars...

However, I think the NHS is an enormous social good and should be supported. No doubt it is inefficiently run and should be reformed but it is grossly simplistic to suggest that all other treatment areas than the few you suggest could be privately insured. Most people who have used private medical insurance have found it to be hedged about with all sorts of restrictions. It also comes with its own waste and inefficiencies. You have the example of the USA where healthcare is massively expensive and yet life expectancy is lower than in Cuba. (I am not advocating the Cuban economic system, by the way).

I would also take issue with your views on pension provision question. It is not the fault of ordinary working people that governments have chosen to run National Insurance as a ponzi scheme. Although life expectancy has risen, the added years are often ones of survival in poor health. The employment situation would have to be improved beyond any realistic hope before such people will be employable.

[Terry Smith]

Prohyp: Please don’t think that I do not sympathise because I do. But the fact is that those pension liabilities are unfunded: the government spent those contributions when it received them. That is why I think pensions should be funded with separate investments. As I point out, the government is moving in the opposite direction with the Royal Mail fund.

Colin McKenzie and Dermot Driscoll: You are probably right to point out the difficulty in getting elected with such proposals although there is the Canadian experience of widespread acceptance of spending cuts of more than 10% in 1995. In any event, I think such measures will have to be applied sooner or later and the right time to do so is as soon as you realise they are necessary, preferably at the outset of this government so that there is some chance of some benefit being realised before they have to stand for election again. As things stand, it seems more likely that the government’s obviously erroneous assumption that economic growth will dig them out of the hole will leads to some of these actions being applied just before an election. I also take the view that a politicians job should be to show some leadership.

[prohyp]

Thanks for you acknowledgement Terry. Now if only someone could persuade that smug, arrogant, overgrown schoolboy, we have acting as Chancellor, to acknowledge that he has been promoted beyond his capabilities and to step down.

[MickC]

Yes, I agree with your proposals.

I also agree that the UK infatuation with housing is unhelpful. However, there is some background to that because, as I have stated before, there are no really good investment vehicles for the ordinary person to put their money into. They are usually geared to making money for the managers who take their cut whether there has been good performance or not. Again as I have previously stated, many (most?) people regard the City as a ramp to take money from the ordinary citizen (note the report today that UK pension funds performance is among the worst on the planet). Until this is fixed, housing it will be.

People need a house to live in, it won't evaporate as money does in some funds. So naturally people have faith in houses-they need them anyway.

Also I have never understood the point about most people in Germany renting. Somebody must be the landlord and receive the rent. It must be profitable for that person to do so otherwise house prices would drop until it was-simple market forces. If it is profitable to own to let, it must be beneficial to actually own. Surely there must be some regulation of the market which makes it better for mot people to rent-but we are never told what that is.

[Terry Smith]

Mick C: I completely agree with you about most investment vehicles, the City and pension funds which is why I launched my own fund: www.fundsmith.co.uk which charges a flat 1%. German housing has seen little or no price appreciation so that the purchasers of houses, whether they are the funds who buy them to rent out or individuals who buy their own house do not expect to make anything from capital appreciation, that is the significant difference. In the UK individuals are under the illusion that if they buy a house to live in and it goes up in value they have made money. They forget that if they sell it, they need to buy another house to live in which will also have gone up in value. The technical term for this is “money illusion”. We also have the problem in the UK that successive governments including the present one have incentivised people to own houses. As a great man once said if a Big Mac costs £3.70 and you invest £3.70 today in a fund which doubles in value in a year but so does the price of a Big Mac, you may feel richer but you don’t eat any richer.

[Terry Smith]

Prohyp: As Clint Eastwood said in Dirty Harry “A wise man knows his limitations".

[Roland de Gustibus]

I agree absolutely about public finance accounting, and that people need to work longer. However the society I would like to live in would provide excellent healthcare (and education) because I think a healthy educated population is fundamental to prosperity. I don't think the private sector always allocates capital better than the public sector, the financial crisis is evidence of that, as is the success of relatively highly taxed and more equitable Scandinavian economies, so the size of the public sector is less important than that it is properly funded - and that might mean raising taxes, especially for the wealthiest. It definitely means being honest about how it's funded.

[Terry Smith]

Roland de Guttsibus: I too would like a state education system which is at least fit for purpose, after all I am a product of it, and please note that I have not suggested any change in spending on the education system, although I would certainly suggest some changes in its operation. As for wanting excellent healthcare, I think that the provision of limitless “free” high quality healthcare is an unattainable ideal. I would suggest this is borne out by the fact that despite the seemingly limitless money spent on the NHS, the recent King’s Fund survey shows that user’s satisfaction with the NHS is at a 30 year low. The ideal of limitless free quality healthcare is like the myth of Sisyphus: the more you provide, the more you will have to provide. I suspect that at least some users of the NHS are beginning to realise that it is an unattainable goal. As for raising taxes on the rich I suggest you check out the Laffer Curve, I would guess that raising taxes on them, or indeed on society as a whole, will lead to a lower tax take. We always get the Scandinavian example cited, but most research I have ever seen shows a clear inverse correlation between the size of the state and taxes, and economic growth. Capitalism is not perfect, it is just better than the alternative. It will always produce some mistakes in the allocation of capital, but the main problem with this is not the private sector-it is when people do not let capitalism do its work. When capital is misallocated by the private sector we need to see companies which are involved fail, including banks, and countries default. It is when we get interventions from politicians and central bankers to prevent these inevitable and beneficial consequences occurring that it produces bad results, like we have now. State intervention can be highly beneficial, Singapore is a good example, but interestingly it is combined with a low tax environment.

[Terry Smith]

Alan Butterworth: Apologies for the delay in response but I overlooked your comment. I agree with all the additional areas of spending which you would cut. The trouble is that we are in such a mess financially that we cannot recover from it without cutting the largest items of expenditure-welfare and health. I didn’t say that some form of NHS is a not good thing or that shouldn’t be supported, rather that the scope has to be curtailed and it has to be run better. Please note that when I named some areas it might be restricted to I said ‘for example’ since I acknowledge that I have neither the clinical nor the insurance expertise to define those limits, although interestingly I named those areas after discussing it with a friend of mine who is a consultant surgeon. Of this I am sure: limitless “free” quality healthcare is an unattainable ideal which has the same drawback as the myth of Sisyphus: the more you spend, the more you will have to spend. I also think that many NHS users are beginning to work this out-the recent King’s Fund survey shows the highest level of dissatisfaction with the Service for 30 years. The Cubans of course run a number of projects in order to contrast their system with the American capitalist system close by. You can attain a good level of health service in such circumstances, but only at the expense of other aspects of welfare-take a look at the overall living standards of the Cuban population.
I also agree completely that it is clearly not the fault of the people who have contributed to the state pension scheme that it has been run as an unfunded Ponzi scheme, but the issue of blame or fault is sadly secondary to the fact that the burden is now unsupportable. Whether you agree with me or not, I assure you that these pension entitlements will be eroded through devices like increasing the pensionable age, switching to indexation which does not truly reflect the increase in the cost of living and simply though inflation. I would prefer some basic honesty about what is going to happen.

[Drofsopkcin]

Bearing in mind that USA spend more than we do on healthcare and have worse outcomes, I'm wondering if your thinking is more idealogical than based on expert knowledge. No offence intended.

You query why government still spending so much, similar to last year of Labour. Rising unemployment, increased demands in economically tough times, can't really throw people to the wolves.

Or is that the idea?

[Terry Smith]

Drofsopkcin: I don’t think I am coming at this from an ideological standpoint but from a practical one. There is not sufficient money with which to pay for the existing state spend and it needs to be radically reduced in order to reverse the deficit and begin to reduce the unsupportable level of government debt. The problem is of such magnitude that it will be necessary to make cuts in the largest elements of state spending-health and welfare. I am confident this will happen whether you agree or not. The only debate is the manner in which it will do so. For example, will there be explicit reductions in pension entitlements or will they be eroded by a combination of higher inflation and an indexation process which ignores many elements of that inflation. Similarly, will we limit the scope of the health service and relieve it of the burden of its burgeoning administrative staff or shall we simultaneously bankrupt ourselves whilst watching the standard of service deteriorate?

[RussH]

This is a list of countries with tax revenue as a percentage of GDP.

https://en.wikipedia.org/wiki/List_of_countries_by_tax_revenue_as_percentage_of_GDP

I notice some of them are not top of the list of places the extremely rich want to be, neither do they seem to contain any companies normally considered to be the kind of innovative companies proponents of low tax regimes claim to produce.

Afghanistan 6.4%
Algeria 7.7%
Central African Republic 7.7%
Congo, Republic of 5.9%
Guinea 8.2%
Iran 6.1%
Nigeria 6.1%
Yemen 7.1%

In addition the post war economic expansion took place where government investing was high and so was taxation so I cannot see how you can claim that low taxes and low government expenditure are required for economic growth. Its also worth pointing out that the internet came about from work funded by the government and so did the world wide web, the mess we are in at the moment is largely caused by private enterprise.

You can have low tax regeimes that have little government like Singapore, although it is an authoritarian regime, is that something you wish for?. However you can also have successful economic systems that are not such as the Nordic model.

If it was true that it was a requirement for a successful economy for there to be low government spending and low tax then we would not have had the post war economic expansion and the Nordics would not be as wealthy as they are. So on the evidence, your premise looks false.

[Roland de Gustibus]

Thanks for your reply.

Your final point on politicians and central bankers not letting capitalism do its work leaves me in a quandary because I agree, politicians do spend beyond our means to curry favour with the electorate and rescue banks to avoid the opprobrium of a collapse on their watch. And (certain) capitalists make off like bandits as a result.

The problem is I don't accept that capitalism would operate unchecked in the common interest. So really neither democracy or capitalism are perfect, and together they're most imperfect.

Regarding the health service. It isn't unlimited. It has a budget. We can argue whether it is too big or too small, but my disagreement with you is that insurable conditions should not be part of it. I wonder if there's evidence that insurance would provide better healthcare at the same cost as the state for most people? I'm doubtful it would.

The thing about the Laffer curve is understanding at what point tax begins to act as a sufficient deterrent to work to lower the take. I still do overtime at 40%, so 40% is not a deterrent to me. I think the Scandinavians pay up to 60% yet they have a bigger per capita tax take.

On Growth and Tax, Martin Wolf wrote an article and published a chart, showing the two are uncorrelated. Those high tax Scandinavian countries appear to be growing just as fast as their Anglo Saxon counterparts. It's here on his blog: http://blogs.ft.com/martin-wolf-exchange/2012/05/31/taxation-productivity-and-prosperity/%23axzz1w9ZnxCfg

[Terry Smith]

Roland de Gustibus: I agree that unbridled capitalism is not the ideal, but I’m sure that not allowing capitalism to work during the past 15 years or so has stored up some serious problems. I am aware of Martin Wolf’s article. By the way, your link to it doesn’t seem to work-try this one: http://blogs.ft.com/martin-wolf-exchange/2012/05/31/taxation-productivity-and-prosperity/#axzz1y8TZCspt. However, apart from Antonio Afonso’s research http://www.repository.utl.pt/bitstream/10400.5/2139/1/ecbwp849.pdf which was mentioned by Jon Moulton on Newsnight, take a look at: 1. The 2011 paper by Davide Furceri and Ricardo Sousa who studied 145 countries over 47-years and found that every one per cent of GDP rise in government spending reduces private consumption and private investment by 1.9 per cent; 2. The 2008 study by Asa Johansson and colleagues of 21 OECD countries over a 35-year period found that every one per cent rise in tax as a share of GDP is associated with a 0.14-0.27 per cent fall in GDP; and 3. The 2009 study of 15 EU member states by Mihai Mutascu and Marius Milos which found that the optimal public spending share of GDP was 30 per cent. Public spending in the UK is close to half of GDP today. One problem with the Laffer Curve is the difficulty of determining the tax maximising rate, but assuming it has some validity, just raising the tax rate will not work at some point. As for the NHS, whilst there is a budget it is ever growing. We may or may not get better outcomes from private insurance but at least it will focus individuals on the need to make choices which is easy to ignore if we are paying collectively.

RussH: I suspect most of the countries you name are low tax regimes because of the difficulty of tax collection rather than in an attempt to promote economic growth. Singapore is indeed a good example of a low tax, high growth regime. I am not sure whether or why that is inextricably linked to limits on democracy. There are also the examples of studies I quote to Roland de Gustibus which show inverse links between the size of government spending and economic growth. I disagree that we are in this situation because of private enterprise. I think the failure of successive governments and central bankers to let the market cycle work are at the root of the problems. The world wide web was indeed invented in the UK with government money and how much did they make from its commercialisation?

[Russ_H]

Thank you for replying. I also suspected there are other reasons behind the low growth of the states I mentioned and their poor economic performance, it was just a flippant way of pointing out coincidence is not the same as causality.

I can see why it might be tempting to correlate poor economic growth with high public spending but you only need one counter example to prove the theory wrong, just as you only need one black swan to disprove the theory that all swans are white.

As a matter of interest the WWW was not invented in the U.K., it was invented in Geneva where Tim Berners-Lee was working at the time for CERN.

In answer to the question how much do Governments make from it, the answer is quite a lot. The people employed get paid and they pay tax which is collected by the Government. The fact that the Corporations employing them seem to avoid it is another subject. Quick question. Why are Corporations not paying tax heroes in the City and Greeks not paying tax villains?