Harry Fairhead: Saving grace for all if Chancellor cuts state further

Many commentators, trade union officials and even some economists argued that savings were unnecessary or that they would cause economic meltdown and even mass unemployment. However, they have repeatedly been shown to be wrong.

Since 2010, employment has risen by over one million as the private sector has grown while the public sector head count has shrunk and unemployment is now down to just 5.3 per cent. Similarly, there was no double- dip recession and the economy has continued to grow.

But most importantly those who said there are alternatives to making savings were wrong. Since the 1960s, tax receipts have never raised much more than 35 per cent of GDP despite virtually every conceivable variation of tax policy being tried. The top rate of income tax in the 1970s was over 80 per cent, corporation tax has ranged from over 50 per cent 40 years ago to 20 per cent now and VAT has been anything from eight to 25 per cent in the same period. And yet, total tax receipts have stayed virtually the same at just under 35 per cent of GDP.

So those who argue that deficit reduction could be achieved through raising taxes need to remember that no matter what you do, somewhere around 35 per cent of GDP seems to be the limit of what can be raised. If we want to return to living within our means we need to recognise that reducing spending is the only option.

Yet, for all the talk of deficit reduction, public spending this year will still be some £70bn more than total receipts and our national debt continues to grow. The Chancellor needs to go further.

In order to hit his target of spending 36.3 per cent of GDP there needs to be a step change in the way we think about the role of the state. This is why the TaxPayers’ Alliance produced a spending plan earlier this year which detailed 41 policies that would help the Chancellor to hit his fiscal targets.

We didn’t just recommend salami-slicing budgets but instead argued that entire expenditure programmes should be axed. Policies we advocated ranged from welfare savings to the closure of several government departments to the scrapping of the Barnett formula, making it a comprehensive “how-to” guide to deficit reduction.

But not only did we offer a manual for getting spending back within our means, we also produced a guide to reducing state spending to 31.7 per cent of GDP in order that the tax reforms we advocated in our 2012 publication The Single Income Tax could be implemented. In this, we argued for reforms to introduce tax simplicity, remove double taxation and most significantly merge all taxes on income into one single rate.

These reforms form part of a very important point: that the state should be significantly smaller than it is now. Government spending has a statistically significant negative impact on growth – studies show that every percentage point increase in government spending as a share of GDP correlates to reduced economic growth of between 0.1 and 0.4 per cent.

The practical upshot of this is that if the state had only spent 31.7 per cent of GDP every year since 1965, average household income today could be as much as 80 per cent higher – an eminently desirable proposition.

In the 2015 general election one of the Labour party’s best arguments was over the cost of living and while their solutions may not have won over the public they made the valid point that life is very expensive. But this is hardly a surprise when, for example, 70 per cent of the price of a litre of petrol is fuel duty and VAT, and restrictive planning policies mean that rents are going through the roof. The burden of the state is so great that the poorest 10 per cent of households hand over up to 45 per cent of their income in taxes. It is obvious that we have a cost of government crisis which can only be resolved through lower taxes and a reduced role for the state.

This would not only begin the long journey of shrinking the national debt but it is also the morally right thing to do. A smaller state and consequentially faster economic growth would raise living standards more surely than any state-operated (and taxpayer-funded) welfare transfer.

The Chancellor spoke in the summer Budget about his desire to make Britain a low tax and low welfare country and the Comprehensive Spending Review is a rare chance for him to do so by making savings and setting the country on a more prosperous course.

Harry Fairhead is the policy analyst at the TaxPayers’ Alliance.