Both tax increases, announced by Sunak when he was chancellor, are damaging. National Insurance is a tax on jobs which discourages employment and increases business costs, as well as reducing disposable income. Reversing the recent increases in National Insurance contribution rates, far from being inflationary, would help to combat inflationary forces.
The planned increases in Corporation Tax would hurt business investment just when we need to stimulate it. They make the UK much less competitive internationally and therefore discourage international mobile phone companies from locating or increasing their operations here.
It is true, however, that tax cuts would tend to increase aggregate demand and therefore, other things being equal, would put even more pressure on the Bank of England to raise interest rates. Some critics would argue that the net result could be no overall boost to demand at the expense of higher public debt.
They may be right. But that’s not all about aggregate demand. The supply side is crucial. In this sense, there are some features of such a different policy mix that they are attractive. The cuts in the Insurance and Corporation Tax would put us in motion the task of structuring the fiscal system to enhance incentives.
In the meantime, it would probably be more helpful for the supply side of the economy to return interest rates to normal, especially since this would put zombie companies under financial pressure. Higher interest rates would also tend to take the heat out of the housing market, while boosting incomes for savers who have had an extremely raw deal in recent years.
However, tax cuts that would merely reverse recent tax increases will not revolutionize our economic performance. After all, we were hardly doing spectacularly well before these tax hikes were announced. So this dispute over whether and when to cut taxes is really a form of shadow boxing.
The great battles are yet to be fought. Liz Truss has said she would not impose “Austerity Mark Two”. I guess what he means is that he would not support the kind of restraint on public spending that George Osborne enacted. This austerity was really unpopular. It could also be argued that it was too intense and poorly structured.
However, if we are to achieve a serious reduction in tax rates over the next few years while reducing debt as a share of GDP, then government spending will have to fall as a share of GDP.
Perhaps the trick is all in the words used to describe this process. “Austerity” certainly doesn’t sound right. And, at least when applied to public spending, the word “cuts” doesn’t sound appealing either. However, a fiscal policy dedicated to the cause of lowering taxes does not have to mean “cuts” in public spending. It just means very tight control so that spending numbers don’t rise as fast as GDP. This does not seem too difficult, but achieving it will require an iron will and great political strength and determination.
However, even sweeping tax cuts alone will not be enough to transform our economic performance. As I have often argued here, we need truly radical policies to increase productivity in both the public and private sectors. These will include measures to curb union power, reform and reshape the education system, reform the NHS, reduce and redesign the civil service and promote competition across the economy.
As it happens, achieving these things will require the same qualities as reducing the tax burden by reducing the share of public spending in GDP. But we still don’t know which of the two candidates is more likely to display these qualities.
Roger Bootle is chairman of Capital Economics