The tendency for chancellors to make poorly targeted giveaways in their Budgets puts the public finances in danger. George Osborne needs to show tomorrow that he will not repeat that mistake
Claims that the Chancellor is meeting or beating his fiscal targets need to be taken with a pinch of salt. In June 2010 the Chancellor set a target for eliminating the structural deficit by 2014-15, but in the Autumn Statement last year this was shifted to 2016-17. The Autumn Statement also saw the target for public sector net debt for 2014-15 lifted to 78.0 per cent of GDP (it was 69.4 per cent). Far from being out of the danger zone the public finances remain fragile. Public sector net debt is still expected to increase by £471 billion over the next 5 years.
It is sometimes argued that, in spite of this fiscal position, further fiscal loosening would make the task of rescuing the public finances easier. This is based on a view that a loosening of the fiscal position would increase economic growth and, in turn, create additional tax revenue to fund consolidation. But the size of these 'multipliers' should not be overstated. The IFS has noted that a loosening of £20 billion would increase GDP by 0.1 to 0.2 percentage points. This is equivalent to around £1.5 billion to £3 billion, and if 36 per cent of this was collected in tax then revenue would increase by £0.54 to £1.08 billion.
Further, this fiscal loosening would not be costless. Such a dramatic change in fiscal policy would be likely to increase the interest that the government pays on its debt. The Treasury estimates that a 1 percentage point increase in interest rates would lead to an additional £21 billion in debt payments from 2012-13 to 2016-17.
Fiscal discipline should not just be a political slogan but a part of everything the government does. This includes tax reform and the 50p tax rate. While the tax system would clearly be better without the 50p rate, scrapping this should not be a priority. The 50p tax rate is not the biggest challenge facing the tax system and is probably not as damaging to entrepreneurship and enterprise as other policies, such as restricting visas for skilled migrants from outside the EU or clawing back personal allowances and pension tax relief. There is a risk of replacing the 50p tax rate with something worse, such as a pension tax raid or a poorly designed tycoon tax or general anti-avoidance rule.
It would also be wrong to increase the personal allowance as only a small amount (£1 in £14) of the tax relief provided by an increase in the allowance to £10,000 would go to families with incomes below this. This policy would also make the tax system more prone to avoidance. As Reform illustrated last week, increasing the personal allowance has meant middle income families that own small businesses can benefit by an extra £600 through tax planning (using the company to split income between husband and wife) and by an additional £750 with an increase in the allowance to £10,000. As HMRC data show, SMEs already account for around 50 per cent of the tax gap (the difference between what should be and what is paid in tax).
The Budget would provide the perfect opportunity for the Chancellor to admit he took the wrong approach to means-testing child benefit. Child benefit is expensive and gives too much to wealthy families. Yet the policy of withdrawing the benefit from families with top rate taxpayers was never going to work as it involves targeting a benefit based on the family unit with an income tax system that uses the individual as the unit of assessment. The better approach would be to simply scrap the child benefit and use an existing means-tested benefit, the child tax credit, to ensure that the lowest income families do not lose out from this change.
The tendency to judge Budgets by the size of their poorly targeted giveaways has put the public finances on a dangerous course. The Chancellor needs to show that he is not about to repeat this mistake. He needs to emphasise structural reform rather than giveaways. And, most importantly, he needs to show that the high watermark for fiscal responsibility in this government has not already passed.
Dr Patrick Nolan is chief economist of Reform
