Tax Trouble for the Tories

Sunak's tax rates are too high to justify financially or morally. But Liz Truss has already promised too much, too soon, and that would be just as bad (if not worse).

Lately, people have been asking me what I make of the Tory leadership race. Who is my candidate? Who do I hope makes it into the final two?

I think the race can be best summed up by two fantastic quotes. I’ll run through both in turn.

The first quote is short and sweet. H. L. Mencken once observed that:

“For every problem, there is a solution that is clear, simple, and wrong.”

I’ll give two examples. Rishi Sunak thinks cost-of-living tax cuts can wait. Liz Truss thinks we can make big cuts in taxes right now with no consequence. Both are clear, simple, and wrong.

But to explain just why these approaches are so troubling will require the other quote. It’s from a famed Scots philosopher, Alexander Fraser Tytler. Usually, this quote is wheeled out in response to socialist demands for massive public spending. But this time, it’s more aptly applied to the discussion around tax cuts. Often cited (and more often misquoted) by Ronald Reagan, this second one is significantly longer:

“A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship. The average age of the world's greatest civilizations has been 200 years. These nations have progressed through this sequence: From bondage to spiritual faith; From spiritual faith to great courage; From courage to liberty; From liberty to abundance; From abundance to selfishness; From selfishness to apathy; From apathy to dependence; From dependence back into bondage.”

Taken together, I’d argue quotes aptly summarise the biggest problem with the Tory leadership race.

Solutions are too simple, and no one is taking the balanced, pragmatic approach necessary to navigate the costs of the pandemic, help the worst-off in the cost-of-living crisis, and get this country back on track.

The promises that are on offer have the same problem Corbyn’s did - they’re not the result of a sound fiscal discipline, but of electioneering.

The word on everyone’s lips is ‘taxes’. Why is everyone talking about taxes? Well, this is a race first and foremost for Tories. And Tories like tax cuts. Tories like tax cuts like Paddington likes marmalade, ducks like bread, shoes like laces, and so on and so forth.

And if Tory party members like tax cuts, Tory MPs like tax cuts even more. But why?

The logic of the Laffer Curve can help to explain. It argues that if you cut rates, allowing businesses to invest their profits in making their businesses more productive, you can raise revenues, even at lower thresholds. This simple fact was evidenced time and time again, first by Kennedy, then by Thatcher, then by Reagan, and most recently by the Cameron coalition.

These profits to businesses have a two-fold benefit to everyday working people. First, as their places of work become more productive and profitable, wages, working conditions, and benefits inevitably also increase. Second, even at lower rates government coffers see a significant increase in tax revenues, allowing for spending on (temporary) welfare and productive infrastructure investment. As John F. Kennedy once said, “a rising tide lifts all ships.”

So, there’s no question that taxes in this country are too high and growth could be spurred by slashing them. It’s not surprising, because to be fair to Sunak, we did just experience a once-in-a-lifetime worldwide pandemic and a once-in-a-lifetime populist Tory socialist government who ran on a manifesto of massive public spending and a number of tax and finance commitments that they’d obviously need to break to fund it sensibly.

Not only are taxes too high for practical growth, but they are also too high to morally justify. VAT on fuel and the rise of National Insurance for the worst-off make very little difference in the grand scheme of this country’s finances but make a big difference to families around the country who are stuck eating dry toast because 1kg packs of Lurpak are now worth enough to justify a security tag.

There is no question that Boris Johnson (and his Chancellor Rishi Sunak) are singularly responsible for the state of the country’s tax burden. Sunak’s argument that ‘I had to save the country’s finances from Boris’s excessive spending demands’ doesn’t really wash. If he really thought Boris’s policies were that bad, he probably should have resigned before he implemented them.

But there’s a huge flip side to this that implicates Liz Truss just as much. The quest to cut taxes is important, but there is one massive consideration one must take time to work out before one does so – and to the best of my knowledge, Liz Truss has never publicly addressed it.

Tax cuts cost money – at least in the short term. Although the logic of rates and revenues are sound, Reagan found out in his first term that they cannot be expected to pay for themselves immediately. A massive hole in the budget appeared only a few years after Kemp-Roth and, having not cut enough his spending demands, was forced to increase taxes once more.

Liz Truss has not addressed the massive long-term reforms needed to our welfare system, age-based entitlement system, and all other unnecessary spendy commitments. That’s because talking about changing all those things is so deeply unpopular that the country will likely see bankruptcy once more before we ever properly address them. These commitments are going to continue to increase until they are fundamentally reformed, meaning that any large tax cut without a commensurate spending cut will leave a hole in our finances that will need to be filled with borrowing.

The reason this is a problem isn’t just because debt is bad for growth. Of course, the consensus among economists is that, for whatever reason, and at some unspecified level, debt is bad for growth. But debt is also a moral hazard – with current politicians using a credit card that future generations will need to pay back (along with ever greater interest to service it). Debt is also a natural security threat. Pre-pandemic, UK debt was approximately 30% foreign owned, with much of that owned by China. Finally, debt empowers the government to spend – and the Tory party is a party of small government, so it shouldn’t be in the business of financing record levels of debt.

It is for these reasons I believe the scale of short-term tax cutting Liz Truss has outlined is both financially and politically untenable. Liz Truss has almost certainly already promised too much to be able to deliver. On the other hand, Rishi Sunak hasn’t promised nearly enough.

Jack Kemp used to say, “I don’t worship at the shrine of a balanced budget.” I agree with that wholeheartedly. Sure, a rising tide lifts all ships. But some ships remain stuck to the bottom, and it’s up to the government (in a limited and liberty-respecting manner) to help loosen them free. For the government to act without crippling in the private sector, small-scale borrowing is often necessary.

But accruing more debt for what would be inflationary tax cuts is frankly silly. COVID-debt is perhaps a little more like war debt than at other times in our history, but our post-War economic experience was hardly fantastic, with the post-War consensus leading us swiftly into the misery of the 70s.

So, it’s not sensible to worship at the shrine of even more mass borrowing either. Borrowing to finance productivity-improving infrastructure or in the case of a (COVID-sized) emergency is one thing. But in general, excessive borrowing is always an economic and moral hazard that should not be found flippantly.

In my mind, both Truss and Sunak’s solutions are too simplistic. Sunak’s don’t give nearly enough scope to helping the worst-off. But Truss’s are socialist in the worst sense of the term. She hasn’t explained that all tax cuts aren’t created equal. She hasn’t explained that the popular tax cuts won’t do very much for growth, it is all the unpopular tax cuts for businesses that would.

It’s throwing largess from the treasury to the dogs for her own short-term political gain. Truss is promising borrowing now to fund tax cuts and win votes, which in my mind is basically the same thing as promising to spend excessive amounts.

I’m sure there’s a better way than either of these approaches out there. Instead, here are a few of my observations.

First, I wish a candidate would outline a program of spending reforms first. Suella Braverman had started, and that’s one of the reasons I was disappointed she was booted out of the race. Austerity is unpopular but necessary.

Second, less talk of tax cuts, more talk of tax reform. Cutting taxes is only one of the ways we can ease the tax burden - Reagan simplified the tax code to great effect, saving businesses administration costs and in no small way giving growth a boost without adding too much inflation to the mix. This is a good, short-term way to get tax on the agenda without blowing up the debt or the fight against inflation.

Third, we need to cut taxes, but in a controlled and sensible way that targets those taxes which are most inhibiting growth first. In addition, and as a separate measure, on day one, VAT on fuel and National Insurance for the worst off should be cut - as a matter of moral duty. As we conquer inflation, growth couldbe boosted further by slashing more.

Finally, and don’t fret if you were worried I had forgotten about it, monetary policy needs to be addressed. QE is a problem - maybe even a big one. But I conceive of it more as a problem of debt than anything else. If you cut expenditure, you surely slash QE.

(In the meantime, I don’t think any future Tory PM should fiddle with the Operationally Independent mandate of the Bank of England - and that’s not just because I like Ed Balls. Sunak is right to say it’s done a pretty good job so far of keeping inflation steady at 2% until COVID and the supply side shocks hit.)

And plus, if Labour forms a government in 2024, do we really want them to have unrestricted access to the printing presses?

Sunak's tax rates are too high. They are too high to justify financially or morally. But Liz Truss has already promised too much, too soon, and that would be just as bad (if not worse). Like any good spectrum, the right answer is probably slap-bang in the middle.

You might have thought this blog was dead. It was, but it is no longer!! Over the next few days, I’ll be thinking a little about the link between debt and growth. Stay tuned!