All of the main political parties in the UK agree that government debt is a bad thing. All of them would like to fund 100% of government spending from taxation alone. There are many respectable economists who will tell you that this phobia of government debt is irrational, and I’m inclined to agree with them, but the zeitgeist tells us that we have to be “fiscally responsible” and “live within our means” so let’s have a critical look at how our politicians propose to make tax revenues match public spending.
The Conservative government has decided that the best way to do it is to cut spending until it coincides, more or less, with existing tax revenues. They tried, and spectacularly failed, to achieve this in the last parliament but somehow managed to con the electorate into giving them another go at it. Whether they succeed without causing widespread misery and social unrest remains to be seen, but the omens are not good. They argue that the money that the government doesn’t borrow and spend will instead “trickle down” into the economy in the form of higher wages. They don’t explain how higher wages will help people who aren’t in paid employment (about half the population of the UK), nor do they seem to have noticed that the trickle down theory has been dismissed as bunkum by everyone from the International Monetary Fund to the long-suffering non-recipients of the non-existent trickle, which means there is a strong possibility that the Tories’ strategy will end in permanent recession. Spending reviews continue apace, however, despite the obvious flaws in this “cut ’til it fits” logic.
The main opposition parties (Labour, SNP, LibDem) condemn the pain that the government’s cuts are causing but none of them appear to be challenging the objective of balancing expenditure with tax revenue. Their individual approaches to the task vary in detail within a common theme of increasing tax revenues to match existing spending. They think they can do this by a combination of raising the rates of some taxes and increasing the quantity of revenue from others by borrowing more money to “stimulate the economy”, the idea being that the borrowed money is used for building stuff like housing and transport infrastructure, which gets money into the economy, which encourages spending, which increases the tax take. At the general election in May the Great British public was not convinced by this argument, perhaps because they’ve heard it before and seen that it only sort of works until the next recession comes along and makes a nonsense of the sums.
Politicians of all colours tell us that they want the economy to thrive so that it will produce enough tax revenue to cover government expenditure, but they persist in taxing us in ways that prevent the economy from thriving, which ensures that there is always a shortfall in revenue. Only seven times in the last fifty years has the UK government succeeded in running an annual surplus, and the cumulative deficit for the other 43 years has been 38 times bigger than the seven years of surplus. You would think that someone in charge would have noticed this and recognised that there might be a flaw in our tax system.
And it’s such an obvious flaw. Almost all of our taxes come from economic activity of one kind or another. The big ones are income tax (c.30%), national insurance (c.20%), VAT (c.15%), and corporation tax (c.10%). Then there are lots of smaller ones like fuel duties, business rates, vehicle excise, and so on. The key thing to grasp here is that the vast majority of tax revenue is collected from money that is on the move: money that is being used for buying and selling stuff, including our labour. Which means that the best way to avoid paying tax is to avoid using money for buying and selling stuff.
This is a big problem for both the economy and the Treasury.
Imagine you’re an individual or a corporation with lots of spare money in the bank, like a million pounds. You have a choice. If you put the money to work in the productive economy by investing in some sort of business enterprise you know that a substantial proportion of it is going to disappear as taxes. This known loss comes on top of the unknown risks that attend every business venture. Unless you have money to burn and a buccaneering spirit why would you choose to risk your financial wealth doing stuff in the productive economy when there are much easier, less risky options? You can lend your money to the government, for example, which gives you a guaranteed rate of return that is 100% reliable. Or you can just leave your money in the bank. Even if the savings rate is only 1% you’re still getting ten thousand pounds a year in interest for almost zero risk.
For an economy to thrive money must be available and mobile. All of the stuff that we need for our security and comfort will not get produced unless businesses are sure that they will have customers, and customers cannot buy the stuff that is produced without money to spend. But money, in the form of profits, accumulates in the hands of the few. So the economy cannot thrive unless the accumulated money is brought back into play, to be used for buying and selling stuff all over again. Our tax system discourages us from bringing our idle money back into play, which means the economy struggles to thrive and the government can rarely raise enough money from taxation to cover public expenditure.
In defiance of logic and empirical evidence our politicians continue to tinker with the tax system and hope that their adjustments will make a difference. Since 1997 Tolley’s Tax Guide, the handbook of tax legislation, has tripled in size to more than 17,000 pages as government after government has tried to squeeze more out of the system, yet the problem persists: the government’s books are well-nigh impossible to balance and the economy continues to lurch from increasingly feeble boom to ever-more persistent bust. Our tax code is now one of the biggest and most complicated in the world and is a fitting testament to our monumental fiscal stupidity. The time to look for more intelligent ways of funding public services is long overdue.