Tory leadership election: why tax cuts are an economic gamble
But matching tax cuts with spending cuts is never easy, especially after years of pre-pandemic austerity. It would be difficult telling workers in healthcare, education and transport that they must accept smaller budgets and less pay after over two years on the Covid front line.
It’s also far from easy to cut spending on the public sector when it remains the the main provider of healthcare and social care for an ageing society. And while the war in Ukraine rages on, refusing urgent pleas for more resources for defence would be a tough political sell.
Yet other candidates have argued that planned tax cuts would essentially pay for themselves. If they kick-start business-sector growth, the public sector will take up less of the UK’s GDP, without the need for drastic cuts to services. The theory is that lower taxes on households can encourage people to work harder, reducing their need for state support. Likewise, reducing tax on companies might lead them to invest more in new technologies and training – unblocking the stagnant productivity growth which has hampered pay levels for over a decade.
This “supply side” case for tax cuts – that they end up invigorating the economy – gained strength from the eventual boom seen under Thatcher’s premiership. Some economists are again making the case that it’s mainly high taxes that are holding back the UK’s economic performance.
In practice, however, Thatcher’s policies raised the overall tax take in the UK. And recent research suggests that tax cuts do more to boost the incomes of the well paid than those on average pay.
Gambling with inflation
Indeed, cutting taxes without a reduction in public spending might actually fuel inflation by stoking demand. That’s why leadership contender Rishi Sunak, who resigned as chancellor, continues to speak up for current tax-raising plans, promising cuts no sooner than 2023.
Whoever does become the next leader of the Conservatives, and prime minister, should also bear in mind that switching from austerity towards economic expansionism after a crisis hasn’t always worked. In 1972, the Conservative prime minister Edward Heath and his chancellor Anthony Barber responded to global energy shock, high inflation and impending recession with a “dash for growth” – spending more while keeping taxes down – and letting the budget deficit widen in the hope of a similar supply-side transformation.
This kind of of fiscal stimulus, spending more on industrial policies to boost investment, often stimulates output more effectively than tax cuts, at least in the short term.
Fifty years ago, Heath’s belief that a more relaxed budget would spark a recovery led by investment and exports was strengthened by there being a pool of unemployed labour, and new trade opportunities in Europe’s Common Market, which the UK had just agreed to join. But hopes of 10% growth soon gave way to higher inflation and renewed downturn.
Today, amid a chronic labour shortage and other supply constraints, some linked to Brexit, the new Conservative dash for growth through wide ranging tax cuts will be an even bigger gamble.
Alan Shipman, senior lecturer in economics, The Open University.
This article is republished from The Conversation under a Creative Commons license. Read the original article.
Article source: https://www.theweek.co.uk/business/economy/957383/tory-leadership-election-why-tax-cuts-are-an-economic-gamble