Debt and taxes

Stability and prudence. These have been the two watchwords of Chancellor
Gordon Brown’s record-breaking tenure at the Treasury. Well aware of Labour’s
past ‘boom and bust’ macro policies and ‘tax and spend’ fiscal reputation, Brown
wanted to break the mould.

On stability, the record looks impressive. The UK has enjoyed the longest
period of sustained growth (57 quarters) since records began in 1870, we have
had the best inflation/interest rate environment since 1945, the highest
employment ever and unemployment levels that were last seen in the mid-1970s.

But Brown can’t claim all the credit for this robust economic performance.
The first 18 quarters of growth took place under John Major’s government, with
Norman Lamont and Ken Clarke at the Treasury, while responsibility for monetary
policy was handed over to the safe hands of the Bank of England in his first
month of office.

And, while the economy has grown, as British Rail of fond memory might have
said, it’s been the wrong sort of growth. Not all sectors or regions of the
country have shared equally in the growth: manufacturing output has lagged GDP
and hundreds of thousands of jobs have been lost, export performance has been
indifferent and business investment disappointing. We have kept going largely on
the back of domestic consumption.

As a result, consumer borrowing has passed the £1 trillion threshold,
equivalent to 140% of annual earnings, while the rise in interest rates is
starting to have an effect. Unemployment is edging up, the number of housing
repossessions and mortgage arrears are both on the rise, while personal
insolvencies are at record levels.

Missed it by £101bn

There are even bigger question marks against the Chancellor’s record on
prudence. First, his ‘Golden Rule’ means that the government will only borrow to
invest, and current spending will be met from current revenue. Secondly, the
‘Sustainable Investment Rule’ commits the government to maintaining the ratio of
Public Sector Net Debt (PSND) to GDP at a prudent and sustainable level,
generally taken to be less than 40%.

In his first term Brown delivered a set of public sector finances that even
his Conservative predecessors would have struggled to match. But since 2001,
when he embarked on a massive programme of investment in public services, his
record looks very tarnished. Two simple statistics illustrate the price that is
being paid for these ambitious spending plans.

The tax burden on individuals and businesses has been steadily rising, from
37.3% of GDP in 1997, to 39.7% today and on to a predicted (by the Treasury) 41%
by 2009. But even this hasn’t been enough to fund the spending. When he
announced his investment intentions, the Chancellor said that he would borrow a
total of £28bn between 2001 and 2006: the actual figure was £129bn.

Promising not to raise income tax helped persuade ‘middle England’ to vote
Labour in 1997. But while honouring this commitment, the Chancellor has
increased a host of other taxes, pushing the tax take close to 40% of GDP.

Income tax may not have gone up but taxes on income certainly have. Foremost
was the £8bn rise in National Insurance contributions. On top of this, ‘hard
working families’, a favourite group of the Chancellor’s, have also had to cope
with the abolition of the married couple’s allowance, the final abolition of
MIRAS (mortgage interest relief at source) (started by Nigel Lawson) and a steep
rise in fuel duty in Labour’s first term, which have all added to households’
tax burden.

Other taxes have not been raised but still the tax take has nevertheless
increased during Brown’s tenure – fiscal drag has lifted the numbers paying
income tax at a marginal rate of 40% from 2.1 million in 1997 to four million
currently. Corporation tax rates were reduced from 33% to 31% in 1997 and then
to 30% in 1999, where they have since remained.

Corporate squeeze

At the time, this gave the UK a significant low-tax comparative advantage but
other countries have followed suit, hence the UK’s ranking has slipped from
first to seventh in the EU 15. Here, the pressures in the UK will be to reduce
rather than raise corporate taxes. The squeeze on the corporate sector has been
on oil and gas producers, which can be justified environmentally, but any
further increases could weaken North Sea investment intentions. The Chancellor
has also ended the 10% starting rate for corporation tax on taxable profits of
up to £10,000 but this step had more to do with closing a loophole than raising
revenue.

For the Chancellor, the real problem is that despite growing his tax rate at
a faster rate than the economy, it is still not enough. The gap between his
receipts and spending has been widening, and much more borrowing is the
consequence.

It has taken some fancy statistical footwork to maintain the appearance that
the Golden Rule has been observed. The method of calculation has been changed
and the length of the cycle adjusted, backwards and forwards, to accommodate the
surge in borrowing. Less controversial has been the Sustainable Investment Rule
but even here, all is not what it seems. In some respects, interpreting this
rule is even more contentious than the Golden Rule.

Brown’s own Budget figures show a steady rise (from 33.2% in 2003-04 to 38.4%
by 2010) but staying within the 40%. One grey area is the use of Private Finance
Initiative or Public- Private Partnership schemes by successive governments to
finance projects such as new schools, hospitals or roads. The government’s
obligations arising from these activities were previously ‘off balance sheet’
but have now been re-defined and included in public sector debt.

Still not included, however, is the government-guaranteed £18bn debt of
Network Rail, equivalent to 2% of PSND. The argument for omitting it is that
Network Rail is technically still a private company.

Even more contentious is the treatment of public sector pensions. Unofficial
estimates of the ‘black hole’ (as it would be called in the private sector)
range from £500bn to £1 trillion. The Office for National Statistics is
currently considering how this huge liability should be included in the national
accounts.

Add in charges of complexity and maladministration surrounding Mr Brown’s pet
projects of family credits and pensioner credits, and some of the gloss comes
off his record. How he will be viewed after he leaves office will depend more on
whether the public believes they are getting value for money from the
Chancellor’s huge increases in spending on services, rather than how much tax
they are paying. At present the jury is still out.