Most political parties, including UKIP, agree that the UK needs to cut the budget deficit. And to the extent that George Osborne’s new budget seeks to do that, he deserves half a cheer. The main thrust of UKIP’s criticism is not that he’s cutting the deficit, but that there was no mention of the immigration issue which is causing massive wage compression at the bottom of the income scale, and damaging the living standards of unskilled and semi-skilled workers. We also argue that while cuts are necessary, he’s cutting the wrong things — attacking the living tree while ignoring the dead wood.
But there’s also a fundamental misunderstanding out there amongst some of the old parties, especially Labour and the Lib-Dems. They see the need to cut the deficit, but they regard that as a simple, binary, either-or proposition. You can cut spending, or you can increase taxes. Take your pick. A billion pounds off spending? Or a billion on taxes? Simple choice.
Except that it’s not that simple, and it misses a third key factor: growth. Economic growth has a massive impact on the fiscal position. Higher growth, with higher incomes and more jobs, has a hugely positive effect on government revenues — to the extent that if we had sufficient growth, we wouldn’t need to cut spending at all. We in UKIP believe that the best way to stimulate growth is to free British industry from the deadweight of EU membership, of EU regulation, and of EU energy policy. But leave that aside for a moment.
Even as we stand within the EU, we have to take into account not just two factors but three – spending, taxation and growth. And of course they interact together – you can’t change one without changing the others. Low growth forces higher welfare spending. But also – and this is the key point that Ed Balls and Danny Alexander entirely miss – higher taxes suppress growth.
So it isn’t a case of a billion pounds off spending or a billion on taxes. Raise taxes, and growth falls. So the billion you thought you had gained in taxation is partly off-set by loss of revenue resulting from loss of growth. And taxation is a business of diminishing returns. The higher the tax rates become, the more damage any further tax hikes will do. It’s that Laffer Curve again — and in the view of many economists, we’re already perilously close to the point where tax rises fail to increase revenues at all — but succeed in punishing growth.
So Osborne is right to focus primarily on spending cuts, not taxation, to close the gap. But that brings us to UKIP’s point: he’s cutting the wrong kind of spending. Britain’s gross EU contributions are (round figures) £20 billion a year; net £10 billion. When we leave the EU, we’ll probably save say £15 billion even after we’ve protected the things we’d want to do anyway, like farm support. The government has ring-fenced 0.7% of GDP — around £13 billion — as foreign aid. UKIP would keep a smaller aid budget primarily for disaster relief, but we could save say £10 billion. By dropping the climate paranoia — and the green subsidies — we could make further massive savings. And dropping HS2 would save a further £50 billion (maybe £80 billion allowing for over-runs). A billion here, a billion there, and pretty soon you’re talking real money.
But the biggest point of all comes back to growth. Outside the EU, outside the stultifying regulatory structures, and especially outside the EU’s energy policy, UK growth will be dramatically enhanced. And growth will be the biggest contributor to deficit reduction.
Memo to George Osborne: by all means cut spending, George. But cut the dead wood, not the living, growing tree.
Note: UKIP’s 2015 General Election Manifesto will be fully and professionally costed.