The debate about the right level of public spending needs to be put into the context of how much tax politicians think they can impose. If you look at the last fifty years figures, you will see that no government, Labour, Conservative, Labour/Liberal or Coalition has ever tried to impose taxes higher than 38.7% of GDP. That high level was reached in one year, under Margaret Thatcher, when she was trying to bring an inherited deficit under control.
Labour governments have been careful about tax levels – or, in other words, Labour have spent more based on borrowing, and subsequently Conservative governments have put up taxes to pay for all the extra spending their predeccesors built into the budgets. In the 1970s Labour taxed at 34-35% of GDP. The incoming Conservative government had to increase taxes to pay the bills and curb the deficit, as well as cutting the rate of increase in the spending. In the 1990s and early 2000s Labour taxed at 35-37% of GDP. The incoming Coalition government has had to raise taxes to cut the inherited deficit.
The Conservatives had got taxes down to 32% by 1973-4, to a low of 32.3% in 1993-4 and to 34.6% in 1996-7 . The Coalition government proposes to keep taxes at the highest levels of the last fifty years for the five year Parliament. The Plan envisages tax rising to 38.5% of GDP by 2014-15. Labour does not recommend any significant increase in current tax levels. Its bigger bank tax is a matter of a few billion, whilst Labour opposes the VAT increase which raises more than the larger bank levy.
I think the politicians show wisdom in these decisions. I do not think the UK does want taxes above 38.7% of GDP. Politicians should therefore plan their spending based around a sustainable level of revenue of around 36% of GDP, the level achieved under Labour. Indeed, there is evidence that the UK economy has performed best when tax revenue is below 36% of GDP, as in the 1990s following ERM exit, and in 2002-5.
It follows from this that unless you now think the UK could and should go from the conventional level of tax to say 45% of GDP going in tax, current spending levels are unsustainable. This year the Red Book forecasts spending at 46% of GDP, miles above the sustainable tax level.
These figures are all in real terms expressed as a proportion of output, because that is the way the Treasury chooses to present them. In cash terms, every year has seen increased taxes. Inflation has often eroded the value of allowances and offsets. People pay tax on the inflationary element in income and gains. Over this Parliament tax is scheduled to rise by 2% of GDP, but by a massive £172 billion a year, comparing Year 5 with the last Labour year. That shows the impact of inflation and growth on tax revenues.
Tomorrow we will look at how within that suggested total of GDP that the government can take, revenues can be maximised and economic damage minimised. Higher tax rates do not always yield higher revenues. Politics can get in the way of revenue maximising tax rates.