Growth is the key to the government’s strategy. Let’s begin with a reminder of what the government forecast in its Budget Book in June 2010:
The March 2011 Budget book raised 2010-11 to 1.9%, cut 2011-12 to 1.8%, cut 2012-13 to 2.7%, and raised each of the last two years to 2.9%. This left total growth at 12.8%, with much more of the growth coming in the second half of the period. The loss of growth between Budgets One and Two would mean £6.5 billion less output and £2.5 billion less tax revenue in the fifth year. This forthcoming downwards revision might have to cut another 1% off the total, losing around £15 billion more output and £6 billion of tax revenue by year five. Even such a cut would still leave the growth rate from 2012-13 onwards at a high level for current conditions.
This week the Chancellor has told us he is likely to face a downwards revision to the growth forecasts for this year in the autumn. The OBR may well have to revise down next year as well, given the international background. I do not think the OBR could revise subsequent years up to make up for the loss.
As so much of the government’s deficit reduction strategy is predicated on extra tax revenues from growth, accelerating the current growth rate is the government’s overriding priority. In addition the government’s politcal strategy presumably relies on getting real incomes rising again after a nasty period of decline in recent years. This too requires decent rate of growth in the next three years to bring it about. The government is currently reviewing its opitions to induce stronger growth. They are looking at tax, regulation, and banks.
Allister Heath yesterday added his voice to the economists who think the government does need to cut the top rate of Income Tax from 50% to 40%. Politicians are wary of this, as taxing the rich is always popular with many voters. The problem the government faces, as Allister points out, is the best way to tax the rich is to set a competitive rate. In 1981-2 when the top rate of tax was 83% the top one perecnt of earners only paid 11% of the total Income Tax. By the end of the last century with a settled top rate of 40%, this figure had shot up to 21.3% of the total Income tax raised. The rich were paying lots more, and a much bigger proportion. This rose further in the last decade.
The Chancellor is awaiting a Treasury study into how much revenue loss or gain there is from a 50% rate. Meanwhile, expect other studies showing that we could tax the rich more by reverting to the rate that Gordon Brown thought was correct throughout his period as Chancellor.