Over the past few weeks, we’ve heard from advocates of more government spending  to attempt to stimulate the economy, advocates of shock-and-awe tax cuts  to stimulate the economy, people suggesting the Government needs more interventionist long-term planning  for the economy, and calls from back-bench Conservative MPs that this should be a‘cost-of-living’ budget .
Following more than £500 billion of deficit spending, £375 billion of QE, interest rates at their lowest level in the history of the Bank of England, a sharp fall in sterling, and with inflation continuously above target, it is difficult not to agree with Sir Mervyn King that most of our economic problems are structural. Years of a stagnant economy despite extraordinary monetary and fiscal policies suggest that in the wake of the crisis we are now suffering from a sustained fall in potential growth on unchanged supply-side policies – which, even if you do believe that stimulus spending policies work, cannot be solved by more short-term borrowing or money printing. Those convinced the economy just needs a kick-start to push it into a new equilibrium of self-sustaining recovery should look at Japan’s recent economic history.
Nor would increasing the structural deficit by borrowing significantly more for tax cuts be sensible. With public sector net borrowing still over 8% of GDP and debts already above the level known to permanently retard growth for two decades, adding to the deficit significantly, two years before the uncertainty of another general election, poses significant risks in bond markets (and even if we print to hold yields down, merely transfers to a problem for sterling).
The Budget then needs to recognise that the UK has a medium-term growth problem. It should therefore contain policies to raise our medium-term growth rate. This is the main insight which drives the 20 recommendations which we set out in Take the Long View , ahead of next week’s Budget. We suggest a three-pronged approach addressing fiscal strategy, supply-side reform and a robust pro-competition agenda in certain oligopolistic industries.
Support is waning for the Government’s fiscal agenda, but in truth cuts to investment expenditure and tax hikes were front-loaded and cuts to current expenditure were back-loaded. For a developed country like the UK, evidence suggests that cutting the latter not only has a far smaller impact on short-term growth , but also enhances medium-term growth . Abandoning the overall plan now, just as it about to start cutting in the right areas, would be madness. In fact, if anything the level of current spending cuts are inadequate. Because of ring-fencing of several large items, current spending overall is actually forecast to increase in real-terms over the course of this Parliament by 0.7%. But this assumes growth will generate large increases in tax revenues to close the deficit. As we mentioned above, we do not believe this will happen on unchanged policies. So further cuts to current spending, in part used for enterprise inducing tax cuts, should be implemented to enhance the economy’s medium-term growth rate.
To decide where these cuts fall the next spending review should examine all spending without any ring-fencing, particularly focusing on areas which have the smallest effects on short-term growth, like pensioner benefits, retirement ages, and eligibility for a host of other transfers. A failure to re-open spending in this way risks some budgets being savaged to protect areas of which have seen significant largesse over the past decade.
On the tax side, the spending review should be supplemented by better resourcing of the Office for Tax Simplification and giving it a more strategic role over efforts to simplify and restore trust in our tax system. Substantial pro-growth tax reform, along the lines of broadening bases and lowering rates, is an area which the Coalition has so far done little.
On the supply-side, the key aim is to raise the productive potential of the economy. A Small Business Incentive Scheme, which includes significant exemptions from regulation for small businesses, should be introduced. Though less sexy, a framework for ‘sunset clauses’ for new regulations should be rolled out and Michael Fallon’s ambitions for deregulation utilised by widening the scope of the ‘One-in, Two-out’ framework further. And the Government should look again at the case for abolishing national pay bargaining , which could substantially enhance public sector efficiency and counter regional inequalities in the medium-term.
Finally, the only sustainable way to address rising living costs for the UK public requires an aggressive pro-market agenda in many oligopolistic industries to enhance innovation and productivity, and to lower costs. Banking, energy, water, rail and education are all necessity industries or state run services where there is scope for much more competition, and there would be much more beneficial long-term effects of removing barriers to entry for new providers, and providing a level playing field for existing market participants, in these than dealing with the symptoms of our current cost-of-living problems through fiddling with changes to certain taxes or subsidies.
20 recommendations for the budget
On fiscal strategy
Announce the remit of the 2013/14 spending review. This should include:
- plans to cut government current expenditure substantially over the next five years with no ring-fences;
- a programme of reducing entitlement eligibility;
- a plan to raise retirement ages more rapidly than currently planned.
- Widen the remit of the Office for Tax Simplification to establish tax reforms for the rest of this Parliament along the principles of base-broadening and lowering rates.
- Pledge no new taxes or further net tax rate rises for the 2013/14 spending review period.
- Set out a path to raise the threshold for the basic rate of Income Tax to the equivalent of the gross income of a full-time earner on the minimum wage.
- Cut Capital Gains Tax immediately, as it is above the revenue maximising rate.
- Commit to further reductions in Corporation Tax.
- Re-open negotiations on public sector pensions.
Announce a Small Business Incentive Scheme to include a package of exemptions from regulations for very small businesses. This should include exemptions from: minimum wage legislation for those under 21; requests for time off for training; and pension auto-enrolment.
- Adopt sunset clauses for all regulations with a post-implementation audit three years after enactment of each regulation; and bring more regulation into the scope of 'One-In Two-Out'.
- Adopt a Consolidated Planning Act and repeal all existing legislation with a single rationalised Act.
- Encourage neighbouring local councils to co-operate in identifying sites for new Garden Cities.
- Abolish national pay bargaining in the public sector.
- Ensure that the recommendations of the Davies Review of airport capacity can be implemented swiftly.
An agenda for competition
Adopt the "Fair Shares" scheme for the re-privatisation of Lloyds and RBS.
- Reduce the regulatory burden on new banks.
- Give the Financial Conduct Authority a competition mandate.
- Require the legal separation of retail and supply arms of water companies, paving the way for the extension of retail competition.
- Encourage far greater competition between operators on the rail network.
- Lift the bar on profit-making companies running academies and free schools.
- Abandon the planned unilateral carbon price floor and phase out subsidies for renewable energies.