The 15p Chancellor? How Osborne could outflank Labour on tax

After a year in power, in the aftermath of a traumatic recession and with unemployment still riding high, the Chancellor needs not only to deal with the immediate economic predicament but also to chart a course to the next election. Economic and political cycles need to be aligned. It is already a commonplace in Westminster that this means tax cuts down the road, though no one knows what form they will take. The Chancellor's first thoughts have already been slipped to the PM in a secret memo.

At least that's how it was for Nigel Lawson back in 1984 --- and today, George Osborne faces a similar challenge. Can a highly ambitious but boxed-in chancellor drag the centre of political gravity rightwards - above all on the touchpaper issue of tax -- and, in so doing, win the next election on Conservative terms?

One main difference in 2011 is the position of the Liberal Democrats. The increase in personal tax allowances to £10,000 is the dominant tax reform of this parliament - and it's their brainchild (see NS, 28 March). So far, this has suited the Conservatives; it has been a useful adhesive for the coalition and, even though most of the gains go to the top half of the income distribution, and although for families the upsides are more than outweighed by the VAT increase, it has allowed both parties to talk about a tax cut for low earners.

Clegg-plus

It seems unlikely, however, that ever greater personal tax allowances will represent the summit of the Chancellor's tax-cutting aspirations. He is unlikely to settle for being "Clegg-plus" on this most Conservative of terrains.

Some Conservatives fear that, for all its apparent simplicity, the £10,000 pledge lacks the electoral impact of lower tax rates. Others dislike the entire premise of removing people from tax: for them, responsible voters should be taxpayers. But it is Lawson who gives the most compelling right-wing argument for a different approach. Lest we forget, he started his own period as chancellor seeking to use "every penny" to increase allowances. Then he changed tack. Why? He said: "I wished to create a large constituency in favour of income-tax reductions . . . the last thing I wanted to do was to reduce the size of that constituency by taking people out of tax altogether."

Osborne is likely to share the same insight. So what might he do? Plans to merge National Insurance with income tax, heavily trailed at the last Budget, are unlikely to be his legacy. It's certainly not electorally appealing; nor is a merger achievable before the next election. What about the 50p rate? Many on the right find it hard to think beyond its abolition. But a cut -- scheduled for 2013 -- that exclusively benefits the richest
1 per cent of earners lacks the mass appeal required for an election campaign. Others favour an assault on fuel duty, which would certainly play well with much of the public, but may offend David Cameron's remaining green sensibilities. And it smacks more of a midterm giveaway than a manifesto centrepiece.

Far more likely is that Osborne will favour the Lawson solution and seek to slash the basic rate of income tax (stopping short of Lawson by avoiding a cut in the 40p rate). That would invoke the glory years of Tory tax radicalism, when the basic rate was cut from 33p in the pound to 30p in 1979 and then, under Lawson, to 29p in 1986, 27p in 1987 and to 25p in 1988.

A modern Lawsonian strategy writes itself . Stick to the £10,000 allowance commitment (knowing that much of this increase is required simply to protect the threshold from higher inflation), but don't go beyond it. That creates clear blue water from the Lib Dems. Provide a modest cut to the basic rate in the second half of the parliament to show intent (as Lawson did with his staging-post cut to 29p). Follow this up with a further pre-election cut, twinned with a manifesto pledge of more to come: could we see a basic tax rate of 15p in the next parliament?

Political jugular

Given the deficit, many will say this is pie in the sky; clearly, if the economy tanks, all bets are off. And if a popular backlash prevents the planned spending cuts from being realised, then major tax reductions may become impossible.

What's more, the scope for tax cuts will be restricted by what is likely to emerge as another top Conservative priority: a big increase in NHS spending towards the end of the parliament. After all, tax cuts served up too neat may not be swallowed by a cynical public; blended with
a selective increase in spending on the iconic NHS, they will be more easily digested.

A reduced basic rate of tax will naturally be very hard to pay for, but control of the Treasury always creates possibilities for a powerful chancellor - as Lawson and Gordon Brown proved in their differing ways. Osborne will be able to set eye-wateringly low spending projections for most Whitehall departments, just as he will be able to sell off public stakes in the banks at a convenient moment. So long as the economy gradually recovers, he will find the resources. As for Labour, it should expect Osborne to go for the political jugular. The idea that he will play the role of Labour bogeyman by focusing his tax cuts on the rich, as he did in 2007 with his inheritance-tax pledge, is likely to be wishful thinking.

If, in two years' time, the performance of the economy has enabled Osborne to consolidate his hard-won reputation for fiscal credibility, then he will be in a commanding position. Expect the promise of sweeping tax cuts in the basic rate aimed at "ordinary families", at the same time as he seeks to neutralise the NHS as an election issue by making it very hard for Labour to outspend the Tories on it. Nigel Lawson would approve. The risk for Labour is that the electorate might, too.

Gavin Kelly is chief executive of the Resolution Foundation