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7 September 2011

Will Osborne pick the wrong tax cut?

Rather than abolishing the 50p rate for the few, Osborne should reduce VAT for the many.

By George Eaton

Last night George Osborne admitted what everyone already knows to be true: that the Office for Budget Responsibility will be forced to downgrade its growth forecasts for a fourth time this autumn. At best, Britain faces a sustained period of anaemic growth, at worst, it faces a double-dip recession. Consequently, the debate about how to stimulate growth has restarted this morning. In a widely publicised letter to the FT, 20 economists call on Osborne to “drop the 50p tax at the earliest opportunity” and return to an “internationally competitive tax regime”.

They are, of course, pushing at an open door. Barely a week goes by without Osborne hinting that he will abolish the 50p rate in the near future. He recently told the Today programme: “I don’t see that as a lasting tax rate for Britain because it’s very uncompetitive internationally, and people frankly can move.” In the US and France, billionaires volunteer to pay more tax. In the UK, the Chancellor suggests that they should pay less.

But leaving the politics of the issue aside, (and 69 per cent of voters, including 60 per cent of Tories, support the retention of the 50p rate), how effective a stimulus would this be? The 50p rate is only paid by the top one per cent (who earn more than £150,000 a year), many of whom will save, rather than spend, any windfall they receive. Rather than prioritising the abolition of the top rate, Osborne should cut those taxes that fall hardest on the low-paid, who spend a higher proportion of their disposable income.

One option, as Ed Balls has argued, is to introduce a temporary reduction in VAT. That would boost consumer spending, lower inflation, protect retail jobs and increase real wages. When Alistair Darling reduced VAT to 15 per cent during the financial crisis, consumers spent £9bn more than they would otherwise have done. A VAT cut today would be a similarly effective fiscal stimulus. As Boris Johnson wisely observed in his Telegraph column in July, “[I]f we were to cut taxes now, it might be best to start with VAT to get people shopping again.” Osborne’s decision to raise VAT (a measure he described as “permanent”) by 2.5 per cent to an all-time high of 20 per cent automatically knocked 0.3 per cent off annual growth (OBR figures).

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Osborne is unlikely to scrap the 50p rate until at least 2013, when the public-sector pay freeze ends. The Chancellor, a keen political strategist, won’t want to hand a tax cut to the richest 1 per cent until he can provide relief elsewhere. But even then there are other political obstacles.

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The Lib Dems are rightly insisting that the 50p rate, if abolished, must be replaced with a range of new property taxes, perhaps including a version of Vince Cable’s “mansion tax”. Some on the right are also beginning to recognise the case for greater taxation of wealth. Even Osborne, in his Budget speech, promised to look at “the taxation of very high value property”.

But if growth is his priority, there is no doubt that the tax Osborne needs to reduce is not the 50p rate but VAT.