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26 March 2007

The swansong has a sting

To the end, the Chancellor retained his appetite for taking from the rich to pay the poor. But was h

By Donald Hirsch

In the swansong to his decade at the Treasury, Gordon Brown maintained the bluster that has so cheered his fans and infuriated his enemies. Both have seen his era as transformational – whether by championing the poor and the public services or by bringing the state into every nook of our lives and taxing us to oblivion.

But in what state is Brown really leaving the public economy? He has had more of a chance than any predecessor to make a mark on it. Yet is the shape of taxation and public spending so different from what he inherited in 1997? And will his changes endure?

Overall, the public economy has not grown hugely in this period. This Labour government has sought neither to take control of the “commanding heights” of the economy nor to introduce significant new forms of redistributive taxation. Public spending has risen by 3 per cent of GDP: from 40 per cent to 43 per cent of national income. This only slightly changes Britain’s international position, which remains about halfway between the US, which spends just over a third of its income publicly, and the Nordic countries, most of which spend more than half.

Despite the failure to increase rates of in – come tax, it is from this source that most of the extra revenue has been raised. Today, about 11.5 per cent of national income is taken in income tax, compared to 9.5 per cent when the government took power – so providing 2 per cent out of that extra 3 per cent of GDP taken by the Treasury. This is principally because tax thresholds have not kept pace with rising incomes, so a greater amount of what people earn is subject to taxation.

This has the greatest effect on the best-off, who pay top-rate tax on more of their incomes than in the past. Over half of all income tax is now collected from the 10 per cent best-off taxpayers. This Budget’s raising of the higher-rate threshold will be more than cancelled out by a higher upper limit on National Insurance contributions.

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Council tax rises, despite all the moaning, have relieved us of far less cash than increases in income tax: we pay only 0.4 per cent more of our income in council tax than in 1997. However, this is large compared to the total council tax bill, which is more than a quarter higher than if it had just risen in line with incomes. People resent this rise because council tax is seen as an unjust way of raising large amounts of revenue, as it is not well linked to ability to pay.

The Lyons review, published on Budget Day, changes council tax around the edges but offers scant prospect of re-establishing the legitimacy of an increasingly unpopular local tax system. The main issue for the central government will be not how many bands to set, but whether it should give councils enough money to fund adequate services without further council tax hikes.

While an extra 3 per cent of GDP for the government does not mark a huge transformation of the balance between the public and the private economy, the £40bn spending that it represents is hardly small change. Where has it all gone? Two-thirds into the health service, and one-third into education. Spending by the Department of Health rose from 4.5 per cent of GDP in 1997 to approximately 6.5 per cent today, and education from about 4.5 to 5.5 per cent. This uses up all of the extra 3 per cent of GDP raised by taxes, so all other areas where spending has risen relative to GDP (notably transport and public order) have had to be matched by falls in other areas (such as defence and social services).

More than his predecessors, Brown has concentrated his efforts on favoured spending areas in order to make a real difference. Health spending growth of 6 per cent a year in real terms for a decade is phenomenal. In social security, more “deserving” client groups such as poor children and pensioners have been prioritised.

The 21 March Budget continued that policy, with new tax-credit money focused on children. The bold move of paying for this by abolishing the 10 per cent tax band (taking roughly a fiver a week off every taxpayer) shows that Brown retains an appetite for taxing to give to the poor. But as lower-income working families are hit most by this flat-rate tax rise, Brown seemed less like Robin Hood than usual.

Over his chancellorship as a whole, then, Brown has focused his tax rises on the better-off, spending the proceeds in a few targeted areas, but not across the board. Can he and his successor keep this up? Probably, in the sense that the gains over the past decade will not be reversed. Yet there seems little prospect of them being extended substantially without a momentous political decision to announce a big rise in taxes. Reducing the basic rate by 2p hardly seems a prelude to this.

Unique decade

Gordon Brown will be remembered most by future historians for the stability he has brought to the public finances through his budgetary discipline. True, he has been sailing very close to the wind recently, but a decade without obvious “stop-go” spending cycles is unique in recent British history. This year’s spending review will finally bring the “stop” sign, with real-terms cuts in some departments and a squeeze on public pay. In priority areas, however, there will be a pause or slowing in growth, not a step backwards.

Yet this relative stability and the system that underpins it also guarantee that most hopes of new spending will be disappointed in the foreseeable future. Once the Chancellor powers down the engines of his public spending supertanker, it will take several years to restore forward motion. Even education spending, the area favoured for new growth, will advance more slowly than previously. The projected 2.5 per cent real-terms increase is only half what we saw in the first Brown decade, and not enough to expand education significantly relative to GDP.

With the tight limits on money to fund new social priorities, it is hardly surprising that the attention of future Budgets will turn to green taxes, which can at least influence behaviours in socially desirable ways. Whether they can also raise serious amounts of money is more doubtful – not least because the more they succeed in curbing behaviours, the less they raise. Since abandoning the fuel escalator in 1999, Labour been cautious about taking big bucks from middle-class polluters.

Will a future chancellor dare to reintroduce some serious tax-and-spend from green sources? Perhaps the only party that will choose to do so will be the one that introduced the fuel escalator in the first place – the Tories.

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