Kwasi Kwarteng is MP for Spelthorne.
In two weeks’ time from today, the Chancellor will stand to make his fourth Budget speech.
It is only a couple of months since the Autumn Statement, and already the OBR’s forecasts look pessimistic. Independent growth forecasts are up, unemployment is falling fast and inflation is down. Those critics who argued that cutting the deficit would doom Britain to a triple dip recession have been disproved.
Now, the same critics argue that recovery was bound to come eventually whatever the Government did. Strangely, they did not think to make such predictions two years ago. Similarly, many economists warned last year of the US Government’s ‘fiscal cliff’. According to the IMF, the US’s austerity measures cut their deficit in 2013 at twice the pace chosen for Britain. It turned out that the only country in 2013 out of the G7 to grow as fast as Britain was America. Fiscal responsibility works.
Nevertheless, it would be a mistake to grow complacent. Many of the hard choices over how to cut our £100 billion deficit have yet to be taken.
Rather than focus on these decisions, the Labour Party has tried to change the subject. However, if the ‘cost of living’ agenda is to amount to more than a political slogan, we have to understand exactly why we all feel poorer.
Our economy is suffering from the aftermath of a financial crisis, an overly large state and a crisis in the Eurozone. Our population is ageing, while assets like North Sea Oil are declining. Our only rival in terms of debt is Japan.
You do not solve any of these problems through an energy price freeze, increased regulation or a larger deficit. Neither is demonising business and driving out investment likely to help.
A free enterprise approach to cutting the cost of living would focus on employment, competition and taxation.
The most important determinant of your standard of living is whether you have a job. We could learn from the Germany, who as part of their labour market reforms in 2003 introduced the notion of ‘minijob.’ These only applied to people who earned less than €400 a month, but paid a flat rate tax of 30 per cent for employers and 12 per cent for households. Because they were so simple, they helped attract the young, the old and the long time unemployed back into work.
Minijobs might give people a good start in the labour market, but the only sustainable way for these jobs to be well paid is to increase the productivity of British firms. Unfortunately, there is no short term solution to this, other than the long term work of supply side reform.
What the Government can do swiftly is cut taxes, the single largest bill most of us pay.
At the Budget each year, many tax thresholds are not increased in line with inflation, let alone earnings. This is one of the easiest ways for Chancellors to stealthily raise taxes. Over the last 30 years, the number of people paying the 40p tax rate has grown six times. The inheritance tax threshold has been frozen at £325,000 for the past six years, while stamp duty land tax on a house bought for £250,000 has been 3 per cent since 2003.
We should pass a law to automatically increase tax thresholds. Each year, they would be raised by the higher of wage growth or price inflation. The Government could overturn this in difficult times, but it would have to bring the changes to a vote in Parliament first.
In order to pay for any tax cuts, we will need to cut Government spending further. Where should we look to for further cuts? The two largest items of Government expenditure are public sector pay and social security. Combined, they make up around half of all government spending.
During the immediate years after the financial crisis, pay in the shielded public sector grew significantly faster than in the private sector. The current one per cent cap on public sector pay rises is set to expire in 2015-16, even though cuts to departmental spending are likely to have to continue till 2018-19. There is a good case for prolonging the cap an extra few years.
We will also have to look again at welfare spending. It is only fair that some benefits such as the state pension are paid equally to everyone. However, at present around a third of our social security spending is paid to people with above average incomes. This is surely too high. We are paying people benefits with one hand only to tax it back with the other.
It is all too easy to forget that we are not even half way through yet what is expected to be nine year long fiscal consolidation. In 2016-17, the budget deficit is expected to still be £48 billion. The good news is that that in the private sector forecasters suggest that this could be the year when wages finally start to grow faster than inflation. Unfortunately in the public sector, the hard decisions are far from over.