Just raise tax? No, there's only one way out of this mess

Telegraph

21 hours ago

On Wednesday, fears that Donald Trump's 'big beautiful bill' would further swell America's towering public debt triggered a sharp sell-off in government bonds across the advanced world.
As anxiety swept global markets, UK gilts were hit especially hard, with US jitters coinciding with Labour's failed welfare bill. Before reversing on Thursday, government borrowing costs in the UK increased by even more than in the US.
You would be hard-pressed today to find a serious investor who believes that Rachel Reeves's fiscal arithmetic adds up. The only question ahead of the autumn Budget now seems to be not whether, but by how much, she will raise taxes to balance the books.
This week's cover of the New Statesman captures the view from the Left. It reads 'Just raise tax'. Since our ageing population is adding to the demands on public healthcare systems and welfare, Left-of-centre analysts argue that Britain simply needs to face the facts and increase taxes to finance the necessary spending.
The solution put forward by the Right is not to raise tax thresholds but to cut them. Have you not heard of the Laffer curve? They say that the way to increase tax receipts is to reduce tax rates.
Both sides are wrong. Putting taxes up would not only be wildly unpopular, but it would further weaken Britain's already mediocre growth rate.
Cutting taxes in a major way is also a non-starter – Liz Truss tried that already, and remember what happened.
Across the whole spectrum of British politics, policymakers have become prisoners of their own economic ignorance when it comes to the causes and solutions of our present fiscal dilemma.
Is this situation hopeless? Not at all. There is, in fact, a way to increase tax yields and hence finance higher public spending without raising tax rates. But the debate needs to refocus on the underlying causes of the fiscal gap and escape the siloed thinking about whether tax rates should go up or down, as if that is the only choice.
The Government faces a serious constraint because of its promise not to raise rates on the big three taxes – on income, employee National Insurance and VAT.
But this does not mean that policymakers have no options to increase the tax yields in these areas. Britain's persistent tax shortfall is a symptom of a persistent growth shortfall, caused by the excessive weight of misguided rules and regulations that arbitrarily slow and even prohibit all sorts of economic activities that would otherwise take place.
Remove the economic straitjacket on our factors of production – land, labour, capital and entrepreneurship – and the fiscal problems will be solved.
Needlessly restrictive and complex planning and zoning regulations prevent a much-needed increase in the stock of housing, transport infrastructure, factories and offices. We have left the EU only to discover that our Eurosclerosis is home-grown.
The surest way to boost the revenues to the Exchequer from income tax and National Insurance would be to implement pro-employment policies that increase the number of people in jobs. Instead, with the Employment Rights Bill, minimum wage increases and the uplift in employers' National Insurance, Labour has delivered the most anti-employment policies in a generation.
The unemployment rate has risen from 4.1pc to 4.6pc during Labour's first year in office and looks likely to rise further. Over the coming years, any rise in employment and incomes will be lower than it could have been. Economists have long known that increasing the ratio of capital to workers is the only way to increase productivity in the long run.
But capital, which includes vehicles, machines and computers, needs power. The more cheap power is available, the greater the opportunities for capital to deepen and productivity growth.
However, under our dogged decarbonisation push, we have reduced the availability of electricity to the economy by around a fifth since the peak in 2005. This decline has occurred due to the planned decommissioning of electricity production facilities powered by coal, oil, and even nuclear.
Ahead of the election, Labour was making all the right noises. But the early promises to focus on growth with a pro-business message seem to have given way to a damaging and self-defeating cycle of growth disappointments and tax increases.
Fears over higher taxes encourage saving and lacklustre spending and investment, which lowers tax yields across the board. Chronically fearful consumers are saving more than 10pc of their income, despite average annual real wage gains of nearly 2pc for over two years while businesses sit on near-record cash balances.
Taxes, like public services, are a second derivative of the real economy. We depend on the profits and investment of British industry, as well as the incomes and spending of private sector workers, to finance our public sector. The UK does not need to raise taxes; it needs to raise supply.
Cutting red tape to promote these activities is the path to fiscal sustainability.