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There are 3 ways to cut the deficit – why has Labour chosen the wrong one?

scissorsThe budget deficit, which has been far more central to this election campaign than it should have been, can be dealt with in three separate ways. It can be reduced by cutting net expenditure either by taxing the poor or by taxing the rich, or it can be reduced by cutting unemployment (the ‘automatic stabilisers’ to sustain the jobless cost £9bn a year per million persons unemployed), growing the economy, raising wages and thus increasing government revenues to pay off the deficit faster.

The Tories once again have chosen the first alternative, making clear that the country is only a third of the way through its toxic regimen of cuts, with at least £25bn still to come, half of which will be levied on reducing disability benefits, cutting back on industrial injury benefits (for which people have paid though national insurance contributions), and clobbering carers’ allowances.

Labour has promised to cut the deficit every year, and its manifesto promises that balancing the books “will require common sense spending reductions”, whatever that means. Presumably this will certainly not include the items in the Tory cuts package, but it is not clear what common sense reductions refers to.

A deficit cutting programme can of course be organised in a very different manner. A financial transaction tax could be brought in in Labour’s first budget before the summer recess (exactly as Osborne notoriously did in June 2010) which even at the minuscule rate of 0.01% would raise £25bn a year. This alone could pay off the deficit, currently standing at £92bn, in less than 4 years. Another option is to replace the council tax, Thatcher’s highly regressive housing tax, by land value taxation which could raise billions largely at the expense of the rentier class. Or the rate of capital gains tax, currently at 28%, could be raised to 40% to match the higher rate of income tax. This is hardly a radical proposal since 40% was the rate agreed by Nigel Lawson, Thatcher’s chancellor. Or the absurdly unfair structure of national insurance, whereby it is levied at 12% on earnings up to £805 a week but only at 2% above that £41,860 a year level, could be largely reversed. Or farm subsidies which give millions of pounds a year to the biggest landowners could be made subject to a benefits cap which is a lot more justified than the households’ benefit cap.

But there is another, and much better, option to clear the budget deficit. Instead of continually contracting the economy by endless cuts, a much better option is to expand the economy through public investment (Labour wisely declined to put a cap on capital expenditure) which would steadily increase the number of full-time well-paid jobs and thus raise wages, boost household incomes, and because people would then spend more it would raise government revenues far more effectively so as to pay off the deficit a great deal faster. What’s not to like about that?

4 Comments

  1. Robert says:

    I suspect it will be welfare to be cut as labour does not do welfare or benefits.

    It will be an interesting time to see who wins out on the battle of the welfare state.

  2. Billericaydickie says:

    Left Futures favourite Bangladeshi mayor Lutfur Rahman guilty of electoral malpractices. We will be expecting a full article from Jon Lansman explaining why he got it all wrong. I’m not holding my breath but you can’t ignore this. Or can you?

  3. David Pavett says:

    Lots of good points in this piece (e.g. about NI and about LVT).

    A couple of question arise however.

    (1) A technical, but not unimportant point if we want to demonstrate economic literacy. It it not incorrect to speak of “pay(ing) off the deficit”? You can reduce the deficit. It is not something you can “pay off”. What needs to be paid off, at the appropriate time, is the national debt, or some portion of it. We should not confuse debt with deficit.

    (2) Should not statements like “a much better option is to expand the economy through public investment (Labour wisely declined to put a cap on capital expenditure) which would steadily increase the number of full-time well-paid jobs and thus raise wages, boost household incomes, and because people would then spend more it would raise government revenues far more effectively so as to pay off the deficit a great deal faster” be rather more carefully framed?

    As a generality it is okay in principle to borrow to invest but this leaves open the crucial question of how much it is wise to borrow in the light of interest charges and probable returns. Without quantifying, at least approximately, these factors or describing how that quantification can be done the gap between serious proposals and fantasy economics becomes alarmingly small.

  4. Barry Ewart says:

    Good stuff Michael!
    I think I have learnt in life that working people seem to be afraid of money – though our labour creates the wealth and makes societies work. Hundreds of thousands, millions, billions, trillions – it is our wealth really.
    Interesting a 5% financial transaction tax would bring in a trillion (getting our share back) plus land tax, wealth tax, collect uncollected taxes rich, public ownership, to creat a humanitarian economic war chest to meet global human need and working sister parties every country in the World. Hope, positivity, simple, international solidarity!

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