Clarke can still please angel and devil

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When most Chancellors take office, they fancy themselves as skilled handymen with the tax system. Given a little time and the right tools, they see themselves re-shaping its layout, knocking through a few partitions and redecorating the lot. By the time they have left office, they have normally achieved the equivalent of no more than re-papering the spare bedroom and patching up some leaks.

Kenneth Clarke didn't appear to arrive in his job in May 1993 with the usual zeal. He appeared something of a fiscal slob when it came to the micro-management of Britain's tax system, never having made much of a career out of attacking it, supporting it or even having to avoid it.

So how will history judge MrClarke? It is an appropriate question to ask at the start of this, his third tax year asChancellor.

In general, some Chancellors (like Nigel Lawson) are remembered as tax reformers; others are favourably remembered for the way they managed the economy (like Geoffrey Howe). On the record of Mr Clarke's predecessors it appears hard to be favourably remembered for both.

There is a reason the double success is so hard to achieve. Tax reform is easy to implement only in the context of overall tax cuts. Change is hard when it hurts. People adjust themselves to the existing tax system, and quite reasonably get upset when you change it in a way that leaves them worse off, even if they can see economic logic in what you are doing.

But if tax reform is possible only in the context of tax cuts, it is unfortunately usually the case that tax cuts are not the right policy for the economy, particularly since the 1970s. In that decade, inflation acted as an implicit tax. Because much of it was unanticipated, it allowed governments to borrow say, £100, and pay back something worth £95. In the 1980s, inflation has been lower, and that particular method of keeping the books in control hasevaporated.

The loss of the implicit inflation tax is nothing to regret; but it has intensified the financial constraints on governments. For these reasons, then, it has been hard to reform the tax system, while keeping taxes up and the finances in good order.

Now Kenneth Clarke is in a good position to break out of that bind. He quite simply went further than he needed to in raising taxes in his first Budget. If one looks at the situation next year for example, relative to the plans left by Norman Lamont he has cut spending by £14.2bn in cash terms. In addition he has raised taxes by £5.4bn. That excludes any effects of economic growth on revenues, and leaves the public sector borrowing requirement at a level more than satisfactory for the phase of the cycle the economy is expected to be in 1996/97. If he wants to cut taxes, the Govermnent's books will not constrain him, even though he might need to raise interest rates to avoid the mistakes of Mr Lawson, who let spending in the economy get out of control with lax fiscal and monetary policy.

So one might argue that Mr Clarke showed early promise as a reforming Chancellor, by creating room to cut taxes. He also embarked on some tax reform in his first Budget. For one thing, he has established himself as the greenest Chancellor for a long time, with about £1. 9bn of policy- induced increases in fuel taxes in his Budgets (not including any VAT on fuel) and a proposed landfill tax that will net him another half to a billion pounds. He has also shown himself responsive to economic logic in introducing new taxes on non-votable segments of spending, like insurance and airline travel.

He could use money raised in measures like these - plus his other spare revenues - to get into a serious reforming mode. In particular, there are two obvious directions to follow: he could unify the taxation of savings around the treatment of PEPS, both simplifying administration and improving incentives. Or he could act to help the low-paid, perhaps dramatically increasing income tax thresholds to take low-paid part-time workers out of tax; cutting employers' National Insurance, or cutting employees' National Insurance at the low end.

Unfortunately, there is a countervailing political pressure on him to get out of reforming mode altogether, and simply to cut income tax in three easy steps instead. The temptation is to spend the money on the basic rate - with its high public profile - even if money could be more effectively spent elsewhere.

So although Kenneth Clarke made a propitious start as a reforming Chancellor, it is far from obvious how he will now choose to proceed. He has an angel speaking into one ear, with a devil on the other shoulder enticing him down a less noble path.

There is possibly one path which will keep both the devil and the angel happy. That is to engage in what is best termed mega-reform; to introduce a package of measures thatraises taxes as well as lowering them; that gets more out of us, but cuts the basic rate of tax, and compensates the net losers, and pays for some reform. A mega-reform package could spread VAT at 8 per cent on a range of new items, it could tax banks like Mr Clarke has already taxed insurance companies, and it could take environmental taxes further. All that could allow a cut in the basic rate of income tax, and leave cash already in the can for clearing up some corners of the tax system and for raising personal allowances to help the lowest paid.

It has the additional political advantage of looking less like an obvious bribe, and more like a piece of economic policy. Mega-reform has pluses on the economic and the political front, therefore.

It's not easy for a Chancellor, but if Mr Clarke wants to earn his place in history as a decent fiscal manager as well as a wily politician, this is probably the only route he's got.

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