Economic View: Brown should eat humble pie

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The Independent Online

Gordon Brown's pre-Budget report was disturbing, and not just because of the deterioration in public finances since the spring. It was also worrying to see the projections for taxation, which he believes should rise in 2008-09 to the highest level as a percentage of GDP for two decades. It is questionable whether this is politically acceptable, given that the present shortfall in tax revenues suggests there is already resistance at the current levels.

The best starting point is the puzzle, noted in these columns, that tax revenues seem to be coming in below expectations despite the fact that growth is within the Treasury's range. Growth this year looks like being above 2 per cent, which while below the long-term trend of around 2.5 to 2.7 per cent, is a lot more than most independent forecasters expected.

Next year the Chancellor expects growth of 3 to 3.5 per cent, again above the consensus of forecasters at 2.7 per cent. But since the Treasury has been right and the rest of us have been wrong, let's give it the benefit of the doubt. Let's also give it the benefit of the doubt for future years. As the first graph shows, the projections for growth through to 2006 look fair enough when set alongside the record of the past couple of decades - less bumpy but perfectly reasonable.

So if growth has been all right - and looks to be all right in the future - why do taxes have to rise so much? The right-hand graph shows how they will reach their highest level for more than 20 years at the end of Mr Brown's present planning period. Of course, they may not reach that level and Mr Brown certainly will not be Chancellor then, but that is the logic of his present plans. Voter resistance to such taxation is likely to be increased by additional demands to pay higher charges for publicly controlled services: university education, road tolls, higher rail fares etc.

The reason for higher taxes is twofold: something has been going wrong on the revenue side, and something has been going wrong on the spending side.

There are at least three revenue problems. One is that there has been a shift in employment, which has hit income tax. High earners are suffering a fall in income (and in the City, a fall in numbers), while part-time workers and self-employment have been rising.

A second is the impact of the fall in share values. For example, many high earners are clawing back earlier income tax payments to top up pension plans, which have been hit by the fall in the markets. You would expect capital gains tax revenues to be down because there are not many gains around. But the fall in the markets has also affected income tax.

A third is that taxpayers are adjusting their behaviour to pay less tax. For example, people are shifting spending away from buying goods and services that incur VAT, and spending more on personal services that often don't. The leakage of VAT on imported spirits and tobacco is also part of this trend. Meanwhile, people are switching to diesel cars: fuel consumption is lower so they pay less tax in total. In London they are not driving into the congestion zone if they can avoid it.

Some of these changes are legal, some not, but it is very hard to do much about the ones that aren't. The informal economy is now reckoned to be about 20 per cent of GDP, against some 13 per cent 10 years ago. This last trend is disturbing because it suggests not that people have become inherently less law-abiding, but rather that they feel tax money is being wasted. No one likes paying tax but if voters feel money is spent wisely, they are less likely to put effort into cutting their tax bill.

They may become even more concerned as the evidence of poor public spending decisions mounts. Few people question the aims of the Government to improve public services, or to use the pool of revenues to improve the position of the disadvantaged. The problem is delivery.

Among independent observers there is a high degree of agreement on this. The Office of National Statistics estimates that since 1998 the productivity of the public sector has been falling. The International Monetary Fund has warned that increases in public spending may have been used inefficiently. And the European Central Bank reported in July that the UK has an inefficient public sector compared with the US and Japan, though apparently not so inefficient compared with continental governments. If we were as efficient as the US, we could spend 16 per cent less and still get the same results.

Now you have to be careful when comparing the efficiency of service industries because it is hard to adjust for quality. It may be there have been improvements in the quality of the output of the British public sector that have not been reflected in the statistics. But the Government is so eager to argue that it is improving things that it becomes difficult to have a dispassionate discussion. There is certainly a huge problem of perception, for all the surveys show voters feel money is being wasted.

So too, when it is being honest, does the Government. The small print of the pre-Budget report shows the Government believes that red tape is costing £12bn a year. The Prime Minister's Delivery Unit fears that the additional funds going into the NHS will not be spent efficiently. Top- down control is clearly not working. In his speech, the Chancellor himself admitted this, announcing a radical change in the way spending would be reported to Whitehall: national targets would be replaced by local service agreements and performance figures.

Maybe these are the first glimmerings of an acceptance by Mr Brown that his actions have wasted a huge amount of our money. If so, I would have liked a little more humility from him. But he is not into that, is he?