Winsor dictates as Bowker fumes in battle of railway finance

Overly prudent
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Tom Winsor, the rail regulator, should by rights have been left high and dry by the renationalisation in all but name of Railtrack into the not-for-profits trust of Network Rail. The rail regulator's office was established to set economic charges and rates of return for a privatised railway, not a publicly controlled one, so once Railtrack was dead and buried, his work should have been done.

Yet now he performs a new role, as guardian of the taxpayers' money, and by the look of yesterday's intransigently worded "access charges review", we should all be jolly glad he does, for there doesn't appear to be anyone else looking after our interests. If there was one redeeming feature of Railtrack, it was that its shareholders could be relied upon to drive down costs and ensure an efficiently run railway. Plainly the process went too far, but now we have the opposite problem of an increasingly profligate railway, run according to the dictates of safety first and zero risk.

With six executives up before the beak on various corporate manslaughter charges to do with the Hatfield rail crash, it should not surprise anyone that Network Rail would rather spend with abandon than risk any further charge of negligence. Fortunately, Mr Winsor remains in situ to ensure the process doesn't get completely out of hand.

Mr Winsor's final review of Network Rail's revenue requirements for the next five years is nevertheless £7bn higher than the amount he proposed to allow Railtrack. Mr Winsor explains the difference by saying the extra money will enable Network Rail to safely and effectively tackle the legacy it inherited from Railtrack of poor planning, inadequate levels of maintenance and renewal, poor customer focus and an insufficient grasp of the causes of poor day-to-day performance.

Strangely, Mr Winsor mentioned none of these things when conducting the same review for Railtrack, whose managers would have welcomed yesterday's more generous determination with open arms. But we'll let that pass. The regulator is being as tough as he dares for today's more exacting safety and performance-conscious environment. The final determination is actually a little bit less than originally proposed for Network Rail. Rather than ease his position, as usually happens in regulatory reviews, Mr Winsor has made it more exacting still.

In so doing, he has identified work costing more than £1bn per annum that the company does not need to do over the next five years. He's also assuming that Network Rail is able to reduce its remaining costs by more than 30 per cent within five years, equal to an annualised saving of £1.5bn. As can readily be seen, yesterday's determination is no free ticket to ride for Network Rail.

It has also left Richard Bowker, the head of the Strategic Rail Authority, almost visibly fuming. Oh please do pay attention. The railways have more regulators than you can shake a stick at, and he's one of the others. What's got Mr Bowker's goat is partly that Mr Winsor isn't allowing him the money needed to complete the West Coast mainline on time. But it is mainly that there is not enough money all round to do what Mr Bowker wants without further resort to the taxpayer or the debt markets. Mr Bowker thinks Network Rail should be allowed to borrow more to invest. Mr Winsor not unreasonably wants to keep borrowings under control.

Confused? Welcome to the Alice in Wonderland world of railway finance where the root cause of the problem is that the Government wants to control the railway but not to pay for it.

Overly prudent

Forget all the heat and noise about whether the Chancellor is borrowing too much, or whether he is about to break his own "golden rule" on the public finances; Gordon Brown's big strength is macroeconomic policy, and as far as I can see, he's getting it more right than wrong. To be raising taxes or cutting public spending at this stage in the economic cycle would be the economics of the mad house. Both the British economy and the public finances are capable of sustaining much larger budget deficits than the £37bn the Chancellor admitted to this week in his pre-Budget report without undue risk to inflation and interest rates. Where the Chancellor is getting it wrong is not in borrowing too much, but in not borrowing enough.

Prudence holds him back, and of course Mr Brown cannot be seen to breach his own, self-imposed rules, but given the size of the deficits being run in most other G7 countries, the Chancellor could reasonably be doing much more to restore sustainable growth to the economy. Commentators worry about whether the deficit is structural or cyclical. Personally I don't think there is much doubt that it is the former, but the way to address a structural deficit is not to cut public spending plans. To the contrary, it is to engage in pro-growth tax cutting so that the size of the tax base can be raised, allowing the deficit to become self-correcting.

I'm not talking here about a couple of pence off the basic rate of income tax, though that would indeed be nice, but rather a further easing in corporation tax, and possibly also a reduction in the rate of tax on dividends. Mr Brown made much of proposals in the pre-Budget report for widening the scope of tax breaks on research and development, yet the plans amount to peanuts compared with what's being proposed in Japan and elsewhere in the developed world for boosting R&D spending in the private sector.

Far from throwing caution to the wind, the Chancellor through his fiscal rules has locked himself into a straitjacket of inappropriately prudential behaviour. It's not that Mr Brown may breach his golden rule that we should be concerned about, but that he may not breach it by enough. Mr Brown still worries that the markets will judge him to be a Labour chancellor of the old school if he lets rip with the public finances. Nearly all previous Labour governments have been brought down by economic crisis, and Mr Brown is determined that this should not be his fate. Yet if he targeted a tax-cutting, pro-growth agenda at business, the markets might not punish him in the way he fears.

The 265-page pre-Budget report contains a bewildering array of different charts and statistics, most of them self serving or downright irrelevant, yet there is one graphic that should cause alarm bells to ring. This is the one that charts tax as a percentage of Gross Domestic Product. From the present level of about 35.5 per cent of GDP, tax is projected to rise to in excess of 38 per cent of GDP by 2008-09, the highest level since the early to mid-1980s.

The worrying feature of this chart is not so much the headline figure itself, although this is concerning enough, as the implication that the Chancellor needs a progressive crowding out of private sector activity to take place in order to stay within his own borrowing rules. As I understand it, the chart doesn't include anything for rising rates of taxation. Rather it assumes that economic growth and fiscal drag alone will be enough to push the tax take to 38 per cent of GDP.

Well, I've got news for the Treasury. It just won't work that way. The more the tax burden grows, the more it will stifle growth, and the greater the incentive to find ways of avoiding it. Even in sclerotic Germany, tax is falling as a percentage of GDP. To assume that tax must take a progressively larger proportion of GDP to pay for public spending plans is entirely the wrong way of looking at the problem.

The way to achieve rising levels of tax to pay for Mr Brown's spending is to produce a strongly growing economy and the way to make the economy prosper is to cut taxes so as to allow high levels of growth to resume. It is indeed possible to have both a growing tax take and a steadily declining burden of taxation, but it does require the Chancellor to take more risks with the public finances. Don't hold your breath.