Huge tax hike and cuts needed, says NIESR

The basic rate of income tax should be raised by 6p in the pound, VAT at the full rate should be charged on everything except for food and children's clothes, and another £15bn of spending cuts will be required to fix the public finances, according to one of the nation's most respected economic think tanks, the National Institute of Economic and Social Research (NIESR).

Echoing the Government's arguments against Conservative plans to take £6bn out of public spending, the researchers say it would be unwise to take that amount of spending power out of the economy this year. Ray Barrell, a senior research fellow at the NIESR said that such a move would cost between 30,000 and 60,000 job losses, and cut growth by between 0.1 and 0.2 per cent over the year. Fears of the UK losing its AAA rating seemed overdone, the NIESR suggested, especially given the UK's very long debt maturity, and the fact that sterling is outside the eurozone. Of a "Greek-style" crisis, Martin Weale, director of the NIESR, said: "It's very unlikely the same sort of thing would happen to the UK."

The NIESR say that unemployment will rise to 2.7 million next year, and that a partial recovery in the private sector this year and next, especially in exports, will be partially offset by retrenchment in the public sector. The NIESR say the economy will "crawl" this year, with a 1 per cent expansion envisaged. Growth next year and in 2012 is estimated to rise to 2.25 per cent, below recent trend growth. While in line with independent forecasts, most recently from the IMF, the NIESR's figure is markedly more downbeat than the Treasury: "We remain concerned that the Chancellor's projections are based on overly optimistic forecasts for GDP growth and tax buoyancy."

By 2012-13, the NIESR forecast that borrowing will still be at £82.3bn over the year, or 4.7 per cent of GDP. Public sector net debt, colloquially termed the national debt, will not return to pre-crisis levels before 2030, according to the research, and it is this that the NIESR identify as a key long-term risk. In order to deal with future catastrophic economic shocks such as the recent financial crisis, public finances need to develop much stronger "shock absorbers" than currently planned.

Reducing borrowing further than the current Government plans, by a further 2 per cent of GDP, is recommended by the NIESR, and they suggest that raising taxes might be a more effective method of raising the funds. Given the squeeze on spending over the next few years, they suggest income tax could be raised by 6 per cent to do the job. The NIESR suggest a total reduction in the public-sector workforce – from next year – of around 30,000 a quarter for five years – some 600,000 staff, or around a tenth of the current payroll. Such cuts would encounter fierce political resistance, as the Governor of the Bank of England, Mervyn King, suggested in reported remarks yesterday.

"An additional programme of deficit reduction worth 2 per cent of GDP should be undertaken once sustained recovery is under way. This is required less because of worries about [possible] debt downgrades and rising risk premia on government borrowing and more to create fiscal headroom to deal with a possible future crisis and to reduce the long term burden o f the e national debt".

A rise in employers' national insurance contributions would not constitute a tax on jobs, say the NIESR, and would have much the same effect as a rise in employees' NICs or in income tax. They also suggested that attempts to reduce waste and use efficiency savings to eliminate the deficit would be largely useless. They endorsed a National Audit Office finding from some years ago that such savings were "largely a myth."

On the global economy, Dawn Holland, for the institute, said that the world was "recovering quite fast", and will grow by almost 4 per cent this year, following a 1 per cent decline in 2009, led by China.

But fears for Greece remain. Even a 10 per cent cut in the public-sector wage bill, say the NIESR, will only improve the fiscal balance by about 1.25 per cent age points – a signal of the near-impossible task facing the Greek government and its eurozone and IMF rescuers.