These calls for tax cuts are getting out of hand

"Although the Chancellor seems sceptical, the political pressure on him to pull this electoral rabbit from the hat will not abate"

Demands from the right of the Conservative Party for phased income tax cuts, taking the basic rate down to 20p by 1998, are getting out of hand. Not only would such tax cuts be difficult to "afford" within the Chancellor's medium-term targets for the public sector borrowing requirement, but the Tory stampede for political salvation at any price is unsettling the markets.

As explained here last week, the 1993 Budgets have left Britain as the only country in Europe without a severe fiscal headache. But we will never achieve enhanced market confidence if our politicians appear so desperate to reverse the beneficial effects of 1993 at the first glimpse of an opportunity.

The Prime Minister appeared to fan expectations of sizeable tax cuts in his Panorama interview last week. Although the Chancellor seems sceptical, the political pressure on him to pull this electoral rabbit from the hat will not abate, and there will be great bitterness if he fails.

The political case in favour of this phased programme is obvious. Both in 1987 and 1992, the Government effectively skewered the opposition by promising to implement income tax cuts immediately after the election, thus offering Labour the choice between being a "me too" party, or the party of tax rises. Labour fell exactly between the two stools, and impressed nobody.

There is a school of thought in the Tory Party that the same trick will not work thrice, since Labour has this time seen it coming. Indeed, the weekend press has reported that Tony Blair is ready to commit Labour to implementing any tax cuts the Tories promise, both before and after the election. In 1997, the question for the electorate will be: who do you really believe will implement their promised tax cuts - the Tories, after their 1993 U-turn, or Labour, which still has a left wing that is calling for tax rises? It is not obvious that the Tories will lose this argument.

The budgetary arithmetic, though, is problematic. There is a tendency to assume that there will be automatic scope for large tax cuts in the next few years, created by a continuing economic recovery. On inspection, this cannot be relied upon. Not only might the recovery falter; even if it does not the fiscal arithmetic looks tight. In the 1994 Budget, the Treasury estimated that, on the basis of 2.75 per cent annual growth in real GDP, the PSBR would shrink from £34bn in the current financial year to zero by 1998-99.

The Chancellor has stated often that his objective is to achieve budget balance - zero PSBR - when the economy has returned to normal. The implication of the 1994 Budget was that 1998-99 should be the target period. There is therefore no margin for tax cuts by 1998-99, even though the Treasury is assuming that the real level of public spending will rise by only 1 per cent per annum in the next four years. If achieved, this would reduce the share of public spending in GDP from 43.5 per cent this year to 40.5 per cent in 1998, but the benefits would be allocated to lower public borrowing, not to lower taxation.

Where is the scope for tax cuts in this scheme of things? On the face of it, there is none. But the Treasury is good at creating fiscal room for manoeuvre when necessary. There are three possible routes. First, growth in real GDP might be more rapid than the Treasury has assumed. But there is no indication yet that growth in 1994 or 1995 has been any higher than forecast, and it is hard to see how the Treasury could credibly pencil into its medium-term forecast an average growth rate any higher than 2.75 per cent. Certainly, it could not do this while maintaining a commitment to inflation of 2 per cent at the end of the period. And there is another point here. If the economy really does grow by more than 3 per cent per annum over the rest of the decade, we should not repeat the mistakes of the late 1980s by throwing the fuel of tax cuts onto an already raging fire.

The second possible route would be to cut the growth of public spending still further. But it is doubtful whether this would carry credibility in the financial markets. Admittedly, the control of spending in the past two years has been good, with the total tending to undershoot published plans. Experience suggests, though, that it will be difficult to keep the lid on public sector pay, especially in a pre-election period. Three years of real growth in public spending would be needed to create room for a 20p basic rate of income tax by 1998-99. Not plausible, m'lud.

This leaves the third route, which is to abandon the balanced budget objective, and to permit a higher PSBR over the medium term than previously targeted. This would not be laughed out of court, since a balanced budget, when the economy is at normal capacity, is a tough target - tougher than would be needed to stabilise the ratio of public debt to GDP. The Chancellor could consider easing this objective. If he decided to reduce the PSBR by only the amount required to stabilise the debt ratio by the end of 1998-99, he would create an extra £17bn of scope for tax cuts over this period - more than enough to achieve the desired 20p income tax rate.

However, it would be difficult to think of a good reason for changing the objective for the PSBR without appearing to be engaging in crass electioneering. If the Chancellor had set an ultimate PSBR target of 2 per cent of GDP a year ago, almost no one would have quarrelled with it, since most independent economists have argued that this is tough enough to attain fiscal sustainability. But having set himself a tougher target, arguing that the Government should be aiming to reduce the debt/GDP ratio when the economy is not in recession, the Chancellor will now have considerable difficulty in wriggling out of his self-imposed straitjacket.

It is therefore quite hard to see how the Treasury can find the scope to reduce the basic rate to 20p by 1998 without tearing up the pledges made on Budget targets last November. Of course, a 20p rate would be attainable if the Government really were ready to freeze public services for three years or to finance cuts in the basic rate of income tax by raising revenue elsewhere (for example, by restricting the value of income tax allowances still further). But then there would be losers as well as gainers from the tax cuts, and the political advantages would be much less clear-cut. All in all, there may be a smaller electoral rabbit in the Chancellor's hat this November than many in his party expect.

voicesGood for Lana Del Rey for helping kill that myth, writes Grace Dent
The University of California study monitored the reaction of 36 dogs
sciencePets' range of emotions revealed
Life and Style
fashion Designs are part of feminist art project by a British student
Joining forces: young British men feature in an Isis video in which they urge Islamists in the West to join them in Iraq and Syria
newsWill the young Britons fighting in Syria be allowed to return home and resume their lives?
Arts and Entertainment
The nomination of 'The Wake' by Paul Kingsnorth has caused a stir
Arts and Entertainment
The Tour de France peloton rides over a bridge on the Grinton Moor, Yorkshire, earlier this month
Snoop Dogg pictured at The Hollywood Reporter Nominees' Night in February, 2013
people... says Snoop Dogg
Life and Style
food + drinkZebra meat is exotic and lean - but does it taste good?
Arts and Entertainment
Residents of Derby Road in Southampton oppose filming of Channel 4 documentary Immigration Street in their community
voicesSiobhan Norton on why she eventually changed her mind
ebookA unique anthology of reporting and analysis of a crucial period of history
Scottish singer Susan Boyle will perform at the Commonwealth Games opening ceremony in Glasgow
commonwealth games
Arts and Entertainment
Dwayne 'The Rock' Johnson stars in Hercules
filmReview: The Rock is a muscular Davy Crockett in this preposterous film, says Geoffrey Macnab
Life and Style
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

PMO Analyst - London - Banking - £350 - £400

£350 - £400 per day: Orgtel: PMO Analyst - Banking - London - £350 -£400 per d...

Cost Reporting-MI Packs-Edinburgh-Bank-£350/day

£300 - £350 per day + competitive: Orgtel: Cost Reporting Manager - MI Packs -...

Insight Analyst – Permanent – Up to £40k – North London

£35000 - £40000 Per Annum plus 23 days holiday and pension scheme: Clearwater ...

Test Lead - London - Investment Banking

£475 - £525 per day: Orgtel: Test Lead, London, Investment Banking, Technical ...

Day In a Page

Screwing your way to the top? Good for Lana Del Rey for helping kill that myth

Screwing your way to the top?

Good for Lana Del Rey for helping kill that myth, says Grace Dent
Will the young Britons fighting in Syria be allowed to return home and resume their lives?

Will Britons fighting in Syria be able to resume their lives?

Tony Blair's Terrorism Act 2006 has made it an offence to take part in military action abroad with a "political, ideological, religious or racial motive"
Climate change threatens to make the antarctic fur seal extinct

Take a good look while you can

How climate change could wipe out this seal
Man Booker Prize 2014 longlist: Crowdfunded novel nominated for first time

Crowdfunded novel nominated for Booker Prize

Paul Kingsnorth's 'The Wake' is in contention for the prestigious award
Tour de France effect brings Hollywood blockbusters to Yorkshire

Tour de France effect brings Hollywood blockbusters to Yorkshire

A $25m thriller starring Sam Worthington to be made in God's Own Country
Noel Fielding's 'Luxury Comedy': A land of the outright bizarre

Noel Fielding's 'Luxury Comedy'

A land of the outright bizarre
What are the worst 'Word Crimes'?

What are the worst 'Word Crimes'?

‘Weird Al’ Yankovic's latest video is an ode to good grammar. But what do The Independent’s experts think he’s missed out?
Can Secret Cinema sell 80,000 'Back to the Future' tickets?

The worst kept secret in cinema

A cult movie event aims to immerse audiences of 80,000 in ‘Back to the Future’. But has it lost its magic?
Facebook: The new hatched, matched and dispatched

The new hatched, matched and dispatched

Family events used to be marked in the personal columns. But now Facebook has usurped the ‘Births, Deaths and Marriages’ announcements
Why do we have blood types?

Are you my type?

All of us have one but probably never wondered why. Yet even now, a century after blood types were discovered, it’s a matter of debate what they’re for
Honesty box hotels: You decide how much you pay

Honesty box hotels

Five hotels in Paris now allow guests to pay only what they think their stay was worth. It seems fraught with financial risk, but the honesty policy has its benefit
Commonwealth Games 2014: Why weight of pressure rests easy on Michael Jamieson’s shoulders

Michael Jamieson: Why weight of pressure rests easy on his shoulders

The Scottish swimmer is ready for ‘the biggest race of my life’ at the Commonwealth Games
Some are reformed drug addicts. Some are single mums. All are on benefits. But now these so-called 'scroungers’ are fighting back

The 'scroungers’ fight back

The welfare claimants battling to alter stereotypes
Amazing video shows Nasa 'flame extinguishment experiment' in action

Fireballs in space

Amazing video shows Nasa's 'flame extinguishment experiment' in action
A Bible for billionaires

A Bible for billionaires

Find out why America's richest men are reading John Brookes