Mehdi Hasan: You can raise spending and balance the budget

For this Conservative-led Coalition, shrinking the state seems to take priority over getting growth

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According to legend, the Gordian Knot couldn't be untangled. Alexander the Great, however, had other ideas. After struggling with it for several minutes upon his arrival in the town of Gordium in 333BC, the frustrated young king pulled out his sword and just cut through the knot. I guess that's why they called him "the Great".

In recent years, less impressive leaders have struggled to untie their own Gordian Knot: how to stimulate economic growth without adding to the record budget deficit? Stimulus itself has become a dirty word; the political and media elite is obsessed with reducing borrowing by slashing spending. Yet the UK economy continues to flatline: growth is anaemic and unemployment, at 2.7 million, stands at a 17-year high. John Maynard Keynes's dictum that "the boom, not the slump, is the right time for austerity at the Treasury" has been consistently ignored by Treasury ministers.

Meanwhile, across the Atlantic, Keynesian economics has been vindicated. The US economy is growing much faster than the UK's, off the back of Barack Obama's $787bn stimulus package. America is enjoying 24 consecutive months of job growth, with the US unemployment rate now below our own.

Here in the UK, however, the Keynesians have lost the political debate. There is no point pretending otherwise. David Cameron is happy to watch basketball with the US President, but won't take a lesson in economics from him; the Liberal Democrats, of course, long ago succumbed to deficit hysteria. We are where we are. Austerity rules, OK?

However, as Alexander discovered in Gordium, there is another way to untie the knot. Whisper it quietly, but fiscal stimulus doesn't always require deficit spending. Economists refer to the concept of a "balanced budget multiplier", by which national income is automatically increased, pound for pound, with any boost in government spending that is matched by a tax rise, especially with interest rates – as they are now – near zero and no risk of the public sector "crowding out" the private sector.

It's an ingenious concept – but there's nothing new about it. Paul Samuelson, who wrote the biggest-selling economics textbook of all time, was teaching his students about the efficacy of balanced-budget stimuli in the early 1940s. "It's a pretty solid argument," Simon Wren-Lewis, professor of economics at Oxford University and a former adviser to the Bank of England, tells me. "In fact, it's one of the most robust arguments in macroeconomics." Wren-Lewis is one of a handful of economists who, in recent months, have been urging the Government to invest in a whole host of major new infrastructure programmes, all paid for by additional taxes.

Coalition ministers don't have to go rummaging around the back of the sofa to find some spare change for such a "balanced" stimulus. Britain, remember, is a relatively low-taxed nation compared with our Continental cousins. There are plenty of new and popular taxes that could be used to fund a short-term stimulus: from a mansion tax to a tycoon tax; from a bankers' bonus tax to a financial transactions tax. Then there's the wide range of existing taxes that could be increased: a single penny on employee national insurance contributions, for example, would raise around £4.5bn; so too would a single penny on the basic rate of income tax. Wasn't the latter once official Liberal Democrat policy?

In February, the Social Market Foundation (SMF) published its own "balanced budget" plan to boost growth, by bringing forward the £15bn of tax increases now pencilled in for after 2015 and using the money to fund new "pro-growth" infrastructure spending over the next four years. "It's time to move beyond the sterile debate" of deficit reduction versus fiscal stimulus, wrote the SMF's director Iain Mulheirn in the Financial Times. By balancing extra spending with extra taxes, he argued, the SMF plan would get the Government off the hook of having to announce a fiscal plan B and provide it with "a potent growth strategy within existing borrowing plans".

It's a no-brainer. Yet, a month later, and less than a week away from the Budget, Mulheirn tells me that there has been "complete radio silence" from Coalition ministers. The Tories, in particular, he says, just aren't interested in his proposal.

Why not? After all, it neutralises the main objection to a further round of stimulus spending: that such a move would increase borrowing and panic the markets. A "balanced budget stimulus", by definition, won't do either – so why the continued resistance from ministers? "You begin to appreciate what their real agenda is," says Wren-Lewis. "They just don't want any new spending." For this Conservative-led Coalition, shrinking the state seems to take priority over getting growth. Deficit reduction has become rhetorical cover for a nakedly ideological assault on "Big Government" – no matter what the cost to the nation or the economy in terms of lost output and jobs.

The time has come for a grand bargain between the deficit doves and hawks, based on a recognition of the fact that we don't need to go deeper into debt to stimulate growth. The balanced budget stimulus presents the Chancellor with an opportunity, in next week's Budget, to cut through the Gordian Knot that's been strangling our economy. Political dogma is all that stands in his way.

Mehdi Hasan is senior editor (politics) at the New Statesman and the author of "The Debt Delusion"

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