What Osborne's Emergency Budget Should Say....

In my Money Week column, I've been looking at what George Osborne's emergency budget on June 22nd. Here's a taster....

It’s not hard to sketch out the scene on June 22nd, when the new Chancellor George Osborne delivers his emergency budget on behalf of the coalition government. He clears his throat, looks around the house, and announces. “Cripes! What a mess. We resign – and one of those Milliband’s can clear up the mess if they are so smart.”
Amusing, but unlikely. In reality, Osborne will have to deliver a set of measures that will define the new government. There are four priorities he should focus on: restoring honesty to the public finances: simplifying the tax system: making deep structural reforms to the way the UK economy operates: and kick-starting growth, even if that means taking some risks in the short-term.
It is a long time since a Conservative Chancellor delivered the first budget of a new Tory administration. The last one was Geoffrey Howe’s, delivered in June 1979, just after Margaret Thatcher was elected Prime Minister. Looking back, it was genuinely radical stuff. VAT was raised from 12.5% on luxuries , and 8% on most items, to a standard rate of 15%. The basic rate of income tax was cut from 33% to 30%, with a target of cutting it to 25%. And the top rate came down from 83% to 60%. Exchange controls were relaxed, and big cuts to public spending were announced. Later budgets by both Howe and his successor Nigel Lawson were probably just as radical. But the main thrust of the Thatcherite reconstruction of the British economy was all laid out in the first speech. It was a clear and decisive break with what had gone before.
Osborne should be no less bold. The UK can still escape from the perilous, near-bankrupt state that thirteen years of Gordon Brown have left it in, but it will require swift and decisive action. Here’s what he needs to do.
First, there needs to be complete honesty about the dire state of the public finances. The UK doesn’t just have one of the highest budget deficits in the world. It has hidden much of the waste and debt of the Brown years. What turned the markets against Greece was not just the scale of borrowing. It was the fact it had fiddled its figures for so long. A 10%-plus deficit might just prove sustainable, given how bad the debt figures are everywhere else. But if the bond markets get the sense they are being lied to, they will move in for the kill. The first task of the new Office for Budget Responsibility will be to root through all the quangos, the private finance initiatives, and the pension obligations, and come up with some meaningful analysis of what bills British taxpayers will have to meet over the next decade. Nothing other than brutal honesty will do.
Next, the tax system needs to be clinically simplified. Over the past thirteen years it has turned into a vast, Byzantine mess that does more to destroy wealth than either collect or re-distribute it. A few basic principles should be established. All taxes should be low, fair, and simple to collect. All taxes should be standardised, whether it is on income, or capital gains, or inheritances, to reduce the incentive to shift assets around. People and companies should be exempted from taxes instead of given allowances or benefits. It will be virtually impossible to reform the current tax system along those lines. Instead, repeal the entire thing, and create a new, simpler tax system from scratch.
Third, make structural reforms right away. Changes to the tax system can have a big impact on the way the economy works. But it will take time. Five years is a minimum, and quite possibly longer. A falling pound by itself isn’t going to revive British manufacturing. But creating tax-free zones for factories would work, particularly if you placed them in the regions that are going to be hardest hit by the cut in public spending (Wales, Scotland, Northern Ireland and the North-East). Encourage saving, with tax breaks if necessary, and make sure debt isn’t subsidised through the tax system. The UK needs to re-balance its economy from financial engineering towards industry, science, technology, media and manufacturing. A start has to be made on that in the first budget if any of the results are to be seen before the next election.
Finally, make a wager on growth. Howe’s budgets were deliberately deflationary. He had to beat inflation out of the system, as well as re-structuring the UK economy. Osborne doesn’t have that unenviable task. Inflation, though creeping worryingly higher, isn’t yet a big problem. Instead, this Tory-led coalition can borrow a trick from Ronald Reagan in the early 1980s. He pushed for radical, pro-enterprise tax cuts, even when he didn’t have the money to pay for them. The gamble was that growth would come through swiftly enough to keep the deficit under control. And he was proved right.
Osborne should try something similar. The UK can’t just cut its way out of this deficit – not without imposing huge pain on public services, for which there will be little political support. It can’t tax its way out either. Taxes are already at the upper limit of what can be raised: push them any higher, and you’ll just collect less revenue. Instead, it has to grow its way out of trouble. Big cuts in corporation tax – say to the 12.5% levied in Ireland – would be the best way to do that. Global companies would flock back to the UK. Follow that up with cuts to the top-rate of tax, and entrepreneurs would be re-motivated as well.
It would be a big risk, of course. But as Howe showed in 1979, this is no moment for caution. Osborne is only going to get one shot at a radical change of direction. And the one thing that is certain is that on its current path the UK economy faces years of austerity and decline – so there is little to be lost, and much gained, from trying to turn that around.