ONCE they started falling, the totems toppled like ninepins this week. For 11 years, New Labour preached the gospel of fiscal prudence: money would be borrowed only for investment, and public net debt kept below 40% of GDP. Economic boom and bust were over; steady prosperity was the shape of things to come. Against this benign background, Britain’s rulers felt “intensely relaxed” about the prospect of people getting filthy rich: in three elections Labour pledged not to raise the top rate of income tax, set at 40% in 1988.
Not one of these pillars has survived the revelations in this week’s £20 billion ($31 billion) fiscal-stimulus plan. Borrowing will hit 8% of GDP in 2009-10 and debt 57% of GDP in 2012-13, even on the government’s optimistic assumptions. The Treasury predicted in March that the economy would grow by 2.5% next year; it now thinks output will shrink by 1%. And a new 45% tax rate for the rich will be imposed from 2011. New Labour’s compact with the aspiring middle classes has collapsed, and what happens next is anyone’s guess.
The package that Gordon Brown, the prime minister, and his chancellor of the exchequer, Alistair Darling, have come up with will cut value-added tax (VAT) temporarily, give income-tax and other relief mainly to those on lower incomes or struggling with precarious jobs and mortgages, support small businesses and bring forward capital spending (see article). All this is to be paid for by a later squeeze on public spending, an increase in national-insurance (social-security) contributions and higher income taxes for the rich—after, needless to say, the next election. Will the package work, and what will it do to the political landscape?
The government’s economic ambition—shaving up to half a percentage point off a recession that looks set to be the rich world’s grimmest—is hardly vaulting. By itself, the stimulus seems modest, equal to about 1% of GDP rather than the 2% the IMF urged on countries that could afford it, and far less than the Americans are now contemplating. The cut in VAT may hardly be noticed amid the flurry of retailers’ frantic price-slashing—and many of the benefits will be felt abroad as Britons buy more foreign goods. Extra help for those with children and for pensioners is rightly targeted on those likely to spend most, but the amounts involved per family are peanuts. And the prospect of heavier national-insurance contributions from 2011 will surely put firms off hiring people.
Yet this modesty must be put into context. Tax revenues are set to plunge faster in Britain than in many other rich countries, thanks to a collapse in receipts from finance and property. Add in the spending, on unemployment benefits and so forth, that increases in a recession, and Britain will get a hefty rise in the budget deficit—and a commensurate fiscal boost—without the government lifting a finger. British manufacturers have already been helped by sterling’s slide. And the Bank of England still has more room to cut interest rates than many of its peers.
Soak the rich; it was such a success last time
The politics revolve around how to pay for the stimulus—and both parties have made fundamental errors of judgment. The Tories’ decision to oppose all unfunded tax cuts is a classic example of cutting off your nose to spite your face. Yes, fiscal discipline is important; but in times as dire as these stimulus is needed and stimulus, if it is to have any effect, has to be unfunded, at least in the short term. The Tories should have accepted that—and reminded people that the boost could have been bigger if Labour had not blown so much cash earlier.
Mr Brown’s error may be still graver. New Labour came to power in part because it persuaded upwardly mobile Britons that it had given up the politics of envy and resentment. Since then business has put up with ever more red tape and stealth taxes (Britain’s state is now bigger, as a share of the economy, than Germany’s). Mr Brown could have balanced the books in the medium term by slimming this bloated monster. Instead, he is playing to the gallery with the new 45% tax rate for the rich. This will affect only 1% of earners, raising at most £1.6 billion a year—and it runs directly against the enterprise culture Mr Brown once sought to foster. This looks like gesture politics of the class-war sort. Farewell, New Labour.