Lord Desai
Main Page: Lord Desai (Crossbench - Life peer)
Lord Desai
My Lords, I have been in favour of a serious cut in the budget deficit since before the election. When I said that, I had no idea which Government would be in power so my desire for a budget cut had nothing to do with political preferences. We have heard that in his March Budget, Alistair Darling proposed a time-path of cutting the deficit over the course of five years. We even had a debate in your Lordships’ House in which the noble Baroness, Lady Noakes, questioned why the Government had not decided to comply with the Maastricht criteria by 2015. I remember speaking in that debate.
The Chancellor has now proposed his own time-path over the next five years. There are some significant differences but they are less dramatic than people think. It is important to note that we have already had a debate about how soon and how much to cut because of whether the current economy is in a fragile or strong recovery, on the brink of a double-dip recession or whatever. That uncertainty remains despite the fact that for the last three quarters we have had positive growth of output—a small 0.4 per cent in the last quarter of 2009, 0.3 per cent in the first quarter of 2010 and then suddenly 1.1 per cent in the second. We have to average these things out and not take recent numbers all that seriously but there have been three quarters of percentage growth so there is a recovery. We do not know how fragile it is. That is a problem in economics: we do not even know what the recent past is, much less what the future will be.
Given that we have had three quarters of recovery, it is worth examining what the Budget does. It has a mild cut in 2010-11. The numbers are on page 37 of the OBR’s Pre-Budget Report. In table C13 and C14, for 2010-11 the cut is only £3 billion—the current spending is £640 billion as in the Alistair Darling Budget and £637 billion in the Osborne Budget. In terms of investment expenditure, there is a slight difference in the two projections. Alistair Darling projected about 1 per cent real growth in current spending over the next five years. The Chancellor has eliminated that 1 per cent and decided that current spending ought to be constant in real terms.
It is not so much that the cuts in spending will be severe this year and so we may have a double-dip recession, but a political gamble that the size of the cuts grows over the Parliament and that more severe cuts come in the third or fourth year. If the Chancellor wants to a take a political risk, that is his business. As an economist, I note that he has left current spending constant in real terms. That is perhaps the best risk-averse strategy if you are uncertain about growth. If you are pessimistic about growth, it is best to leave current spending constant in real terms so that it grows a little year by year but not much more than that. That requires the Chancellor to do a variety of things, such as freezing public sector pay for those above a certain level, freezing various benefits or indexing them slightly lower, perhaps at CPR rather than RPI, and so on, although I do not wish to go into too much detail on that.
The spending strategy is quite straightforward but current spending should be kept under control. To those who disagree with that and would like spending to be higher, I say that it should be higher only if it is investment spending and not current spending. Even if it were desirable to do so, I do not believe that we would get a revival based on consumption or current spending. A revival has to be based on investment. If the private sector is not ready to invest, the Government can borrow in benevolent surroundings but only if they do so for investment purposes. The markets would probably tolerate that. That, so far as I can see, is the strategy to follow. In my view, the risk is not that there will be a double-dip recession, although no one knows. Indeed, as noble Lords have said, especially the noble Lord, Lord Stern, if we have a double-dip recession, the Government should be ready to relax the constraints —not just through monetary policy, as I think the noble Lord, Lord Razzall, said, but also through fiscal policy.
The advantage of overbidding on the cutting side, if I may put it that way, is that the Chancellor will have some room in the future. If he did not cut too much now, he would not be able to relax later, so I think that he has front-loaded the psychology of the pain so that he will be able to retract if there are problems later. However, I suspect that we will have not a double-dip recession but very weak growth of perhaps 1.2 or 1.3 per cent this year and maybe somewhere between 2 and 2.5 per cent next year. Some of the sluggish growth relates to longer-term problems, as the noble Lord, Lord Stern of Brentford, said in an excellent speech. The sources for rapid growth, or an accelerated 3 to 3.5 per cent growth, are extremely weak in the view of economists. Unless we do something really fantastic by way of green technology or some such innovation, we will face severe competition in the standard manufacturing sectors from Asian economies, which have not suffered a recession. They are growing very fast and are acquiring, through research and development, the kind of industries in which we thought we had a temporary monopoly. There are already complaints in Germany and the United States that various Chinese industries are catching up in relation to some of the capital goods that China used to import but now exports. I think that we will have to be quite organised about a growth spurt, but it will have to come from investment and not from current spending.
I want to say something about taxation. My personal preference would have been for a higher proportion of tax increases rather than spending cuts but that is a judgment which a Government in power have to make. I welcome the VAT rise. I have always been a hawk on VAT and in a speech some time ago in your Lordships’ House I even said that the Chancellor should have taken the opportunity to remove the zero-rating on VAT and go all the way. I do not mind saying that I have been sacked twice from the Front Bench for saying that, but the IMF agreed with me that zero-rating of VAT should be removed and that we should have no sacred cows when it comes to taxation. We have to reduce our consumption and raise our saving and investment. VAT is a tax on consumption. We should think much more progressively about using VAT and not be worried by what I might call the standard economic 101 response that it is a regressive form of taxation. It is not quite true, but we ought to define it.
I am worried that the Government have not taken the opportunity to do very much about taxation of work. I do not know how national insurance contributions got to be where they are, but it is interesting that we tax earned income more than we tax unearned income. Someone in employment pays both income tax and NIC. If I were sitting on my butt at home drawing dividend income I would pay income tax only, not NIC. There is an opportunity for this or any Government to think about integrating income tax and NIC and the real extent of how much we tax earned income will become clear. It is about one-third. Having to pay 30 per cent plus tax on earned income is something that we ought to think about seriously. We should try to reduce tax on work and raise it on spending.
There is a lot of scope for simplification and integration of tax. I do not see why there is an upper limit on NIC. That makes it very regressive and it should be brought into line with income tax. I am not, and never have been, in favour of the Liberal Democrat proposal to increase personal allowances from £6,500 to £10,000. I have spoken about that before. I think that that would be a regressive step. I commend the fact that the Budget limits the regressive effect of that tax cut by not letting the higher income levels earn the benefit of raising the personal allowance as well. There is something else to think about regarding personal allowances. We could make them more into a tax credit rather than maintaining them as they are, but I have spoken before on that so I shall say no more.
I hope that the Government do not adopt a graduate tax. I beseech them not to do that. I would much rather British undergraduates paid the same fee that foreign students pay, which is roughly £10,000. I have been advocating that since 1997. We should allow universities to charge whatever fees they want and remove the subsidy for undergraduate tuition fees. The money saved could be put into research for universities, which would be a much better use of money and more growth-enhancing than having 18 year-olds who have nothing better to do but to go to college. There is no logic in subsiding them up to £7,000 a year over three years—£10,000 would be the right amount. We currently subsidise EU students coming to British universities, and we could eliminate that if all students, from wherever they came, had to pay the same amount of £10,000. I hope that the Government will consider these mild proposals.