Finance (No. 3) Bill

Viscount Hanworth Excerpts

Monday 18th July 2011 Lords Chamber

[Viscount Hanworth]

My Lords, the report of the Select Committee on Economic Affairs conveys one startling fact. We are told in paragraph 125 of the latest available estimate of the tax gap, which for the year 2008-09 was £42 billion. The gap is defined as the difference between tax collected and the tax that should have been collected.

This gap represents an enormous sum of money and one must look for ways of putting it in perspective. The comparison that comes to mind immediately is with the size of the budget deficit. Of course, this is a highly variable amount, but for the past two years it has been at roughly the same level. These deficits have been roughly four times as large as the tax gap and they were preceded by deficits that were virtually negligible.

The immediate cause of the rising deficit and the rising debt was the financial crisis. It was not, as some have suggested, the result of the profligacy of the then Government. The Government were constrained to buy a large proportion of the equity of the failing banks and to supply them with funds in other ways as well. To do so, they had to raise the money by selling bonds.

Following the crisis, there has been a savage fiscal retrenchment by the current Government, and one might have expected the debt and the deficit to have been reduced as a result. This has been a false expectation. In explaining the fallacy, one needs to make a firm distinction between the gross budgetary effect of a marginal reduction in the Government’s expenditure and its net effect. The net effect of a reduction of £1 of expenditure is the value of £1 less the reductions in the tax receipts occasioned by the additional unemployment and the reduction in economic activity, and less the consequent expenditure on unemployment benefit. In the present circumstances, a reduction in the expenditure has barely any effect on the net level of the deficit.

Given that this is the case, one is bound to wonder why the coalition Government have placed such emphasis on their strategy for reducing the budgetary deficit by reducing the expenditure. The answer may be twofold. First, there may be a mistaken belief in the effectiveness of such fiscal stringency in reducing the deficit and the debt. Secondly, it fits well with the Government’s political and economic philosophy to take steps to reduce the level of government economic activity.

The Government’s economic strategy may have been influenced by the desire to obtain the approval of the risible credit rating agencies. These agencies have been passing judgments on the viability of various European economies and on the likelihood that they will default on their sovereign debts. Perhaps, therefore, we should compare our economy with the economies that have suffered from the adverse effects of the assessments of the credit rating agencies and wonder whether it might reasonably be subject to the same aspersions.

It should be remarked at the outset that whereas those economies that are currently subject to debt crises have a substantial proportion of their borrowings in short-term loans from the money markets, UK debt is, by contrast, preponderantly of the medium and long-term varieties that have a limited exposure to the whims of the markets. The UK’s public debt as a proportion of GDP stands at 80 per cent. By comparison, Greece’s debts are 142 per cent of GDP, Ireland’s debts are 96 per cent, Portugal’s 93 per cent and even Germany has greater public borrowings than the UK at 83 per cent of GDP.

One should also compare the size of the annual deficits of the various countries. Here, at present, Britain does not fare so well. As a proportion of GDP, its current deficit is the third largest in Europe. It must be conceded that the UK could and should do better in reducing the level of its budgetary deficit. Given that this cannot be achieved effectively by reducing government expenditures, one must ask by what other means it might be reduced. The means must be by securing the growth of the economy and by increasing the levels of personal taxation.

There is ample scope for obtaining significant revenues by increasing the top rate of taxation. The current British rates are below those of other northern European countries and they have been at low levels ever since their radical reduction in the early years of the Thatcher Administration. The basic UK rate is at 20 per cent; the higher rate, which becomes effective for incomes above £35,000, is 40 per cent; and an additional rate of 50 per cent—which is a recent provision—is operative only for incomes in excess of £150,000. At the level of income where the additional rate is chargeable, it becomes common for remunerations to take various forms that are aimed at the avoidance of tax. Disguised remunerations are widespread throughout the financial sector and at the higher reaches of corporate enterprise. These sidestep income tax through awards or incentive payments mediated by trusts, third parties or offshore pensions. Non-repayable tax-free loans are also common. If the additional rate were raised and tax avoidance tackled, we should go a long way towards eliminating the budget deficit.

The Government are well aware of the problems of tax avoidance and they have widespread backing for their aim of stamping it out. There is much to be done before tax avoidance in the upper echelons is successfully quashed. To defeat the cunning of the tax avoidance industry requires an ongoing and sustained commitment to the task. The problems will not be overcome until the level of capital gains tax is further increased. It should be graded according to income so as to become commensurate with the levels of income tax. This is because much of the higher remuneration is gathered in the guise of capital gains.

The importance of the task and the reward for undertaking it are increasing as the distribution of income in this country becomes more unequal and as the ranks of the middle-income earners are decimated. It should be noted that the UK records the highest value in northern Europe of the Gini coefficient, which measures the inequality of income distribution. It remains to say how the economy should be stimulated. It should be stimulated not from the demand side but from the supply side by the provision of capital to businesses and enterprises, both large and small. The banks should be called upon to provide this capital, and they should be subject to severe penalties if they fail to do so.

The Government have recently declared bold plans for investing in renewable energy and in nuclear power generation, but these will come to nothing if the necessary capital is not available. At present, the encouragement to banks to lend more is akin to pushing on a string. The Government need to be far more commanding in their approach to this problem.