With promises of tax cuts galore, the Conservatives are out of touch with economic reality | Larry Elliot

IImagine for a second that it is Labor rather than the Conservatives who choose the next Prime Minister. Consider what the response would be if the hopefuls said it wouldn’t be hard to find an extra £30billion to tackle poverty or an extra £40billion for the NHS, and competed for the most ambitious spending pledges.

It doesn’t take a genius to know what the response of the Conservatives and the newspapers that support them would be. At the very least, there would be questions about how the plans would be funded. More likely there would be warnings of a run for the pound and impending economic collapse. Headlines would read something like: ‘Loony left behind plans to bankrupt Britain’.

Curiously, a different view is being taken on the deep and immediate tax cuts now promised by nearly everyone who wants to replace Boris Johnson. For those who encourage the candidates, it is not reckless tax incontinence that will scare the City. They do not represent voodoo economics, in which tax cuts pay off. If you think the Tories in the summer of 2022 are in a similar place to where Labor were in the 2019 general election campaign, you couldn’t be more wrong. As far as the right is concerned, tax cuts are the only way to grow the economy and make Britain great again.

This is wrong on many levels, but let’s start with the idea that there is something extremely dangerous about the level of tax in the UK. International comparisons produced by the Organization for Economic Co-operation and Development To display that last year, tax revenues as a share of national income of its members from rich countries amounted to 32.9%. The figure for the UK was 32.8%.

Admittedly, tax levies in the UK are increasing and are set to be the highest since Clement Attlee was Prime Minister, but this is to cover two developments: a pandemic and upward pressures on spending caused by an aging population. The baby boomers are doing a bit, which has implications for spending.

A quick glance at the OECD’s international tax table shows the range of options. Countries with generous welfare states have high taxes. Countries that have rudimentary welfare states can be low tax. No country has Swedish government spending levels and US tax levels.

There are those on the right who know this and are honest enough to point out that the logic of lower taxes is a smaller state, with people expected to contribute more to their own well-being, whether through payments for health care or less generous state pensions.

Rank outsider Kemi Badenoch is really the only candidate for Johnson’s job willing to argue that tax-spending trade-offs might have to be made. Even Rishi Sunak, who has cast himself as the fiscally prudent choice, says tax cuts are a matter of when not if.

Insofar as there is an economic strategy, it is that cutting taxes will pay for itself because it will lead to faster growth and higher revenues for the treasury. This is supposedly what worked for Margaret Thatcher in the 1980s, but it is simply not true.

Income tax cuts made by the new Thatcher government in 1979 were offset by a rise in VAT. Taxes were raised as the economy was in deep recession in 1981. It was only after several years of growth and a marked improvement in public finances that income tax rates were reduced. Until 1988, the maximum income tax rate was 60%.

The idea that personal tax cuts are a silver bullet that will restore the economy’s vitality and solve the cost of living crisis is also a serious misdiagnosis. Britain has serious economic problems, but they are mostly long-term and structural rather than short-term and fixable through an injection of consumer purchasing power.

The reason inflation is heading towards 10% and the trade deficit is exploding is that supply is failing to keep up with demand, and the only way to deal with this is to address chronic deficiencies in the UK in skills, investment and infrastructure. Tony Danker, the chief executive of the CBI, is absolutely right when he says that personal tax cuts would only make inflation worse, and that if there were to be any, they should be designed to stimulate investment and be part of an overall growth plan. A tax cut would almost certainly cause the Bank of England to become more aggressive with interest rate increases.

There are of course other ways to spend more while taxing less. One option would be to borrow more – something that could pretty much be done while respecting the government’s own rules, but which leaves little room for maneuver if the economy continues to struggle.

Another option would be to print more money. According to proponents of Modern Monetary Theory (MMT), governments that issue their own currency do not need to resort to taxes or borrowing to cover their expenses because they can print whatever they need up to when inflation becomes a problem.

It is reasonable to assume that in the current circumstances, with inflation already at 9.1%, none of the aspiring prime ministers will come out in favor of MMT. This, however, means that they must come up with a coherent explanation of why tax cuts are needed and how they would be paid for. So far there have been a lot of wishful thinking and not much else.