Can Labour fix the deficit?

Senior Labour figures such as Lord Wood have made much in recent weeks of the similarities between Labour’s view of progressive capitalism and the achievements of the former US President Theodore Roosevelt. It was Roosevelt who broke up the energy behemoth Standard Oil as part of a broad range of action against private sector monopolies. Following Ed Balls’ commitment at the weekend to raise the top rate of income tax for those earning above £150,000 per year to 50p, we should remember perhaps Roosevelt’s famous remark that “too much cannot be said against the men of great wealth”.

The challenge of raising taxes on the rich is that they might raise much less money than it seems they should. When the top rate of income tax was raised to 50p by the previous Labour Government, it was estimated that the increase would raise £2.5bn a year. Analysis by HMRC suggests that somewhere between £16-18bn of income was brought forward to the year before the increase was implemented. Business groups also argue that the higher tax rate functions as a disincentive to inward investment as well as to new business development by UK entrepreneurs. The true yield of the tax rise was at least 80% lower than forecast; and it may even have been negative.

Roosevelt too worried about the scope for evasion like this, going so far as to say that a tax that can be evaded is “worse than no tax at all, as the least desirable of all taxes is the tax which bears heavily upon the honest as compared with the dishonest man”. Balls, though, seems to view the effect described by HMRC as a one-off; he said confidently in his speech that if the higher rate of tax had remained then this would have raised an additional £3bn a year.

Obviously there are some people who will not be able to avoid the tax rise. The Prime Minister will not be able to bring forward his income to the year before a higher rate is brought in, nor will Whitehall Permanent Secretaries or the handful of Chief Constables paid above £150,000 per year. But these numbers are limited, higher salaries are more common in the private sector, especially in sectors such as banking. This makes the timing of Balls’ announcement fairly curious; the further in advance that you indicate a change like this, the greater the likelihood that it will produce, as HMRC delicately calls it, a “behavioural response”. Equally Balls has already hinted that the tax rise may be temporary, which makes it all the more likely that income will be brought forward to before the rise comes into effect and pushed back until after it is expected to end.

This suggests that the announcement may be just as much about indicating Labour’s vision of a fairer society than making the critical inroads to achieving it. In that sense, it’s an important reminder that the party is still committed to old-fashioned re-distribution as well as the much talked about ‘pre-distribution’. That said, if more competition is successfully introduced into sectors such an energy and banking, as Labour is claiming it will do, then perhaps high salaries will become less common or at the least they will be more justifiable, better linked to excellent performance and high levels of service to consumers, than they are at the moment. The tax rise may therefore be a stop-gap measure while a Labour-led activist state fashions a more progressive economy: tax first, reform later.

The other significant fiscal announcement in Balls’ speech was that a Labour government would run a current account surplus during the next Parliament. They would even legislate to make this into a binding commitment. The critical words here are “current account”; Balls went on to say that a Labour government would also assess the case for extra capital investment. Depending on how capital is defined, this will make the task of running a current account surplus harder or easier. This may seem like a minor definitional issue, but in fact it goes to the heart of the question of how much Labour will need to cut public spending and raise taxes in order to achieve the surplus it is targeting.

The higher rate of income tax may raise under £1bn a year, that doesn’t do much to help in the task of running a surplus; compared to that, if capital and current spending are to be subject to different rules, then the temptation for getting to the surplus more easily by switching current spending into the capital budget may be much greater.

Balls’ argument will be that capital spending is different in kind to current spending; better infrastructure has for example the potential to raise the long-term productivity of the economy. That same argument though can be made for universal free childcare or more higher education, spending on these can potentially increase productivity too and perhaps we can think of them as human capital, just as we think of infrastructure as physical capital. Certainly there is a case to be made that, with productivity growth languishing at 0.5% on the latest figures, running a surplus by putting off productive investment is the wrong decision to make.

Nothing in Balls’ speech yet indicated how he views the boundary between capital and current spending or how much investment he may be willing to make. The argument about the 50p rate of tax is already raging, and it will continue throughout the election campaign, but it may be the quieter, more technical question about how different types of public spending are categorised that has the greater significance within Labour’s fiscal plans. What would Theodore Roosevelt say about that?


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