Osborne must get radical or face defeat

Winning the next election may already be beyond the present government, argues Matthew Lynn. But there's still time for George Osborne to leave a lasting legacy.

What would be the riskiest thing George Osborne, the chancellor, could do in his Budget next week? Chance everything on some tax cuts and risk splitting an already fragile coalition? Borrow some more money to fund infrastructure spending and perhaps see Britain's credit rating taken down another notch?

No. The riskiest thing Osborne could do is put safety first and do very little. The next general election looks already lost. It would be far safer to roll the dice and reform at least one major tax. It might just have a chance of working in time for the coming election and even if it didn't, it would leave a legacy that would be hard for the incoming Labour government to reverse.

The arguments for caution are familiar. Britain's triple-A credit rating has already been lost, and could be downgraded again if the budget deficit is not kept under tight control. A new governor of the Bank of England is about to take office and needs time to establish his own strategy.

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The eurozone crisis may have calmed down, but with fresh elections likely in Italy, and anti-euro parties being formed in Germany, it could flare up again at any moment. While growth may be slow to materialise, at least the economy is not in recession again.

So Osborne should plough on as before, it will be argued: some mild austerity, massive borrowing, and some fiddling with the tax system to give the appearance of doing something, even while the economy stagnates.

The trouble is, this approach isn't working. It is now clear that Britain will be poorer in 2015 than it was in 2008. Countries such as Germany have already recovered their losses from the 2008 global downturn and America is starting to grow at a respectable rate again. But British output is still no higher than it was five years ago. The result is that the average person is getting poorer.

Between 2007 and 2012, real wages have fallen by 4.4% in Britain. There is little sign of that turning around any time soon. Wages are still rising at a slower pace than inflation and with the pound getting hammered on the currency markets, inflation is likely to go higher. By 2015, the average person will be worse off than they were when the coalition took office in 2010.

No government, and certainly not a minority one, can expect to be re-elected with a record like that. In 1970 Roy Jenkins, the then Labour chancellor, put forward a damp squib of a safety-first' budget and was later blamed for losing Labour the election later that year. If Osborne does not want to go down the same path, he should throw caution to the wind and make at least one bold move.

There is no shortage of candidates for a radical tax cut. When the government takes out 39% of the economy in tax (and spends more than 45% of GDP), then it is clear that just about every form of activity is taxed more than it should be.

You can make a case for cutting VAT to help out the high street, for reducing income tax to boost spending, for cutting stamp duty to keep the property market alive, or indeed for cutting inheritance or capital gains taxes to reward the Tory base and stop too many of the party's core supporters abandoning it for the UK Independence Party.

But to make an impact before the next election, the most effective move would be a deep cut in corporation tax. Osborne could slash the rate to 10% 2% less than Ireland. That would give Britain the lowest corporate tax rate of any economy in the OECD club of rich countries.

The coalition has been taking baby steps towards making the UK corporate tax regime more competitive but baby steps aren't enough. In the OECD, 17 countries have a lower corporate tax rate than Britain, according to a ranking by the Sad Business School.

When the effective tax rate is calculated, taking into account allowances and reliefs, Britain does even worse. It ranks 22nd out of 33 countries. There's nothing competitive about that. A huge number of firms moved to Ireland to take advantage of its low tax rates there's no reason they shouldn't move to Britain.

But a clear and dramatic message is needed: the lowest rate in the developed world would do the trick. No one re-locates their business to take advantage of the 17th lowest rate in the world. Only the lowest headline rate will do.

True, this move would worsen the deficit. Corporation tax raises £43bn a year, so halving it could cost £20bn-£25bn annually. And yet past cuts in corporation tax have cost far less than you might think.

According to a study by the Centre for Policy Studies, corporation tax has come down from 52% in 1982 to 26% now. Over that period, it has gone from collecting 2% of GDP in 1982 to 2.8% of GDP now. Slashing the corporate rate is in effect self-financing because it pulls in so much extra business.

If the government doesn't do something radical, it is doomed to defeat. A bold move at least has some chance of working. And even it does get defeated, wouldn't it be better to leave behind at least one radical tax change that it will be very hard for the next Labour government to reverse?

The incoming chancellor (my bet is David Miliband) would be very reluctant to double the rate of corporation tax in his first budget. Even if Osborne can't win another term, he can leave a legacy that will stand.

Matthew Lynn

Matthew Lynn is a columnist for Bloomberg, and writes weekly commentary syndicated in papers such as the Daily Telegraph, Die Welt, the Sydney Morning Herald, the South China Morning Post and the Miami Herald. He is also an associate editor of Spectator Business, and a regular contributor to The Spectator. Before that, he worked for the business section of the Sunday Times for ten years. 

He has written books on finance and financial topics, including Bust: Greece, The Euro and The Sovereign Debt Crisis and The Long Depression: The Slump of 2008 to 2031. Matthew is also the author of the Death Force series of military thrillers and the founder of Lume Books, an independent publisher.