City Journal

5/28/13 7:06 PM

Nicole Gelinas

The British Evasion
David Cameron pledged to shrink the government; instead, he raised taxes and strangled economic recovery. Spring 2013

When the financial hurricane struck in 2008, Britain found itself in a crisis very much like the
American one. A giant credit bubble had fueled an unsustainable rise in the price of real estate. British homeowners, feeling rich, had spent and spent, pushing up their household debt to a staggering 106 percent of GDP, up from 61 percent just eight years earlier. When the bubble burst, hitting house prices and making people feel poorer and afraid, British consumers went on strike; employers promptly imitated them, and the United Kingdom lost 1.6 percent of its jobs between 2008 and 2009. (America, with its easier hire-and-fire culture, lost 5 percent.) With bubble-era tax revenues gone, a British government deficit that had seemed manageable became cavernous, expanding from 3.5 percent of GDP over the 2004–08 period to 11.5 percent in 2009. In the spring of 2010, David Cameron ran for Britain’s prime ministership, promising to tell the truth about the country’s fiscal mess and to take the unpopular steps needed to clean it up. Britain was laboring under “the biggest budget deficit of any developed country in the world,” Cameron warned in a televised debate. “If we think that the future is just spending more and more money, we’re profoundly wrong.” British voters, terrified that investors would cut their nation off from global bond markets, ditched the incumbent Labour Party, which had been in power for a decade, and gave Cameron’s Conservative Party a plurality in Parliament. Another party, the Liberal Democrats, joined the Conservatives as the junior partner in a coalition that came to power that May. Rather than bicker and stall, the Conservatives and the Lib Dems—which, like America’s two major parties, hailed from opposite sides of the ideological spectrum—had agreed to get along in order to shrink the enormous deficit. These seemingly functional politics, however, have produced an economy marked by nonexistent growth. Britain hasn’t fixed the fisc: the Moody’s credit-rating service cut Britain’s triple-A rating a notch in February, something that Cameron had said that his budget would prevent. And public services are deteriorating at an alarming rate. For the many American pundits who insist that Republicans and Democrats should make compromises and moderate their own stances on deficit reduction—lower spending and higher taxes, respectively—the British experience should serve as a warning.

In June 2010, Cameron sent his chancellor of the exchequer, George Osborne, to Parliament to
present an emergency midyear budget. Osborne wanted to slash annual spending by £40 billion (about $60 billion) to get Britain off the “road to ruin,” he said. Echoing Cameron in slightly different terms, Osborne told lawmakers that the government had inherited “the largest deficit of any economy in Europe” except Ireland—“this at the very moment when fear about the sustainability of sovereign debt
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right after Lehman Brothers collapsed. not welfare.” Osborne said glumly in his emergency speech.” Autumn 2012). came immediately. though not on groceries or books. To raise £13 billion yearly—the biggest share of the government’s overall tax grab—Cameron and Osborne walloped every Briton with a massive increase in a tax that most people paid almost every day: the value-added tax.org/printable. the bad tax policy outweighs the good. not higher taxes. The higher VAT prolonged the slump.” Osborne cited empirical evidence to back him up. The coalition has done some good things on the tax front. Deep spending cuts. Unfortunately. Osborne continued. an austerity budget was “unavoidable. Osborne said.4 percent increase.) Osborne may be adept at reading a page of projected spending and revenue numbers and trying to make them meet somewhere in the middle. Most significantly. Just after Christmas 2010. as was happening in Greece.php?id=9091 Page 2 of 6 . he temporarily slashed the VAT to 15 percent. since “the country has overspent. by contrast. as part of a laudable policy of rewarding work. But there was a catch.5 percent to 20 percent.475 to £8. And the spending cuts would kick in much more slowly than the tax hikes. cuts would constitute just 59 percent of deficit reduction. would take time to enact: officials would need to figure out what the government spent money on and then determine where to cut and by how much. “Thousands http://www. the VAT rose from 17. having dropped by 2 percent (after inflation) in 2009 and by another 1 percent in 2010. The money raised would be money that “we don’t have to find from extra spending cuts or income tax rises. Though tax raises weren’t good policy.” promised Osborne: “roughly 80 percent” of deficit reduction would come from lower spending and 20 percent from extra taxes. their share had actually fallen. and by 2012. the coalition increased the amount of money that people could earn each year without paying income taxes.105. Consumer spending was already falling. The International Monetary Fund had found that budget fixes delivered “through lower spending are more effective at correcting deficits and boosting growth than consolidations delivered through tax increases. the promised 77 percent wouldn’t arrive for five years. from £6. Vacant storefronts and bankrupt retailers have ruled British front pages for years now. Consumer spending fell by 1 percent in 2011 and remained flat last year. It has not been undertaxed.” (Back in late 2008.” The solution was spending cuts. Taxes will rise by another £5 billion next year. For the first year. a smart change meant both to encourage firms to move jobs to the United Kingdom and to discourage the widespread legal tax avoidance that has put Starbucks and Microsoft in tabloid headlines for their tiny British tax bills. “The years of debt and spending make this unavoidable.” he said (see “The Kindest Cuts. So the government would follow an “80:20 rule of thumb.” To avoid the investor flight that would precipitate a public debt crisis. Labour prime minister Gordon Brown had taken the opposite tack: to try to encourage spending.” The goal was “an economy where the state does not take almost half of all our national income. Today. Also. though. The actual figures that Osborne gave showed that he planned to take 77 percent of the reduction from the spending side and 23 percent from taxes. The tax slam. British taxpayers shoulder an annual burden that’s £21 billion heavier than it was before the coalition took power—a 4.City Journal 5/28/13 7:06 PM is the greatest risk to the recovery of European economies. they’ve cut the corporate tax rate for large companies from 28 percent to 24 percent. but he and the rest of the coalition seemed oblivious to how flesh-and-blood people would react to the VAT increase. a sort of sales tax on everything from adult clothing to restaurant meals. they were a handy tool for reducing deficits immediately.city-journal.

either. moreover. which has pushed up the price of goods and the resulting tax haul. Between 2008 and 2012. especially if he lives near expensive London.city-journal.000 to £50. the coalition nearly doubled the tax rate for capital gains.5 billion annually. The coalition has begun to take away child tax credits at the £40. a 2 percent loss in sales equals “one-third of the profit margin. the tax remains 12.000 threshold.” The coalition. who had already lost income during the crash. Wealthy people. Britain plans to slap retail yet again.200 annually—nearly £100 worse off. on average.” Still. this time by raising property-tax rates for businesses. but during the coalition’s first year in power. As Osborne acknowledged two years later. Osborne waved through Brown’s earlier plan to boost income taxes by 25 percent for people earning more than £150.php?id=9091 Page 3 of 6 . The tax changes have left the poorest 10 percent of families—those making less than £14.000) is indeed in the top 20 percent of British earners. Because retailing is a low-margin industry. British taxpayers aren’t paying into a more efficient tax system. the coalition government has reaped the VAT revenues that it anticipated only thanks to persistent inflation. Hyman adds. In early 2010. To stay in business. changed course and brought the top rate down to 45 percent this year.000 jobs—3. All that economic pain notwithstanding. which included not only fallout from the financial crisis but also the rise of Internet shopping and the higher cost of imported Chinese-made goods. a cost that doesn’t show up in the tax figures. the retail industry lost 197. didn’t come close to bringing in the revenues that the coalition expected. than they were before the coalition’s reforms.” Analyst Richard Hyman says that the VAT increase “inevitably exacerbated” the forces already battering British retail. and their biggest cost was people. the government has concluded.” even if a retailer is operating efficiently. In Osborne’s words: “The government believes it is neither efficient nor fair to maintain a tax rate that is not effective at raising revenue from high earners and risks damaging growth. Not that the poor and lower middle class are benefiting from all the new government revenue. on average. people in the middle class are £200 worse off. A second major tax increase. for instance. “the behavioural response has been larger than expected. stores therefore had to cut costs. Again. and pushed households making just over £30. this one on the wealthy. Other recent tax changes have hit the middle class.9 percent of the total. According to government figures. And though someone earning £40.” the Financial Times reported this February.City Journal 5/28/13 7:06 PM more shops could close in the coming year leaving one in six stores empty.000 annually.2 percent across the country’s top 650 town centres.5 percent higher than it was before the coalition came to power. according to the same government figures. “it’s quite possible” that the result “could be negative. and it backfired.000 (roughly $60.” Supposed to raise £2. he probably won’t pay £300 more in taxes annually—the average hit for the upper middle class—without feeling it. that benefit to the poorest was more than offset by the VAT hike alone. for a top rate of 50 percent. The coalition government had http://www. the hike raised £1 billion or less—and once enough time passes. has borne the brunt of higher tuition fees at public universities. admitting its mistake. worked less or moved their income to avoid the levy.000 into a higher marginal tax bracket. The middle class. It was the first such increase in three decades.500 empty shops and a national vacancy rate of 14. This year. the coalition raised the level of earnings exempt from income taxes.org/printable. to 28 percent. And in another move to soak the rich. a fraction seven times bigger than in the rest of the workforce. The paper cited research finding “more than 35.

in 2009.city-journal. which was at least a principled decision. but taxes on fuel purchases are down. In his first budget. “Overall the tax system is probably more complicated than it was when they came to power. As of early March.7 percent increase exceeded Britain’s 2011 inflation rate. head of the nonprofit TaxPayers’ Alliance. on average. Prime Minister Brown had proposed to spend £646 billion for the fiscal year ending in 2011. since the British press hasn’t found any voters in favor of such spending. for example. up from £601 billion the previous year. Cameron and Osborne had to force harsher reductions onto the rest of the budget. Like many Western leaders. In January. Yes.4 percent of GDP. however. The coalition has cut taxes for the video-gaming industry. the country’s socialized health-care system—consumed almost one-sixth of the government’s total spending. was a 4. Inconveniently. the coalition has been less than draconian in cutting spending. since bakeries heat pasties solely for “aromatic” reasons. Aside from the straightforward corporate-tax cut. and “winter fuel allowances. An accountancy firm weighed in during the ensuing controversy. To protect health care. he moved to classify warmedover Cornish pasty. Osborne’s long-range plan allows the NHS to keep growing while forcing the transportation agency. Osborne’s tinkering devolved into farce. Last year. In his 2012 budget.php?id=9091 Page 4 of 6 . In fact. all Osborne has done with the code is a lot of confusing tinkering. but elevated them for the oil and gas industry. The public outrage over the “pasty tax. Though it has taxed aggressively. the TaxPayers’ Alliance compiled a spreadsheet of 254 tax increases and 109 tax cuts that the coalition had enacted in three years. though.5 percent. a sort of meat pie. After all. as a hot food. Nor was that first coalition budget an aberration. saying that the hot tax shouldn’t apply. The deepest austerity that Britain had seen in a generation. Taxes on savings accounts are down.) It wasn’t so surprising that the coalition opted not to go where the money was. than at any time between the start of Margaret Thatcher’s premiership nearly three decades ago and the extreme spike that hit in the aftermath of the financial crisis. the coalition’s budget for next year called for spending £672 billion. But the coalition’s 4. Britain’s £103 billion health-care bill—nearly all of which goes to the National Health Service (NHS). including America’s. so that the government could levy the VAT on it as though it were a restaurant meal. That represents 44. Taxes on alcohol and gambling are up and down (but mostly up). and the government ended up spending even less than that: £629 billion. more than halfway through their five-year term. for example.” as the tabloids dubbed it. That hasn’t stopped Cameron and Osborne from continuing to congratulate themselves. which peaked at 4. Taxes on airplanes are up. in early 2013. to take a haircut of 21 percent in real http://www. it didn’t dare to challenge benefits for the elderly—such as free bus passes. higher than this year’s 43. then. was so intense that Osborne had to scrap it. Osborne lowered Brown’s £646 billion to £637 billion.” even for those who live abroad in warmer climes.1 percent and higher. for cutting spending relative to the profligacy of the preceding Labour government. One flaw in the coalition’s spending cuts involved what it decided to cut. spending must keep pace with inflation if it’s going to buy the same quantity of goods and services. In his final budget document.7 percent spending increase relative to the previous year. (They also “ringfenced” the foreign-aid budget. which they get regardless of their income.” said Matthew Sinclair.org/printable.City Journal 5/28/13 7:06 PM promised full-scale reform that would end distortions in the tax code and make it simpler. Cameron and Osborne thought that touching health-care entitlements would be political suicide. but taxes on venture-capital trusts are up.

Britain has jettisoned 554. Osborne slashed London’s grants to local governments by 27 percent in real terms over a projected four years. That may not be a problem in the short term. in just a few years and in the middle of a historic recession.” as he put it in his 2010 emergency speech. prompting government workers to strike in March. just under 8 percent.3 percent cuts. But spending. saving money.3 percent smaller (after inflation) than it was in 2007. and the threat of a new recession looms. but Cameron has still kept public-sector wage growth below inflation. The public-sector workforce is now the same size that it was in 2002. And the coalition has shrunk the number of people on disability by 145. something that America can’t yet say. That shift can be a sign of healthy entrepreneurialism.) Yet these changes weren’t enough to slow the growth of the state immediately. as the coalition had unwisely pledged. while those of people working for someone else are down 434. Making the cuts still worse was that they didn’t help the budget situation much. though lower than the 2011 peak of 4. Osborne should never have believed that he could achieve “sound public finances.8 percent of the precoalition total. inflation.000. such as transferring the Royal Mail’s assets to the government and calling it a £28 billion shrinkage in infrastructure spending. official employment figures show slightly more jobs now than before the 2008 crisis. and it meant whopping service cuts. the defense budget has fallen from £38 billion (in today’s pounds) to £27. Because such grants had constituted 55 percent of localgovernment spending. Cameron and Osborne want to save another £3 billion yearly on public-sector pensions. have risen by 367. Economic growth was flat at best last year. some of the coalition’s spending cuts make sense. while NHS ranks are flat. the unemployment rate remains high. again.org/printable.000 government jobs.5 percent. http://www.000 in four years. Its GDP in 2012 was 2. The ranks of the self-employed. and raised nuisance fees. hasn’t fallen commensurately. The government has capped welfare benefits so that “people are better off in work than on benefits.6 billion. rolling back other services and laying off government workers don’t make enough of a dent in the budget. With spending on health care still rising. saving £5 billion annually. it’s more likely a sign that many people are doing odd jobs to scrape by. which covers longterm infrastructure investments and would take a 29 percent capital hit over four years. The British press has eviscerated Cameron and Osborne over the past few months for missing various fiscal targets and for resorting to budget gimmicks. And since 2010. for example. But those numbers may mask the true extent of economic weakness. 8. Like its tax policies. Making more room for the NHS has also eaten into Britain’s capital budget. The government will gradually increase the private-sector retirement age to 67.” another smart move. it will raise the cost of British-made goods. Yes. far greater than the operating budget’s 8. laid off workers. since fraud is rampant. A second flaw in the coalition’s budget-cutting was that the government merely shifted some of its spending burden onto localities. was still 40 percent above the government’s target of 2 percent. Britain’s economy hasn’t turned around. suggesting that many bosses have retained employees even with limited work for them to do. take a look at who got the pink slips: police numbers are down by 10 percent.City Journal 5/28/13 7:06 PM terms.php?id=9091 Page 5 of 6 .city-journal.000 by aggressively assessing “whether they are capable of working. And the coalition froze public-sector pay for two years. hurting the country in the global marketplace. but over time. workforce productivity is way down. Why not? For a clue. Over the last three years. local British governments have shuttered libraries. this was a big deal. Further. (The freeze has expired.” as Cameron puts it. Since the coalition came to power. both by forcing current workers to pay more and by raising the retirement age for today’s younger workers.

and what can America learn from the experience? One lesson is surely to avoid steep.” Osborne said in his emergency speech. that’s still grim. rejecting new taxes and designing solid NHS reforms while waiting for the longer-term impact of the pension and welfare reductions to kick in. “Backbenchers” in the Conservative Party. a year later than set out. Back in 2010. snatching $45.K. sudden tax hikes. as the public and politicians alike have grown tired of the coalition’s austerity measures. as well as Liberal Democrats and members of other parties. There’s no evidence that bond markets. Nicole Gelinas is a City Journal contributing editor. Congress axed a temporary cut in Social Security taxes. would have revolted at such a gradual course. “And where’s their money?” The other lesson from the coalition’s failure is still more sobering. since investors in British bonds might have balked at an even bigger deficit. they were necessary.City Journal 5/28/13 7:06 PM As for the budget outlook. though the tax increases damaged the economy. American-style—was going to cure the West’s woes in a matter of months. kicked off 2013 with an American version of the big VAT increase. we’ll raise taxes then. Many budget watchers still maintain that. It may take even longer to get out. since it harmed economic growth and hurt public support for deficit reduction. the Conservatives placed third. Cameron and Osborne implied that the 2010 spending cuts would unleash instant private-sector growth: “Today we have paid the debts of a failed past and laid the foundations for a more prosperous future. out of every American family’s paychecks every two weeks. In America. in a closely watched off-year regional election in Eastleigh. after the Liberal Democrats and the conservative U. In Britain. Cameron could have said: If we can’t figure out how to lower spending over five years. To avoid the fiscal cliff. as in Britain. “Where are all the customers?” fretted a Walmart executive in a February e-mail that was later leaked to the press. are calling for measures to help people with the rising cost of living. How did British austerity go so wrong. and it may be too rosy. But that’s only a projection. http://www.city-journal.php?id=9091 Page 6 of 6 . But it took a long time to get into this mess. Obama made the mistake of saying that the 2009 stimulus program would quickly bring unemployment below 8 percent.” Osborne wrote last fall. No fiscal program—whether fiscal austerity. Cameron’s cabinet members in charge of security and other areas are openly questioning why they must make deeper and deeper reductions to their departments even as health care is protected from belt-tightening. The payroll-tax increase may already have stalled the economy’s sputtering growth. and the author of After the Fall: Saving Capitalism from Wall Street—and Washington. with the Republican House assenting.org/printable. And in March. What’s the harm in waiting? The United States should pay particular attention to that lesson. But shouldn’t investors have been still more worried about Britain’s inability to curb the health and other social spending that comes with an aging population and a stagnant workforce? Cameron and Osborne should have focused on those long-term problems. which have remained complacent in Britain (just as they have in America). The coalition’s rapid tax slap got Britain no closer to its fiscal goals. on average. “Public sector net debt as a percentage of GDP will be falling in 2016–17. Independence Party. the Searle Freedom Trust Fellow at the Manhattan Institute. or fiscal stimulus. President Obama.

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