Traditionally the Bank of England has relied on inflation to pay down the National Debt. Like your mortgage, the Debt is a nominal, or money, figure so it reduces in real percentage of GDP terms with inflation. The Debt is now £2.9 trillion which is 95% GDP, and the OBR’s latest forecast outcome for the 26/27 annual deficit is £115.5 bn, although 12 x the April 26 monthly borrowing requirement of £24.3 bn gives £291.6bn! Of course revenues are not received equally over the months. Either way it is way over what we can afford. If you take inflation at the target rate of 2% that would offset a deficit of £58bn. Above that the debt is spiralling up out of control. Last year the cost of interest to the taxpayer of interest on the debt was £110bn which the OBR forecasts to rise to £137bn by 30/31, money that would be far better used for tax cuts and patching up our public services. The interest cost rises both because of the increase in the debt itself and because the rate of interest we have to pay is also rising, partly because the markets are less confident in our ability to repay. The inevitable result of this trend is bankruptcy.
The usual reaction to this is a cry both for growth and for spending cuts, with no suggestions as to how these might be achieved. I have talked about growth above and I examine opportunities for spending cuts below, but before we do that we must model a Source and Application of Funds Strategy which produces sufficient quarterly surpluses to start allocating funds to paying down the debt, tax cuts and patching up our broken public services.
| Source of funds | By Year 5 | By Year 10 |
| Benign taxes (the sort few will notice) | 100 | 100 |
| Expenditure cuts and savings | 100 | 200 |
| Growth (assume % progression of 0,1,2,3,4,4,4,3,2,2) | 100 | 250 |
| Sub total – £bn | 300 | 550 |
| Application of funds | ||
| Eliminating the deficit and substituting an ongoing surplus of 1% GDP | 75 | 175 |
| Scrapping Net Zero carbon taxes | 30 | 55 |
| Increasing defence expenditure to 4.5% GDP | 30 | 60 |
| Maintaining pensions triple lock and increased NHS and care demand | 30 | 60 |
| Eliminating structural barriers to reducing unemployment | 35 | 50 |
| Sundry other tax cuts and services improvements | 100 | 150 |
| Sub total – £bn | 300 | 550 |
Implementation – front-loaded fiscal consolidation
This where we will need a very strict new fiscal rule: SAVE FIRST – SPEND LATER. Not a penny more.
Benign taxes are needed to get the ball rolling as most savings and growth will only come through later. We need ‘white holes’ appearing each quarter asap. Once they do come through 50% will be retained by the Treasury to pay down the deficit (one third), and one sixth to deal with structural unemployment (mainly regional policy and training but also some tax and welfare streamlining), and the other half passed across to cabinet to be spent according to party priorities. I envisage a regional policy based on tax discounts by post code where the discount is directly proportionate to the local level of unemployment. Also a ring-fenced budget to get the NHS recruiting British graduates and school leavers again.
I envisage two principal benign taxes as follows:
1. A turnover tax or stamp duty on central foreign exchange markets (sometimes called a Tobin tax after the American economist James Tobin who first proposed it). The Bank of England has reported (in dollars) that around £750 trillion of FX transactions are traded in the UK FX exchanges every year. You would only need a rate of 0.00001 (a thousandth of a penny) on this to raise £7.5bn for the Treasury. The policy was reviewed by the Coalition in 2011 and found to be feasible but was not pursued because it conflicted with EU intentions. That of course is no longer relevant. The review also calculated that a rate as high as 0.00005 would not cause undue distortions in the market. It’s microscopic. The punters wouldn’t even notice! So that could raise £37.5bn a year.
2. Abolish IHT but substitute a legacy tax in the hands of beneficiaries. We could simultaneously reduce the top rate of income tax back to 40%. A withholding tax of 50% would be applied at source (subject to the same rollover reliefs as for IHT) of which up to 40% is advance income tax which beneficiaries who are not higher rate taxpayers could recover the difference with their marginal rate. This makes it much more progressive. The ONS reports that around £150bn of estates are granted probate pa. Allow £30bn for rollover reliefs and 10% would raise £12bn. If the average beneficiary is a basic rate taxpayer that raises another £24bn. Knock off the IHT foregone and the Treasury could raise an additional £25bn a year.
Other possibilities include a profit cap on companies doing business with government, stopping multinationals from shifting their profits into tax havens by taxing their global profits apportioned to the UK by turnover, and import tariffs on the EU and others in accordance with WTO rules. And of course fiscal drag from the current freeze on income tax allowances and bands increases each year it continues, and the OBR estimates £30bn pa by 30/31. Everyone wants to end this freeze of course but under my fiscal consolidation rule that is only possible when funds become available. They will arise on a sort of drip feed quarter by quarter. Depends on priorities how they are allocated.
When I was studying economics at Edinburgh in the late 1960s there was debate over the choice between Keynesian fiscal policy and Monetary policy as the bast way to control demand in the economy. In fact both are equally effective; it was just about how they should be applied. Monetary policy was established first by the Bundesbank and then here by Norman Lamont, Ken Clarke and Gordon Brown when they negotiated and then delegated the setting of interest rates with the Bank of England by reference to inflation. There has to date been no similar procedure to establish the control of fiscal policy.
I am therefore commending the adoption of this Fiscal Consolidation policy, especially the predetermined splitting of any savings between the Treasury and Cabinet so that Cabinet is faced with difficult political priority decisions, ideally to be enshrined on the statute book, so that never again can a government spend money we don’t have. If inflation falls below target then the Bank of England can step in with a reduction in interest rates. Quantitative Easing, where it increases the national debt, becomes a thing of the past. A final step might be to transfer the control of interest rates to an AI Bot so that the MPC does not falling into the trap of trying to second guess the future. As any experienced financial trader will tell you, just respond to what the market is telling you.
John Poynton 