Cameron's Cuts Will Spur Britain's Recovery
The new coalition government in the UK (made up of Conservatives and Liberal Democrats) has had to take the axe to government expenditure in order to get its fiscal house in order this week.
Under Gordon Brown’s Labour (who were thrown out at the May election) government spending had spiraled out of control over the last three years. From 40% of GDP, Labour had ramped up spending to over 50% of GDP in a matter of years and in the process driven the budget to a record (non-wartime) deficit of 12% of GDP. Some northern parts of the UK had come to rely on government expenditure for 65-70% of the economy – rivaling Soviet era levels in eastern Europe. Britain was headed for sovereign debt downgrades, soaring interest rates, debt serving levels consuming one-fourth of government spending and an economy crippled by the overbearing burden and cost of government. This from a nation that had for 25 years been a leader in Europe and the world in terms of privatization, tackling entrenched union power in the labor markets, lowering taxes and competing with free open markets – all of which had delivered high growth and incomes to the UK.
The new government has risen to the challenge of a bankrupt government and through a combination of small tax increases (mainly raising the VAT up to 20% from 17.5%) contributing 20% of the mix and drastic expenditure cuts making up the balance or 80% of the fiscal tightening to bring the structural deficit (the worst in Europe) under control over a 5 year period. Britain has had to cut defense expenditures by 8%, including the immediate retiring of its aircraft carrier, Harrier jump-jet fleet and closing the naval academy that once trained the world’s most impressive naval fleet. With the exception of health and overseas aid (which were ring-fenced for political reasons from cuts not withstanding their waste) the rest of government has suffered a 20% average cut – a total of $130 billion p.a. (or over 4 ½% of GDP). Middle income families have also lost the child tax credit (now capped at £40,000 of income), universities will dramatically increase fees charged to students and almost 500,000 public sector jobs will be cut.
The UK government has chosen a private sector led growth path in stark contrast to its Labour predecessors who believed government spending was the driver of jobs and growth. Remember Labour also used the financial crisis to forcibly nationalize much of the UK’s banking industry and harangued the likes of Barclays for choosing private capital over government control!
Notwithstanding the fiscal measures, the Coalition government has committed to progressively cutting the corporate income tax rate to 24% by 2015, which will be the lowest of any G7 nation (in stark contrast to the U.S.’s 35% federal rate – which combined with state taxes is the highest in the OECD). They have also withstood pressure for significant increases in dividend and capital gains taxes in order to encourage enterprise.
With this backdrop, American policy makers need to change direction too. The faith in government as a savior is misplaced. The out-of-control spending increases of the last two years have not helped and need to be rapidly reversed. What is needed is a pro-growth private sector-led economic renaissance agenda, which focuses on rapidly cutting government expenditure, eliminating the deficit and lowering income tax rates, especially for enterprises so American business can once more compete – without being weighed down by excessive government taxation and regulation.