Turbo-charging the rhetoric

Polly Toynbee was at it again today. She produced another long whingeing article in the Guardian, complaining about cuts to local authority grants. She described the coalition's plans as "brutal" and a "turbocharged program for accelerating inequality".

I'm sure that her main proposition is right; Britain will be a more unequal country in five years than it is today. Unfortunately, in policy terms, that projection doesn't take us very far. In a more benign world, the coalition would have been quite happy to keep public expenditure at its current levels. Sadly, that option is not available.

The government's budget, like those of a household, is a matter of arithmetic. The government receives tax revenues, and makes expenditures. If the government spends more than it receives, then it has to borrow. At some point in the future, debt has to be repaid. Therefore, government borrowing is taking future taxes and using them today. History is full of examples of ruined economies where the government kept on borrowing and eventually "maxed out the credit card.

Mercifully, HMG's borrowing has not yet crossed the unsustainability threshold. Nevertheless, it would be wise to avoid any flirtation with the precipice. Instead, we need a thorough diagnosis of our present difficulties and a realistic policy framework that ensures long term budgetary stability.

This diagnosis will show that the immediate cause of our budgetary difficulties is taxation. True, government expenditure as a percent of GDP had been drifting upwards for at least a decade. However, it was the revenue collapse that wrecked the ship. When the housing bubble crashed, and the financial sector almost disintegrated, a huge proportion of government revenues disappeared, literally overnight.

The government lost revenue through various channels; Stamp duty revenues collapsed,. Corporate income tax fell sharply, as banks racked up huge losses. As house prices fell, people felt poorer and cut back on consumption expenditure, thus reducing VAT revenues. Lower consumption rippled into the labour market, increasing unemployment and reducing personal income tax revenues.

If this shock to revenue were temporary, then it might make sense to keep on spending and borrowing. However, over the last 20 years, the UK had become dangerously dependent on the financial sector. Banks are bloated and under capitalised. The balance sheets of UK financial institutions are riddled with dubious assets. UK banks would be unable to survive without the direct assistance of the Bank of England. In short, the financial sector is looking at decades of stagnation and tax revenues are unlikely to recover any time soon.

To be fair, Toynbee has an answer to this permanent loss revenues. They say we should aggressively tax the rich. For example, the bankers who caused this crisis, should be a particular focus of more vigorous revenue collection.

To which I say "go for it". If you think you can solve our budgetary problems by taxing Fred the Shred and his wicked banker mates, then you haven't examined the Treasury numbers close enough. Britain's bankers might be obscenely wealthy, but their ill gotten gains don't quite run into the tens of billions yet.

This leaves the government with an unenviable choice. Does it continue borrowing, wistfully hoping that revenues will eventually recover? Or does it do the difficult thing, and reduce expenditures in line with available revenues?

We can all put on a sad face, and complain about the terrible inequality that characterises modern Britain. Unfortunately, our budgetary difficulties are a more immediate problem. A painful adjustment is inevitable. However, the longer we delay, the larger the government debt stock will be, and a greater will be the adjustment.