Why Ed Miliband shouldn't concern himself with how a VAT cut is funded

(Source: Reuters)

During a radio interview yesterday, leader of the opposition Ed Miliband said that a Labour government would introduce a cut in VAT to boost the economy. He's right to support a move like this. Almost all of us are hit by VAT, and like many consumption taxes it's particularly regressive:

(Source: The TaxPayers' Alliance, ONS)

Where Miliband stumbles is in questioning about how the tax must be 'funded' (a perspective quite unique to those who think that our money belongs to the government to begin with). The sum talked about is meagre, just £12bn (or less than two per cent of government spending) and for just one year. Miliband fumbled and justified the tax cut on the basis that it would pay for itself (the same argument as that used against high top rates of income tax).

This all rather misses the point, we shouldn't want government to be taking so much in tax anyway. Studies tend to agree that at least in the long-run, resources are far more productively used in the private sector. From 1997 to 2010 ONS statistics suggest that productivity growth in the public sector has been flat:

In all of Labour’s 13 years in power, state-sector productivity stayed flat according to the Office for National Statistics. In the period state spending rose almost 50 per cent.

There were some variations from year to year – productivity grew at its fastest in 1998 at 0.7 per cent, and fell most in 2002 at 1.3 per cent – but average productivity growth was flat.

(Full article)

If we care about higher long term growth (and we should, because growth is well correlated with higher incomes, and evidence suggests higher incomes are linked with greater happiness) then we should be concerned about freeing resources from state control. Ryan Bourne of the Centre for Policy Studies suggests that introducing competition to our services is key:

Without improving productivity, labour-intensive service industries like healthcare result in much higher costs – not least because the state still has to compete for labour in national markets where other wages are increasing. With healthcare demand ever-rising, it’s vital that steps are taken to induce competitive pressures and markets in service delivery – or else costs will spiral, resulting in an ever-increasing tax burden.

(Full article)

Getting the deficit under control will require some taxation, but refusing to cut tax because such cuts can not be 'funded' will constrain our capacity for growth. And net spending is just one side of the coin. Our concern should be for the ratios of deficits and debts to GDP. A program of tax cuts, in conjunction with sensible reform of public sector services could yield productivity gains and get public finances under control.