The tax cut battleground

Cameron has outlined a national insurance tax break for companies as an incentive to take on staff. It would be funded from unemployment benefit savings. In other words, companies would receive a proportion of the benefit payment in the form of a tax break. Cameron said it costs the taxpayer over £8,000 every time someone takes unemployment benefit and his proposal would see approximately £2,500 of that sum used to fund a cut in the amount of NI paid by businesses. The Conservatives say their plan would create 350,000 jobs and cut the tax burden on companies by £2.6 billion.

Cameron described his announcement this morning as a "budget submission," rather than a future policy pledge for an incoming Tory government, to help alleviate unemployment which he hoped Brown would accept and Darling would implement next week in the Pre-Budget Report.

Brown has already disappointed Cameron though by rejecting it as a "one-off initiative," said the figures "simply do not add up" and said "serious policy" was needed for "serious times." The government line continues to be that the Conservatives have an incoherent economic strategy.

Moreover, as Guido has pointed out, it is more of a tax credit than a tax cut. He said that although it was more welcome help for small businesses, the problem with it was that the £2,500 tax credit was only for new created jobs and did not apply to companies that were thinking of laying off workers to cut costs. In other words, it might help small businesses, if implemented, who want to grow and recruit staff - thus cutting unemployment; but will do nothing for those who want to retain staff but cannot afford to do so - thus doing nothing to prevent unemployment.

One must conclude that this is another welcome proposal but nothing revolutionary and once again small in scope. It thus can be added to other initiatives announced by the Tories on council tax, NI and VAT.

It will undoubtedly disappoint those who wanted to see something more substantial.

If Cameron is moving towards acknowledging that monetary policy alone is going to be insufficient to get us out of recession, "fiscal stimulus," as the PM puts it, will be necessary. So again we are back to two choices. Increased public spending or cut taxes. A Keynesian spending splurge will not work; it is far too slow. So we are left with tax cuts as even Brown seems to have come to admit.

Three more questions arise:

1) What taxes to cut? 2) By how much? and 3) How to pay?

1) WHAT TAXES TO CUT? The Conservatives have thus far focused most of their attention on measures to help small businesses (council tax pledge being the exception). They reason that it is SMEs that are the driving force of the economy so that by keeping them going, the economy will be stronger.

The Lib Dems (and possibly Labour - we'll see possibly next week) have argued that income tax should be cut to help stimulate demand. The Lib Dems, for example, have said they would cut the basic rate of income tax from 20% to 16% thus helping low and middle income earners.

Ordinarily I would be all for a cut in income tax but there is a problem with it. For it to have the desired effect, the government would need to ensure that people spent the extra money they were being allowed to keep. However, given the constant flow of bad economic news, it is quite probable that a majority of people would try and pocket the tax cut, saving the money in anticipation of worse times ahead. I can't see how the government can compel people to spend the money from the tax cut given the fear being whipped up by the media.

Nevertheless, in an ideal world a combination of the Conservative and Lib Dem approach - measures to help business and a cut in income tax would probably be the best option to help alleviate the effects of the recession and help stimulate demand.

But that leads us on to 2) BY HOW MUCH? How large should the tax cut be? The Institute for Fiscal Studies (IFS) has said that a tax cut would need to be in the region of £15 billion to have any effect.

The Conservatives are wedded to their 'fiscal responsibility' approach, which Rachel Sylvester in the Times today has called the 'housewife strategy' (households are having to tighten their belts and make sacrifices, so should government - it is no time to get another unaffordable credit card). He can't claim that the cupboard is bare to then suddenly magic up £15 billion worth of tax cuts. So if we really are entering the ‘tax cut war’ between the parties, the Conservatives will lose in the battle of who can promise to cut tax the most. Cameron will be trumped by both the Lib Dems and Labour which is a surprising position for a Tory leader to be in. Yet, ‘sound money’ is also a strong Conservative principle. Cameron is taking a punt that the British people will reward him for his pledge not to saddle future generations with large debts and high taxes. He is essentially saying that Gordon might have left Prudence at the alter, but she's dating Dave now. In contrast, Brown is saying to hell with Prudence, in 'unique' times like these, he needs Miss Profligate Spendthrift on his arm.

This leads us to the last question: 3) HOW TO PAY? This is the clear dividing line between Brown and Cameron. Brown is willing to borrow to cut taxes while Cameron is behaving like the Brown of old saying there should be no unfunded tax cuts. Brown is hoping that the British people will let him borrow and spend and ignore the fact that for decades he has been accusing the Tories of offering unfunded tax cuts but is now proposing to do just that himself. Cameron is hoping that the British people, and the media in particular, will not let Brown get away with it and instead will reward, prudent Cameron, the responsible steward of the economy. Cameron is setting himself out as responsible and therefore Brown as irresponsible.

There is of course more scope for Cameron to offer ‘funded’ tax cuts but he seems unwilling to go down that route, to the dismay of many Conservatives. He could pledge to cut public spending but Cameron would probably argue that cutting spending at such a time would not be ‘responsible’ as it would cut demand in a recession. However, many on the right disagree, including Nick Clegg, and say that public spending has increased by vast amounts over the last eight years or so, a significant proportion of which is wasted and spent inefficiently. But Cameron will know from his experience of the 2005 general election working for Michael Howard that a policy of tax cuts funded by pledges to cut government waste has not proved successful. Cameron might also be fearful of opening up another unnecessary front in which he is open to attacks from Brown that he is cutting vital frontline services – whether true or not. We all know that Brown doesn’t let truth and honesty get in his way. But nonetheless, if Cameron wanted to be bolder, there clearly is scope to offer funded tax cuts – though it is true that cutting waste is often easier said than done.

This is a ‘game’ of high stakes. Whoever wins the battle of borrow and spend vs. fiscal responsibility could very well have the keys for Number 10 in 2010. Cameron's approach is sensible, though not flashy, will help minimise the effects during the recession and will significantly reduce the hurt after the recession and place Britain in good shape globally ahead of the upturn. Brown's approach is likely to prove bold and brash, may very well have a greater effect during the recession (though this is not guaranteed as it could hurt the value of pound sterling, for example), but its recklessness will prove damaging after the recession as the costs of his borrow and spend policy are borne by us all through higher taxes and/or significant cuts in public spending. This could leave Britain behind the curve internationally in trying to benefit from any economic upturn.

What seems clear, however, is that Brown looks like throwing everything, including the kitchen sink, at this recession in the hope that it wins him another term in office after 2010. Brown is obviously in power so we will get what he wants and Cameron can only warn, criticise and set-out what he would do differently. Unfortunately for us, that means we will ultimately suffer the consequences and if Cameron does win the next general elections he will be left picking up the pieces of an economic wreckage caused by a reckless driver by the name of Gordon Brown.

UPDATE: Adam Boulton makes a good point I meant to include. He's written: "The challenge for the Tories will be whether they hold their nerve and oppose hand backs which are likely to appeal to hard-pressed voters and businesses." Will shall see...

UPDATE 2: Been thinking... If Brown does indeed offer unfunded tax cuts Cameron needs to hit home the message hard that we will all pay for it through higher taxes. Labour may offer short-term gain, but it will end in long-term pain!