The Liberal Democrats made a significant step forward at their Conference last week when we passed the Make It Happen policy paper.
The main issue of the debate revolved around Nick Clegg’s pledge to cut billions of pounds from the income tax of low and middle income families. The party has broadly welcomed this, though many have accepted it only as long as it is accompanied by a promise that the overall tax-take will remain the same, and that richer people should shoulder more of the tax burden.
This redistributionist error was sadly reinforced by Clegg himself in an otherwise excellent interview with The Times, in which he said:
Economically it makes no sense when you are heading into recession to give tax cuts to the better off because they will just save them. You have to give them to people on lower incomes who will transfer them into consumption on food and fuel.”
In this he is half-right. Wealthy people do save additional income, whereas poor people spend it. Right now, who wouldn’t love to squirrel away spare money into an ISA so that they have something in reserve? But when your children are growing out of their shoes, or you haven’t had a holiday in three years, you are more likely to spend a few hundred quid in tax relief than save it. On this point, at least, Nick is correct.
Unfortunately though, there is no long term prosperity as a consequence of such a policy. Rather, it is based on one of the most fundamental economic fallacies: one of which the leaders of all three political parties – and even (dare I say it?) Vince Cable – are guilty. This is the assumption that consumption drives growth.
This is utter folly. Consumption is important to a healthy economy, but growth can only be achieved through investment, and investment is a euphemism for saving. And it is growth, not redistribution, that is the real root to prosperity.
Growth averaging just 3% per annum will double household incomes within a generation. By comparison, there is no level of redistribution that could double the household incomes of the majority of the population.
To put it another way, the only way that real wages can rise is if the productivity of workers rises. This requires investment in new plant machinery, new IT solutions and training for employees. This can only come from companies and investors. In addition, this productivity rise makes consumer goods cheaper (which is the equivalent of making consumers richer) and creates new jobs (as productivity overtakes wage costs) so that unemployment is reduced.
So while Nick is right to say that “the better off … will just save [tax cuts whereas]… people on lower incomes … will transfer them into consumption” he is utterly wrong to say that “Economically it makes no sense”. Economically, it is vital.
Politically, however, tax cuts for businesses and entrepreneurs are unpalatable. Our party, much like the other two, often suffers from the reactionary instinct of “something must be done”; yet while noble sentiments lead Liberal Democrats to want to tackle poverty urgently, we should consider how these goals are best served through overall increases in prosperity. The long term interests of everyone in society – and of the poorest most of all – are best served by tax cuts that will ensure that our children are twice as prosperous – that their lives are twice as easy – as ours. Temporary relief is no substitution for such prosperity.
Scepticism over such tax cuts at least recognises the political realities of the 21st century. No matter how correct the economics, it would be impossible to implement tax cuts solely for businessmen and companies, because the vast majority of voters would understandably ask why their taxes are not being cut while those of £billion businesses and rich oligarchs are.
What is needed, therefore, is a sort of liberal realism that recognises that lowly paid workers, who form the bulk of the electorate, will want to see some of the short-term gain that their richer peers will enjoy as they wait for the longer term growth-benefits to kick in. One might suggest that a little honey today keeps us sweet until tomorrow’s jam arrives.
So Nick Clegg and Vince Cable are half-right to advocate tax cuts for those on low and middle incomes. These are indeed vital, not primarily as poverty-reduction tools but as symbols of the fairness that the party holds so dear. These in turn will buy support for the tax cuts that will make a real difference to the prosperity and so the lives of every person in this country (and to the poorest most of all): tax cuts for businesses, investors and entrepreneurs.
The great lesson of liberalism is that it is not only from one’s own wealth or prosperity that one can benefit, but also from that of others. To put it another way, it is not from benevolence that we expect our dinner, but from others’ regard to their own interest.
The Lib Dems were right to cut taxes for the poor. Now, for the benefit of the poor most of all, it is time to cut taxes for the rich as well.
* Tom Papworth blogs at Liberal Polemic, where (he tells us) “you can read a more in-depth explanation of the relationship between tax cuts, investment and prosperity for all”.