David Davis has set out his stall on the size of the state and tax cuts:
A Conservative Government led by David Davis would introduce a new ‘growth rule’, ensuring that public spending increases by one per cent less than the trend rate of growth in the economy. This would allow for a reduction in the nation’s tax bill of £38 billion a year by the end of the next Parliament, which could be used to cut the basic rate of tax by 8p in the pound.
That sounds nifty. Public spending up, tax bills down, without adding to borrowing. All through the miracle of economic growth.
No, it isn’t. Here’s why:
- It locks in whatever level of spending a Davis Government inherits – which might follow a pre-election spending spree, or a cyclical spending trough.
- It chokes off the automatic stabilizers, adding to the boom and bust cycle. Public spending should vary counter-cyclically. Spending on benefits rises naturally when economic growth is slow. This rule would force cuts in discretionary spending to offset those cyclical increases. (An alternative formulation of the rule would have trend growth of spending slower than trend growth in GDP; this is avoids the mistake of being pro-cyclical, but at the expense of being impossible to monitor and enforce).
- It is too blunt – it fails to distinguish government spending on goods and services, in which the government actually pre-empts the use of the economy’s resources, from transfer payments which move purchasing power from one person to another. It is not at all obvious that these two – which have very different economic effects – should be subject to the same target growth rate.
- It is too centralist – a central government target for General Government Expenditure means that central government has to set limits on local spending and stifle local decision making. But then you cannot delegate choice to local communities to spend less, or more, on their local services. Under this rule, if local communities decide to pay less tax, and reduce their local services, then central government would immediately step in to expand spending and tax elsewhere in the system to compensate.
- It is not ambitious enough – it is a managerialist rule under which everything would grow a little bit every year. A change of government should be the opportunity for radical reforms to produce a smaller public sector – for example by abolishing CAP, industrial subsidies and the independent nuclear deterrent.
- It creates perverse incentives to fiddle the figures – a ceiling on General Government Expenditure creates incentives to pursue policy in sub-optimal ways such as through complicated tax reliefs instead of spending subsidies or by shifting spending to public sector corporations.
(I cannot resist making the ultra-pedantic point that the growth of public spending should be one percentage point, not one per cent, below the trend growth of the economy. This only matters because it suggests that whoever wrote the policy does not have much feel for economic statistics.)
Deciding the right size of the state is one of the most important choices any government can make. It defines the scope Government’s program and ambitions, and its attitude to the relationship between state and citizen. A simplistic rule like this does not do it justice.
Update 3 November: Check the comments. On my estimate, the Davis Rule would involve increasing spending by £30 billion a year by the end of a 5-year parliament. It would be £14 billion a year lower than if spending grew in line with GDP (not £38 billion a year lower as DD claims).