Britain's Mix Of Higher Taxes, Quick-Fix Austerity Hasn't Worked

In the spring of 2010, David Cameron ran for Britain’s prime ministership, promising to tell the truth about the country’s fiscal mess and to take the unpopular steps needed to clean it up.

Britain was laboring under "the biggest budget deficit of any developed country in the world," Cameron warned in a TV debate. "If we think that the future is just spending more and more money, we’re profoundly wrong."

British voters, terrified that investors would cut their nation off from global bond markets, ditched the incumbent Labour Party and gave Cameron’s Conservative Party a plurality in Parliament.

Another party, the Liberal Democrats, joined the Conservatives as the junior partner in a coalition that came to power that May. These seemingly functional politics, however, have produced an economy marked by nonexistent growth.

For the many American pundits who insist that Republicans and Democrats should make compromises and moderate their own stances on deficit reduction — lower spending and higher taxes, respectively — the British experience should serve as a warning.

The coalition has done some good things on the tax front — most significantly, cutting the corporate tax rate for large companies from 28% to 24% — but the bad tax policy outweighs the good.

To raise £13 billion yearly — the biggest share of the government’s overall tax grab — Cameron and Chancellor of the Exchequer George Osborne walloped every Briton with a massive increase in a tax that most people paid almost every day: the value-added tax, a sort of sales tax on everything from adult clothing to restaurant meals, though not on groceries or books.

Just after Christmas 2010, the VAT rose from 17.5% to 20%. Osborne and the rest of the coalition seemed oblivious to how flesh-and-blood people would react to the VAT increase.

Consumer spending was already falling, having dropped by 2% (after inflation) in 2009 and by another 1% in 2010.

The higher VAT prolonged the slump. Consumer spending fell 1% in 2011 and stayed flat last year. Vacant storefronts and bankrupt retailers have ruled British front pages for years.

"Thousands more shops could close in the coming year leaving one in six stores empty," the Financial Times reported this February.

Analyst Richard Hyman says that the VAT increase "inevitably exacerbated" the forces already battering British retail, which included not only fallout from the financial crisis but also the rise of Internet shopping and the higher cost of imported Chinese-made goods.

In short, Britain’s economy hasn’t turned around. Real GDP in 2012 was 2.3% smaller than it was in 2007. Economic growth was flat at best last year; inflation, though lower than the 2011 peak of 4.5%, was still 40% above the government’s target of 2%; the unemployment rate remains high, just under 8%; and the threat of a new recession looms.

The budget outlook remains grim, too.

"Public sector net debt as a percentage of GDP will be falling in 2016—17, a year later than set out," Osborne wrote last fall. But that’s only a projection, and it may be too rosy, as the public and politicians alike have grown tired of the coalition’s austerity measures.

What can America learn from the Britain’s troubled austerity experience?

One lesson is surely to avoid steep, sudden tax hikes. The coalition’s rapid tax slap got Britain no closer to its fiscal goals, since it harmed economic growth and hurt public support for deficit reduction. Many budget watchers still maintain that, though the tax increases damaged the economy, they were necessary, since investors in British bonds might have balked at an even bigger deficit.

But shouldn’t investors have been still more worried about Britain’s inability to curb the health and other social spending that comes with an aging population and a stagnant workforce?

Cameron and Osborne should have focused on those long-term problems, rejecting new taxes and designing solid NHS reforms while waiting for the longer-term impact of the pension and welfare reductions to kick in.

There’s no evidence that bond markets, which have remained complacent in Britain (just as they have in America), would have revolted at such a gradual course.

Back in 2010, Cameron could have said: If we can’t figure out how to lower spending over five years, we’ll raise taxes then. What’s the harm in waiting?

The U.S. should pay particular attention to that lesson. President Obama, with the Republican House assenting, kicked off 2013 with an American version of the big VAT increase.

To avoid the fiscal cliff, Congress axed a temporary cut in Social Security taxes, snatching $45, on average, out of every American family’s paychecks every two weeks. The payroll-tax increase may already have stalled the economy’s sputtering growth.

The other lesson from the coalition’s failure is still more sobering. No fiscal program — whether fiscal austerity, as in Britain, or fiscal stimulus, American-style — was going to cure the West’s woes in a matter of months.

In Britain, Cameron and Osborne implied that the 2010 spending cuts would unleash instant private-sector growth.

In America, Obama made the mistake of saying that the 2009 stimulus program would quickly bring unemployment below 8%.

But it took a long time to get into this mess. It may take even longer to get out.

This piece originally appeared in Investor's Business Daily

This piece originally appeared in Investor's Business Daily