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Commentary By Josh Barro

Great Britain's Roadmap to Fiscal Restraint

Economics Tax & Budget

Britain’s new Coalition government, elected earlier this month, faces a fiscal situation even more dire than America’s: they are tasked with closing a fiscal deficit of 12% of GDP. They must do this while placating the right - and left - wing constituencies that respectively back the ruling Conservatives and their junior partner, the Liberal Democrats.

Often, coalition governments produce wishy-washy policy platforms designed to change little and offend nobody. Surprisingly, Britain’s new government is proposing to freeze public sector salaries and reform employee pensions. They even plan to raise the retirement age for Britain’s equivalent of Social Security -- not just far in the future, but as soon as 2016. In their platform, David Cameron and Nick Clegg provide some clues for how Republicans and Democrats could come together to close America’s budget gaps at all levels of government.

The Coalition agreement starts off on the right foot, calling for a reduction in Britain’s budget deficit “with the main burden of deficit reduction borne by reduced spending rather than increased taxes.” This is essential, both in America and Britain, because entitlement spending growth is set to grow faster than the economy in perpetuity, and cannot be made sustainable simply by raising taxes.

Of course, it is one thing to say you will cut spending, and another to propose specific program cuts. The coalition has provoked surprising controversy even by proposing to cut just £6.2 billion ($8.9 billion, or 0.3% of GDP) from the 2010-2011 budget; while the outgoing Labour government warns that these cuts could reverse the incipient economic recovery, they also won’t get Britain’s budget anywhere close to balance.

But the agreement also points to more significant savings to come. First, it includes a plan to freeze public employee salaries, which was part of all three parties’ election platforms. The freeze would include a feature proposed by the Liberal Democrats, designed to protect low-paid government workers from its effects.

While details have not yet been announced, the Liberal Democrats’ platform would have capped public pay increases not at a percentage, but at a fixed amount of £400 ($577) per year, meaning that the lowest-paid employees would see the greatest salary increases. Even more savings could be achieved if the fixed increase were set lower, or if higher-income employees got no raise at all.

Currently, employee pay freezes are on the table in New Jersey and New York, among other states. (Even Andrew Cuomo, the presumptive Democratic nominee for Governor in New York, wants a one-year freeze on state worker salaries.) But where a full pay freeze is politically impossible, the Liberal Democrats’ proposal shows a way that the concept can be structured to appeal to progressives: by giving raises to low-wage workers, while higher-paid workers bear their share of the budget-balancing burden.

You might be surprised who counts as a high-wage worker. The average New York City transit employee makes $68,000 per year in wages, plus another $24,000 in benefits. If New York copied the Liberal Democrats’ proposal to give all workers just a $577 pay increase, that would mean a raise for transit workers averaging 0.8% -- not the 4% annual raise that an arbitrator awarded transit employees last year -- and the Metropolitan Transportation Authority would not face such a dire budget crisis.

The Coalition also pledges to establish a commission to review the “long-term affordability” of public sector pensions -- not exactly a bold policy move, but the first step is admitting you have a problem. Here, most state legislatures are either ignoring the issue (California) or passing reforms that don’t get at the root of the pensions’ unaffordability (New York, New Jersey, Illinois).

Admirably, the Coalition is more specific on old-age pensions, which despite the name are a program for the general public akin to Social Security. Currently, the minimum age for eligibility is set to rise from 65 to 66 by 2026 -- but the Coalition would make this shift as early as 2016 (and 2020 for women, who have historically become eligible at a lower age.)

Coincidentally, Social Security’s eligibility age is 66, but set to rise to 67 by 2027. Why not match the British plan, and accelerate that move by a decade? Unfortunately, while Representative Paul Ryan’s Roadmap plan would gradually raise retirement ages, most Washington politicians (in both parties) are disinclined to touch Social Security benefits. In January, the Senate even voted 97-0 to prohibit a proposed fiscal commission from recommending any changes at all in Social Security.

Britain’s Coalition also promises cutbacks in “welfare for the wealthy” programs, such as child tax allowances for high-income people. There are good and bad ways to do this -- offering tax allowances and then phasing them out as incomes rise increases the marginal tax rates experienced by taxpayers, which harms economic growth.

But American politicians should consider converting tax deductions into tax credits, to target aid to the needy while reducing the size of tax expenditures overall. Such reforms have been a key component of Republican health care proposals, including John McCain’s 2008 election platform and the Ryan Roadmap.

Not everything in the Coalition platform is good. Particularly, it includes a misguided plan to raise the individual tax allowance, which would remove 4 million Britons from the income tax rolls entirely. Worse, the Coalition would pay for this reform by raising Britain’s tax rate on capital gains, currently 18%, to rates “similar or close to those applied on [ordinary] income” -- which top out at 50%.

But just because the tax side of the Coalition agreement leaves much to be desired, that doesn’t mean American policymakers shouldn’t take cues from its spending side. The Con-Lib plan attacks the main drivers of unsustainable spending at America’s federal level (entitlements) and state and local levels (employee compensation and pensions). If Britain can overcome political division to face up to these challenges, why shouldn’t we?

This piece originally appeared in RealClearMarkets

This piece originally appeared in RealClearMarkets