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Reagan Tax Cuts Offer Crutch in Kingdom of Lame: Matthew Lynn

Who should U.K. Chancellor George Osborne emulate this week when he delivers his second budget speech since the coalition government took power last year?

A reformist prime minister such as Margaret Thatcher? A crisis leader like Winston Churchill? Neither of them. He should have Ronald Reagan in mind.

In the 1980s, the former U.S. president wasn’t afraid to take chances with the economy. He cut the top rate of tax to 28 percent from 70 percent, even though he inherited a budget deficit of about $80 billion from Jimmy Carter’s administration.

Osborne should take the same gamble. The debt crisis in Europe, the U.S. and Japan means the U.K. isn’t likely to be a target for the bond markets any time soon. Britain can afford to take the chance that cutting taxes will get the economy moving again, and end up paying for tax cuts. It worked for Reagan when he tried it three decades ago.

The U.K. was hit as hard by the credit crunch as any developed economy. Its heavy reliance on banking and financial services, a rampant property market and consumers who borrowed money with the wild enthusiasm of kids left alone in a candy store left it highly vulnerable.

There are some glimmers of life. Manufacturing has started to recover, helped by a weakening of the pound. The U.K. is starting to produce and export things again, and it is a long time since that has been true. Unemployment has risen but not by as much as some people expected.

Economy in Doldrums

And yet the U.K. economy remains in the doldrums. It will grow 1.5 percent this year, according to the Organization for Economic Cooperation and Development. The budget deficit remained massive at more than 11 percent of gross domestic product in the last fiscal year. Inflation was stubbornly high at 4.2 percent last month, and at some point the Bank of England may need to raise interest rates so much that it may snuff out any recovery that is under way. If there are new industries about to spring up, there is not much sign of them yet.

What’s the way out?

The easy answer is that the government needs to promote economic growth. The trouble is there are not many levers at its disposal. What industries should the U.K. be specializing in for the future? High-tech manufacturing? Media? Pharmaceuticals? Or should it just bet the house on ramping up its banking and financial-services industries again? No one really knows, and certainly not the government. Even if it did know, how exactly is it going to make that happen?

Tax Cuts

In truth, the only way government can stimulate growth is by cutting taxes and letting entrepreneurs get on with the job. Britain is now a high-tax country by global standards. A top income-tax rate of 50 percent is one of the highest in the developed world.

It’s hurting. About 43 percent of London-based financial professionals have either considered or are considering leaving the U.K. because of the burden of taxes, according to a poll by the London-based group Policy Exchange. It found that 11 percent have already made up their minds to go.

Companies are reaching much the same conclusion. A few high-profile businesses have already left Britain. More important is the number of multinational companies that will just do a bit less of their business in the country. According to the Policy Exchange poll, 25 percent of senior corporate managers thought they would move teams out of Britain because it had become so expensive to remain there. Individually, those don’t matter much. Add them all up, and it will amount to a lot of economic damage to the U.K.

Irish Advantage

Osborne needs to turn that around fast. Once business leaves a country, it takes a long time to get it back again. He should start by slashing the top tax rate back to 40 percent. Getting corporate tax down should be his next priority -- why not compete with Ireland’s 12.5 percent rate, particularly as Ireland may be forced to get rid of it as part of the price of the bailout by its fellow euro nations?

The objection, of course, is that you can’t cut taxes while the budget deficit is so huge.

Not true.

The U.K. has managed to hang on to its AAA credit rating, and it looks safe for now.

After all, bond investors have to put their money somewhere, and few major economies look in great shape. The euro area has a major sovereign-debt crisis. Japan doesn’t look much better. Nor does the U.S.

In the kingdom of the lame, the guy with a crutch looks like a good bet. Right now that is the U.K.

That gives Osborne a window of opportunity.

He can cut taxes now, let the budget deficit widen a little, and the bond markets will let him get away with it.

It is, of course, a gamble. He’ll be betting that lower taxes will stimulate enterprise, get growth moving again, and so provide the tax revenue that will get the deficit back under control. And he’ll be betting that the bond markets won’t turn on Britain the way they have on Greece and Ireland.

But Reagan would have taken that wager. George Osborne should follow his lead.

(Matthew Lynn is a Bloomberg News columnist and the author of “Bust,” a book on the Greek debt crisis. The opinions expressed are his own.)

To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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