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Britain's Austerity: 4 Lessons for Washington

October 25, 2010 |
Refreshingly, the Brits show none of the foolishness we do about promising to make changes without touching taxes. Their model suggests a sensible sequence: Cut spending first, then raise taxes as needed to close the remaining gap.
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The Brits sure did mean it when they promised a tough fiscal austerity plan. Man, the difference between our two governments' ability to act when necessary is depressing. It sure would be nice to have a parliamentary system at a time like this.

The U.K. coalition government last week spelled out spending reductions that average 19% across all agencies over 4 years. That's 500,000 public-sector jobs. Little is spared. Housing benefits and education funds will be cut. Defense will be pared 8%. The cuts go on.

It remains to be seen whether this aggressive plan will be enacted as outlined, and how the U.K. economy will respond. But there are already a number of lessons for Washington.

Too quick a pace for U.S.

Prime Minster David Cameron's plan is structured to aggressively reduce the deficit over the next four years.

That schedule jibes with the time span for the U.K. parliament.

But given the state of the world economy and the need to balance stimulus and deficit reduction, such a short-term timeframe is too aggressive for the United States to follow. And we are lucky that, thanks to the dollar's "safe haven" status, we don't have to follow a tight time frame.

In fact, Britain's timeline highlights a flaw in President Obama's current approach: The White House fiscal commission is laboring under the goal of trying to eliminate the primary deficit by 2015. That goal too is too shortsighted. (Deficit cutting: The first cut is the deepest)

A more sensible plan would be to set a medium-term fiscal target to be achieved over about 10 years.

In the first few years we should focus more on "fiscally responsible stimulus," while also adopting a specific deficit reduction plan that can be phased in gradually as the economy recovers.

This is not the Krugmanesque model of giving lip service to the need for future budget changes with all the emphasis on stimulus now. Instead, we need a multi-year legislative agenda that includes specific stimulative and deficit-reducing policies.

The savings should kick in when the economy is strong enough. But Congress needs to commit to budget cuts in law as quickly as possibly -- or the markets just won't believe us.

On target: Go after spending

Thumbs up to the Cameron team for its aggressive tack on spending. Past experiences show that spending cuts tend to be better than tax increases for trimming deficits while generating strong economic performance.

We'll need to take a page from Britain here. The U.K. reductions in public sector employment are a useful model -- and we should emphasize wage freezes and compensation restructuring.

And while we talk timidly about freezing spending, we will need to think in terms of cuts as well.

The British government is also right to means-test where possible. For example, its decision to scale back the universal child credit for those on the high-end of the income scale is an excellent model for many of our universal programs, including Social Security and Medicare.

Footnote: Refreshingly, the Brits show none of the foolishness we do about promising to make changes without touching taxes. Their model suggests a sensible sequence: Cut spending first, then raise taxes as needed to close the remaining gap.

Tax pitfalls

I argue over and over that tax increases will have to be part of the budget solution. Still, I share many of the fears of the anti-tax crowd: A value-added consumption tax could become a money machine and temporary taxes will inevitably be made permanent.

And, yup, these fears are borne out in the Britain austerity plan.

Once a VAT is in place, the rates keep getting ratcheted up, as the Brits are doing now. If we do end up with a consumption tax in this country, we need to find a way not to turn it into an AMT.

Similarly, there's a good lesson for Congress in the Brits' plan to make their temporary bank tax permanent.

I support a temporary consumption tax to help with stimulus and close the fiscal gap. (Beware the VAT: Why the consumption tax is possible)

But any temporary tax needs to hit a broad swath of taxpayers so there's a big constituency rooting for its demise as soon as the fiscal ship is righted.

U.S. lawmakers need to focus on the big picture: Systemic budget reforms and a fundamental restructuring of the tax system.

Dramatically reducing tax expenditures and reforming the corporate tax code would serve as an excellent first step in enhancing efficiency and competitiveness while increasing revenues.

Political courage: If only ...

Finally, Cameron has shown real leadership in indicating that fixing the budget situation is worth risking losing office over. He is right. Would that a politician or two here in Washington be willing to show that kind of courage.