Chancellor: Geoffrey Howe; Prime Minister: Margaret Thatcher (Conservative)
Context: a new era in macroeconomic policy
Overall growth in 1978 was the strongest for five years and unemployment fell throughout the year. Whilst still high by post-war standards, the unemployment rate fell throughout 1979 as well. However, the Government had serious problems containing pay inflation during the second half of 1978 and the Winter of Discontent of 1978/79 was to epitomise the final months of the Labour Government. The Government lost the May 1979 General Election and Margaret Thatcher became the U.K.’s first woman Prime Minister.
1979 marked the beginning of a new economic paradigm in the United Kingdom. The old fiscal tools of demand management were shunned in favour of monetary weapons. The fiscal reform which took place over the 18 years of Conservative rule was to radically alter the tax system to foster business and individual incentive. As I have discussed, these themes were also strong in previous Conservative Budgets, but the important difference after 1979 was the complete lack of emphasis on demand or any attempt to control it. The list of Budget tax measures was also to become much longer and more technical. There were very few
589 Ibid. 590
HC Deb 08 May 1978 vol 949 c801 591
HC Deb 05 July 1978 vol 953 c591 592
HC Deb 05 July 1978 vol 953 cc469-597 593
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endogenous, demand management actions; most of the reforms were for long-run purposes and so this marks a distinct break from the previous 34 years of post-war macroeconomic policy.
Overall Objectives in 1979
The new philosophy is nicely summarised by the new Chancellor’s comment: “it is our belief that many of these failures are themselves the result of actions and interventions by the Government themselves”.594 Four principles were set out to reverse the “years of decline”595: strengthening incentives; enlarge freedom of choice and reduce the role of the State; reduce the burden of financing in the public sector; and ensure those taking part in collective bargaining understand the consequences of their actions, to promote a proper sense of responsibility.596 Priority was given to monetary policy and the importance of “sound money” through “firm monetary discipline and fiscal policies consistent with that, including strict control over public expenditure”.597 This included progressive reductions in the growth of the money supply. On the fiscal side, Howe planned for a reduction in the PSBR as a percentage of GDP, “from over 5½ per cent. last year to under 4½per cent. in the current year”.598 Fiscal policy was to support the overall monetary and disinflationary strategy. There is no discussion of the ‘right’ amount of fiscal tightening so as to influence demand: no ‘Budget judgement’. In a rejection of the old stimulus/contraction terminology the Chancellor noted that the Budget cannot be seen as contractionary as “To make that claim is to argue that an alternative course of fiscal policy would produce more growth and more employment”.599 The overall tax changes were relatively neutral but altering the balance of different taxes within that total. The deficit reduction measures then largely fell to the control of expenditure: “In order to reduce the borrowing requirement and the burden of direct taxation, we must make savings in public spending and roll back the boundaries of the public sector”.600 Tax changes supported the Government’s long-term objectives: “At this stage, we have concentrated on tax changes of strategic importance”.601 Most of the tax changes are therefore exogenous.
Major Budget Tax Measures
Most significantly, income taxes were cut and indirect taxes increased as: “We made it clear in our manifesto that we intended to switch some of the tax burden from taxes on earnings to taxes on spending. This is the only way that we can restore incentives and make it more worthwhile to work and, at the same time, increase the freedom of choice of the individual”.602 Consequently V.A.T. was increased and rates unified at 15 per cent from 18thJune 1979. This measure raised over £4 billion (2 per cent of GDP), which was then very close to the total value of the income tax remissions. The income tax reductions were “the keystone of our policy. Excessive rates of income tax bear a heavy responsibility for the lack-lustre performance of the British economy”.603 The higher rates of tax above 60 per cent were abolished and there were changes to the bands from October 1979. The main personal allowances and the additional personal allowance increased above indexation from 6th April 1979 (and I now use the above indexation figures in the tax series as the indexed rise had been statutory since 1977). “To help the elderly”604 the age allowance was increased from 6th April 1979. The investment income surcharge thresholds were raised from October 1979, a measure which combined “a considerable simplification of the tax with a measure of justice that is long overdue”.605 The Chancellor also proposed “to implement immediately our election pledge to war widows”606 and exempt their pensions from tax as of 6th April 1979. Finally, the basic rate of income tax was cut by 3p and there were extensions to the band from October 1979. With the exception of the age allowances, the investment income surcharge and the war widows pensions, which appear exogenous ideological changes, the others I
594
HC Deb 12 June 1979 vol 968 c240 595
HC Deb 12 June 1979 vol 968 c236 596
HC Deb 12 June 1979 vol 968 c240 597
241 598
HC Deb 12 June 1979 vol 968 c243 599
HC Deb 12 June 1979 vol 968 cc243-244 600
HC Deb 12 June 1979 vol 968 c246 601
Ibid. 602
HC Deb 12 June 1979 vol 968 cc249-250 603
HC Deb 12 June 1979 vol 968 c258 604
HC Deb 12 June 1979 vol 968 c260 605
Ibid. 606
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classify as exogenous, long-run for economic purposes. The V.A.T. cut was to fund this switch in the tax burden and was also for exogenous, long-run economic purposes.
There were a few other changes to indirect consumption taxes, namely increased fuel duties from 12th June 1979. These are listed separately from the V.A.T. rise to fund the income tax cuts, although the revenue gained clearly offset cuts elsewhere. Taking the Chancellor’s justification at face value these changes appear endogenous and to manage the demand for oil in response to continuing troubles with supply and prices from the Middle East. The Chancellor explained that there is a “general case for measures that will help us to meet the growing and undoubted need to conserve oil. At a time when there is a worldwide shortage of crude oil, it is essential that we should play our full part in achieving the 5 per cent. reduction in consumption to which the previous Government rightly committed us”.607 I therefore classify this as endogenous, demand management. However, given the overall comments about control of the public finances, these may well have been to offset the exogenous remissions – with V.A.T. and fuel duty increases almost exactly matching the income tax cuts. I therefore provide an alternative classification of the Fuel Duty increase as exogenous, long-run, in keeping with the majority of the income tax cuts608.
These changes accounted for over 95 per cent of the remissions and nearly 95 per cent of the increases.