How To Make Britain Great Again

I learned a valuable lesson this week: before you write about British politics, call Buckingham Palace and ask: “Your Majesty, who is Your prime minister this week?”

Barely had I submitted this essay to my editor under the title “Truss Can Make Britain Great Again” before Truss announced her resignation. She will remain longer in office than the 38 days that went by before she fired Chancellor Kwasi Kwarteng, but the U-turn she made on tax policy that precipitated Kwarteng’s exit pales in comparison to her U-turn out of 10 Downing Street.

This turmoil in conservative leadership makes for good political comedy, but it is not what Britain needs. Brexit returned the UK to sovereignty and created a great opportunity for transformative conservative leadership. The British economy, which benefited from severing ties with Brussels, could become a true European powerhouse.

All it would take to make it happen is a steadfast conservative hand at the helm. 

Clearly, Liz Truss did not have what it takes to provide that leadership. She failed the first test of economic policy skills: she believed Chancellor Kwarteng’s tax-cut proposals had upset the markets and sent the British pound into a tailspin. 

As I explained recently, this is not true. The pound and other European currencies took a beating from rising U.S. interest rates and a stronger dollar. It is no more complicated than that. 

By abandoning the tax cuts, Truss forfeited an opportunity to give the British economy a shot in the arm just as the world is heading into a recession. If the prime minister had stood up for her own tax cuts—and if she had known how to remain in office for a little longer than 50-some days—she could have done so much more for the long-term prosperity of the British people.

All it will take for the next conservative leader to put his or her country on the economic fast track is to combine well-designed tax cuts with well-designed spending reforms. Such a package would reinvigorate the British economy for decades to come.

Spending reforms are necessary: as I will explain below, the British welfare state is in decline. It is the product of erstwhile economic thought and isn’t even doing what it was designed to do, namely, to help low-income families. 

Liz Truss’s vacation-long tenure as prime minister notwithstanding, the mini-budget that Kwasi Kwarteng proposed could have been a conversation starter about broader conservative economic reforms. Neither Kwarteng nor Truss expressed any interest in such reforms, but Truss herself opened a broader economic discussion when she ran for conservative leadership. 

Back in August, our writer Harrison Pitt characterized Truss as a ‘Reaganite’ on fiscal policy. This is a reference to supply-side economics and the argument that tax cuts can pay for themselves through economic growth. Truss also made a pitch for changes to government-employee compensation—a small but respectable foray into spending reform.

As Pitt points out, she U-turned on that idea within 15 hours. Her prime ministerial U-turn looked almost perennial by comparison, but her quick reversal on addressing government outlays deprived her of an opportunity to distinguish herself from Rishi Sunak, her fiscally more conservative opponent for conservative leadership. 

Pitt explains Sunak’s fiscal-policy priority as managing “the crisis of debt in the short term, rather than promising tax cuts” on the basis of supply-side tax cuts. Truss believed in the tax cuts and was apparently ready to accept the budget deficit that would have been their short-term consequence.

It is true that tax cuts generate economic growth and thereby new government revenue. What is not true is that you can somehow balance a government budget solely based on that new revenue. As America has demonstrated over the past 40 years, you can cut taxes all you want, but as long as welfare-state spending continues to grow as usual, tax revenue will never catch up with spending. 

That is not to say that Rishi Sunak’s fiscal conservatism would be much more successful. As I explained in my book Industrial Poverty, the strict enforcement of balanced budgets can have downright catastrophic consequences. 

There is only one path forward for conservatives: to combine tax cuts with structural reforms to welfare-state spending. So far, the conversation of such reforms is notably absent in the conservative party. If the next leader of the party does not open that conversation, but insists on balancing the budget at all times, the conservative party will be fiscally indistinguishable from the Labour opposition. Recently, Labour shadow business secretary Jonathan Reynolds appeared on The Take with Sophy Ridge where he pledged that Labour would not allow government finances to descend into red ink.

A Labour government, he said, would be ready to bring in more revenue, i.e., raise taxes. 

What would a conservative government do if it rules out growth-generating tax cuts and is unwilling to make spending reform?

This is where welfare-state reform comes to the rescue. The British welfare state, like almost all its brethren across Europe, exists solely for the purpose of economic redistribution. Taxes disproportionately burden those who make more, and benefits are disproportionately paid out to those who make less. 

When designed this way, a welfare state will always put upward pressure on taxes. The benefits discourage workforce participation, entrepreneurship, and career development; the taxes have similar effects. Gradually, over time, this slows down economic growth, household incomes grow more slowly, fewer people pay more in taxes than they get in benefits.

The result is a long-term slowdown of the economy as a whole—and a structural deficit pressure in the government budget. As demands on the welfare state slowly outpace the ability of the economy to pay for those demands, the welfare state also becomes more inefficient. 

We can see this inefficiency in data from His Majesty’s Office of National Statistics, ONS. While the welfare state goes to greater lengths to redistribute income, the differences in household income—also known as income inequality—actually continue to rise. 

Bluntly speaking, British taxpayers keep paying for a welfare state that delivers less and less economic redistribution.

Let us take a look at the ONS data, starting with a review of how the welfare state works in relation to household finances. In 2021, the average British household earned £46,572 from work. Adding equity-based income, pensions, and other sources, they totaled £54,407 in so-called original income. This is income before taxes and government benefits.

Cash benefits from the welfare state, worth £6,031, increase household income to £60,438. Income taxes take away £9,351 and payroll taxes—including national insurance contributions, net council taxes, and student-loan repayments—claim another £4,613. 

Left with £46,474, the average British household pays £2,623 in value-added taxes, VAT, on their annual spending. They also pay other indirect taxes: liquor duties, tobacco duties, vehicle excise duties, stamp duties, TV license fees, air passenger duties, betting taxes, custom duties, hydrocarbon oil duties, air-you-breathe taxes (OK, that one I made up)… 

Including VAT, indirect taxes grab £5,640, or 12.1% of disposable income. Then the welfare state adds in-kind benefits, the largest chunk of which is the National Health Service. Its benefits are worth £6,350 per household. Second on the list is education at £5,069. Including other benefits, the average British household enjoys £12,876 worth of services from the welfare state.

Taking all taxes and benefits into account, we are left with what is best referred to as the welfare-state income: £53,711—almost exactly the same amount as the original income. The difference is just 1.3%, which begs the question why the welfare state should at all be involved in people’s lives.

The answer, again, is economic redistribution. Since these are average numbers, there are some households that get more benefits and pay less taxes, and others at the opposite end of the scale. The ideological point of this is to provide benefits not only to those who live in destitution, but to the gainfully employed who are able to support themselves. 

This is what the ideological fight against income differences—inequality—looks like. So long as it remains the prime directive of the British welfare state, it will continue to demand more taxes while doing an increasingly poor job at reducing those income differences. 

If the next conservative leader wants to make a real difference, this is where he or she should begin: by replacing this old socialist structure with a new, socially conservative welfare state. 

Britain is not the only country that would benefit from such reforms. As I pointed out back in December, Portugal could solve its Gordian knot of conflicting fiscal-policy goals if it scrapped its ambitions on economic redistribution. It can be done, if we are ready to navigate the stormy waters between three types of welfare states, take conservatism from theory to practice, and consider fresh reform ideas.

The case for conservative welfare-state reform is reinforced by the blatant inefficiency of the current structure. Returning to ONS data, we start with the Gini-coefficient which is a commonly used measure of income distribution. The closer to zero the coefficient number is, the more evenly distributed is total income; at a value of 100, all income is theoretically concentrated in the hands of one person.

Income differences in Britain have increased over the past 45 years. If we go back to 1977, the Gini coefficient was 36.8 for income before taxes and benefits, i.e., original income. 

Once the welfare state had provided its benefits and taken all its taxes, the coefficient fell to 22. This 40% reduction of income differences was typical for European welfare states in the late 1970s. 

Fast forward to 2021, the Gini coefficient for original income was 40.8, and 29.9 after taxes and benefits. In other words, income differences had increased since the late 1970s. 

In fact, for 2021, the Gini coefficient after taxes and benefits was more than one-third higher than in 1977. This happened despite the fact that Britain had an elaborate, socialist welfare state created for the very purpose of reducing income differences. 

Another way to look at the inefficiency of the welfare state is to compare its ability to reduce income differences to its ‘generosity.’ While the Gini coefficient has risen since the late 1970s, the welfare state has gone to greater and greater lengths to improve the economic conditions of lower-income British households. 

Using the ONS numbers for so-called equivalised income, which captures a lower segment than average income, we find that in the 1980s, household income after taxes and benefits was on average 89% of original income. 

In the 2010s, it was 108%.

The more the welfare state tries to help lower-income households, the more those households fall behind the rest.

But isn’t this the result of insufficient tax revenue? Can’t we just raise taxes to fix the problem?

No. A comparison of total tax revenue to GDP, based on data from the OECD, shows that the British government has claimed approximately the same share of the economy for a good half century now. In the 1970s the tax-to-GDP ratio was on average 32.6%. In the 1980s, it rose to 34.6%, only to fall to 30.7% in the 1990s. 

It has remained at 32% on average for the past 20 years. In short: no real change in the tax burden for 50 years. Meanwhile, the British welfare state is fighting a losing battle for its own ideological purpose. 

British conservatives have two options. They can continue to administer an ailing socialist fiscal architecture, or they can lead Britain into the future, based on the socially conservative wisdom of Lord Beveridge.