A Brief History of British Fiscal Policy from 1776 Until Today
In 1776, British economic policy was characterized by significant government funding of economic ventures. Most notable among these is the British East India Company, through which all British trade with India was conducted. Adam Smith is the most noteworthy economist from this time period, having published The Wealth of Nations in 1776. Smith, however, was not particularly influential in terms of fiscal policy in Britain at the time. Due in large part to political concerns, British fiscal policy would move further away from market reforms before reversing direction and becoming the free market-oriented policy we see today.
In 1802, the Napoleonic Wars began. Britain, being the only country other than France which fought continually for the duration of the Napoleonic Wars, had to change its fiscal policy to pay for the estimated $3 billion in war expenditures. Britain chose not to significantly increase taxes, instead relying on outside loans at a relatively low interest rate. France, conversely, chose to rely on increased tax revenue for wartime expenditure, which slowed their economic growth significantly. Over the course of the war, however, foreign sources of grain dried up for Britain due to blockades. Less agriculturally suitable land was used for farming, and all farmers enjoyed high prices for their produce.
After the war ended in 1815, British farmers pressured Parliament to pass the Corn Laws, a massive tariff scheme on all grain imports to Britain. The Corn Laws are analogous historically to the United States Smoot-Hawley Tariff Act in that they signify the highest tariff rate in recent history of the respective countries. David Ricardo, however, proved the Law of Comparative Advantage shortly after the Corn Laws were passed, and gained prominence and political influence in Britain. Parliament soon began to follow Ricardian principles in decision-making, choosing increasingly free market economic policies. Ricardo's influence culminated in 1846, 23 years after his death, with the rescindment of the Corn Laws. Britain had committed to free-trade nearly 90 years before the United States, allowing it to stake a first claim towards being a global financial center.
The next major shift in British fiscal policy came in the period leading up to and including World War II. Fiscal policy had become dominated by Keynesianism and was characterized by extensive price controls on virtually every good and service in the market. The British government nationalized many industries, and the free market had been severely curtailed. In 1943, during the height of Keynesianism and World War II, estimates of the government share of British GDP were as high as 55%. Keynes remained influential until Margaret Thatcher took office.
Margaret Thatcher was an incredibly influential conservative Prime Minister from 1979-1990. Among her most important economic policies are her decisions to refuse to acquiesce to union pressure, to cut government spending, and to privatize industries that had been nationalized. Steel and coal miner's unions engaged in the bitterest fights against Thatcher's economic policies, but were defeated. In 1979, at the beginning of Thatcher's tenure as Prime Minister, union membership numbered 13 million. By 1996, that number had declined to 8 million. Thatcher's spending cuts and privatization policies were also enormously successful. In 1979, public sector net worth in Britain was approximately 80% of GDP. By 1996, public sector net worth had declined to a mere 8.5% of GDP.
The Value-Added Tax (VAT) in Britain
In 1973, the Parliament abolished the Purchase Tax and the Selective Employment Tax and replaced them with the new Value-Added Tax. The VAT is a residual of Marxist conceptions of worker exploitations, where company profits are taxed then reapportioned to the workers through provision of social services. The VAT remained a significant source of government revenue through the conservative government of Margaret Thatcher. Thatcher, in her first budget, even chose to extend the VAT in some areas, such as luxury boats. Currently, the VAT rate is 17.5% on most goods, and brings in nearly £80 billion in revenue, which is approximately 60% of HM Customs revenue. The VAT is a very complex tax - since the tax is collected from and entity other than the being who bears the cost of the tax, usually the seller rather than the consumer, this brought on worries of over/double taxation. This has lead to recent controversies over its implementation.
In 1991, British courts were asked to decide whether the food product "Jaffa Cake" (an orange jelly-filled cookie/cake hybrid) was officially classified as a biscuit or a cake. The makers of Jaffa Cake pushed for classification as a cake because cakes are a VAT-exempt product, whereas biscuits are a VAT-rated (taxed) product. The courts ruled in favor of the makers of Jaffa Cake, saving them significant tax expenses.
Similarly, in 1994, Blackpool Pleasure Beach sought classification for one of its rollercoasters as public transport. They argued that a rollercoaster is, in essence, a one-stop over ground railway system. Blackpool Pleasure Beach sought this classification because public transport systems are VAT-exempt, but entertainment spending is VAT-rated.
Small businesses have often complained about the complexities of the VAT system. Businesses are allowed to deduct the VAT they spend on capital goods, but some goods are rated at reduced rates and the rules for what goods' VAT a business can deduct are not straightforward. Many small businesses miscalculated the amount of VAT they were required to pay to the government, which resulted in widespread penalties. In 2002, Parliament attempted to address the complexity of the VAT by providing a flat VAT rate for some small businesses.
Fiscal Policy Today
The Government has taken significant steps to strengthen the framework for fiscal policy since taking office. Fiscal policy is now directed firmly towards maintaining sound public finances based on strict rules. In setting fiscal policy, the Government takes a deliberately cautious approach. This approach is implemented by basing public finance projections on cautious assumptions for a number of key variables including the economy's trend growth rate, levels of unemployment, oil, and equity prices.
Since the Finance Act 1998 and the Code for Fiscal Stability, approved by the House of Commons in December 1998, the government has take implemented key principles, rules, and features when it comes to making and implementing fiscal policies in the United Kingdom to meet certain fiscal objectives set out by the government.
Fiscal Objectives
Over the short term, fiscal policy wants to follow monetary policy framework. In the medium term, in addition to the short term goals, the government wants to ensure sound public finances and that spending and taxation impact fairly both within and between generations. In the long term, adding on to the short and medium term, the policy makers want to promote high and sustainable economic and employment growth.
Fiscal Principles
There are five principles of fiscal management in the UK. These principles are transparency (in the setting of fiscal policy objectives, the implementation of fiscal policy and the publication of the public accounts), stability (in the fiscal policy-making process and in the way fiscal policy impacts on the economy), responsibility (in the management of public finances), fairness (between generations), and efficiency (in the design and implementation of fiscal policy and in managing both sides of the public sector balance sheet).
Fiscal Features and Rules
There are two main fiscal rules that are in accordance with the five principles in the UK. These rules help with UK fiscal policy feature taking account of the cycle, distinguishing between current and capital expenditure, focusing on sustainability, and taking cautious and audited assumptions for fiscal projections.
The first rule is The Golden Rule. This states that over the economic cycle, the Government will borrow only to invest and not to fund current spending. The Government will meet the golden rule if, on average over a complete economic cycle, the current budget is in balance or surplus. Some pros of The Golden Rule include promoting fairness between generations. This means that the bill for today's current spending, which mainly benefits today's taxpayers, will not be passed onto future generations. This explicitly recognizes the different economic nature of current and capital spending. Also, the Golden Rule is assessed after the business cycle, which allows automatic stabilizers to work. Some cons of the Golden Rule are that the government and policy makers can only pass definitive judgment on whether or not the Golden Rule has been met in retrospect since you can only tell if the Golden Rule has been achieved at the end of the cycle. Assessing in the midst of a cycle whether the Golden Rule is on course to be met over the whole cycle is complicated by the need to identify where the economy stands in the cycle at any given time.
The second rule is The Sustainable Investment Rule. This states that the public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level. The Chancellor has stated that, other things equal, net debt will be maintained below 40% of GDP over the current economic cycle, in accordance with the sustainable investment rule. A desired rationale to use the Sustainable Investment Rule is the government indebtedness should not increase explosively. However, it is hard to argue that the ceiling of 40% of GDP is necessarily more sensible than 30% or 50%, or some other ceiling percentage. Also, focusing on debt may not provide an accurate measure of the long-term sustainability of the country's public finances. This can show an ignorance to requirements to provide benefits and pensions to future generations, which is fairness that is located in the five principles.
The British economy has been more stable over the last 15 years than any other comparable period. Although some argue that policy-makers do not pay that much attention to fiscal policy and their macroeconomic process, these features and rules described above are none less than positive effects on the UK.