The dangers of Cameron's latest wheeze

On the radio this morning, David Cameron sounded ever more preposterous in his faux-shock at the Prime Minister's borrowing strategy and the decision to spend £12 billion on a 2.5% cut in VAT. No term of abuse was too strong for this idea, despite its being first proposed by one Kenneth Clarke, because of its impact on public debt (though significantly, Cameron admitted he wasn't suggesting much lower debt levels himself).

By lunchtime, we saw where Cameron was headed. He had his own tax cut plans - worth £4 billion a year with no indication from whence they might be funded, though health, schools, defence and international development budgets would be left unaltered. Tax-free income would rise £2000 a year for the average pensioner and basic rate taxpayers would pay no tax on savings.

But what would the economic impact of this unfunded largesse be? As the respected Institute for Fiscal Studies pointed out, there was a chance that it would result in less money flowing into the economy. Moreover, once the four ringfenced areas were left unscathed it could result in a "very sharp slowdown" in the rate of spending growth across many areas of government.

Which might, incidentally, also lead to higher council taxes, as DCLG is not protected. Back to the drawing board, chaps?

The truth about the VAT story

When I was running David Blunkett's office in Opposition, we received a bit of paper that been designed to pressure No 10 for more money, with the admission that schools were short of money with the phrase "insufficient resources threaten the provision of education in the state school sector". I duly passed it on to the much-missed political editor of the Evening Standard, Charles Reiss, who made it his splash as it happily coincided with a cabinet awayday which was being seen as another relaunch of John Major's beleaguered government.

Needless to say the media diverted its attention to the leak story and the relaunch was suspended. Nobody remembers the leak now and it was of little long term consequence. Afterwards, when in government, one official told me that they were just relieved we hadn't seen the more radical statements in the rest of the paper.

In many ways the 1995 leak was more explosive than today's accidental publication of an earlier Treasury document on the Internet, because it confirmed what everyone in education already knew at the time, but which ministers had been denying. But it was also reasssuring to know that officials were aware of what was happening in the real world.

I was reminded of those events hearing the excitement surrounding today's story showing that ministers considered raising VAT to 18.5% in order to pay for the temporary cut. The controversy will play out but it is worth recognising the reassuring elements, which are stronger than those in the 1995 leak.

All sensible - and some radical - options are considered and should be considered over any policy. The only bombshell would have been if they had not considered the VAT increase option. The issue is not whether such options are considered, but what decision is made in the end and why. In a sense, a rise to 18.5% would have been the most logical way to pay for the VAT cut. But it would also have been the most regressive, as even the poorest have to pay it on many goods and services. The government opted for a more progressive method of repayment, which is to their credit.

But the fact that this was a serious option until the last minute also gives the lie to the notion that ministers have deliberately set out to wreck New Labour principles in order to pacify leftwing backbenchers; the top rate rise and NI increase were simply the least worst options.

Overall, a strong package

The Pre-Budget Report was a bit like Budget day, but with fewer real rabbits from the hat. The Chancellor did well to set out not only the giveaways but how it would be paid for. There were also well-judged measures for businesses, on the environment, for families and for pensioners. I still wonder just how much impact the VAT cut will really have. But it will hopefully give people confidence in the run-up to Christmas, alongside rises in pensions and child benefit. And nobody can now repeat the Tory rubbish about a tax bombshell. For George Osborne, it was a shrill shrieking response suggesting more concern about pre-rehearsed slogans than the economy. His days must surely be numbered.

Stimulating times

Today's Pre-Budget Report is expected to see two flagship measures: a 2.5% cut in VAT and plans for a higher rate tax increase in 2010. The latter is intended to reassure people that the former will be funded and will not hit them, for the most part.

I wonder what the impact of these measures will really be. The VAT cut - advocated by Kenneth Clarke on Saturday - will reduce average household bills by a tenner a week, which is not unwelcome. But at a time when major stores are typically cutting 20-30% off their prices in unprecedented pre-Christmas sales, will the VAT cut be enough? I'm not always taken by Jon Cruddas's prescriptions, but his suggestion that all basic rate taxpayers get sent a cheque for £500 could have a more dramatic and targeted impact at similar cost.

As for the tax rise on those earning upwards of £150,000, it will not raise much money and will not really impact much on those having to pay it. But what is the message that it sends? I hope that Brown and Darling are right that in these post-Obama times, and such a rise is politically acceptable to middle England. The concern about raising higher rates in the past - when some lobbied for higher rates above £100k - was the fact that far more people believed they might earn such sums than ever had a realistic prospect of doing so, but £150k may be high enough to allay such fears.

Nevertheless, the government needs to be very clear about who will pay and what they pay; media reports erroneously make out that people pay 45% on their whole income rather than on sums in addition to the £150k. More importantly, the Chancellor will need to say more today about where else the money is coming from; he must not give the Tories ammunition to claim there are hidden taxes to come.

That said, the Tories' attitude to the crisis is utterly bizarre and a recipe for wholesale depression. One might debate the government's methods, but they are producing plausible policies. The same cannot be said for their do-nothing opponents.

Nick Clegg's tax rises

So despairing are some Conservatives about David Cameron's embrace of tax rises that they are giving house room to Nick Clegg's pretensions of being a tax cutter. In one sense, you could credit Clegg with being the heir to Margaret Thatcher: after all, her income tax cuts were paid for by a hike in VAT. In fairness, Clegg's proposals are more progressive. But Clegg is promising two tax rises that will hit middle earners hard: an extra £1000 a year tax for £50,000 earners contributing 10% of their income to pension (something that will particularly hit those who save for old age without employer contributions) and a big rise in council income tax (for many, it will be over £1000) to boot. For them, this is a tax rise. There is certainly a case for raising the threshold at which people pay tax - perhaps by removing some tax credits - but I do wonder how many Lib Dem voters realise that for them, Clegg's tax 'cuts' would leave a big hole in their pockets.