The UK needs an emergency Budget full of shocks

There is no attitude more shameful and debilitating than defeatism, as Britain learnt at great cost in the 1970s, when managing decline became our crumbling establishment’s default strategy.

Yet our present, increasingly fatalistic acceptance that the British economy is set for a lost decade of stagnant growth, falling real incomes and untold other humiliations is becoming eerily reminiscent of those bad old days.

Such thinking should be unacceptable. I become angry when I talk to unimaginative economists or cowardly politicians who believe that we are powerless to influence the economy and have therefore quietly resigned themselves to years of misery. Just because interest rates cannot be cut further and printing yet more money won’t work doesn’t mean that we should give up.

Austerity, when it comes to public spending, remains essential. But we should also be adopting, in parallel with spending cuts, the sort of radical, pro-growth supply-side tax reforms that have always worked wherever they have been tried. David Cameron has already successfully made one historic U-turn on Europe; he needs to perform another on the economy.

This doesn’t mean that he should jettison all Coalition policies just that a dose of shock therapy is desperately required to jolt the UK back into growth. For that, an emergency Budget is required, together with a dramatic gear shift by the Chancellor, who needs to understand that the political and economic risks of doing nothing are now much larger than those of taking bold action.

A simple three-point plan would do the trick. First, and most radically, George Osborne needs to slash corporation tax to 11pc, just below the level levied in Ireland, which at 12.5pc is the lowest of our close competitors. It would be essential for such a sweeping, historic move to begin with the new tax year in April, in a blaze of publicity. The excitement this would generate, and the message it would convey, would transform Britain’s prospects.

The UK would suddenly become the most attractive location in which to conduct and base commercial activity; nobody would believe any longer that the UK is closed to business. It would end the row over tax avoidance, as multinationals would rush to base their operations in the UK, and it would create huge numbers of jobs. It would be a genuinely revolutionary policy, and one which would be surprisingly fiscally manageable. Corporation tax is expected to yield £38.9bn in 2013-14, with the rate set to fall to 23pc this April and to 21pc from 2014. On a worst-case scenario, which implausibly doesn’t assume any change in behaviour or any additional investment in the UK, slashing the tax to 11pc would reduce government revenues by around £20bn a year; the immediate pro-growth effect will almost certainly mean a smaller hit, even in the first year.

But merely slashing corporation tax is not enough. My second, immediate reform would be to abolish capital gains tax (CGT), currently levied at 28pc following one of Osborne’s early raids. This tax creates more economic damage and distortions for every pound it raises than almost any other. It is set to bring in £4.6bn next year, a relatively insignificant sum given its impact and the fact that the Government has been forced to introduce so many avoidance mechanisms from Isas to Enterprise Investment Schemes to mitigate its effects.

CGT depresses the returns to capital, thus reducing the incentive to invest at a time when we desperately need to encourage business expenditure and risk-taking. The main reason why so many firms are using the UK as a cash cow, shifting funds generated here to finance investments abroad, is because the returns to be made in Britain, especially in manufacturing, are too low. Eliminating capital gains tax and slashing corporation tax would help rectify that. Most City analysts would argue, quite correctly, that the value of a share is the net present value of its future expected dividends. But dividends are already taxed, as are profits - even under my proposed reforms - so also hitting capital gains with a levy is tantamount to triple-taxation, which is unfair as well as counter-productive.

Getting rid of CGT would deliver a major boost to the stock market, almost guaranteeing a double-digit increase in share prices. Investors, including pension funds, would enjoy huge windfalls; a buoyant market would make it easier for companies to raise equity, reducing their cost of finance and allowing them to grow, spend and create jobs.

Ditching CGT would also encourage property investors to put buy-to-let homes on the market: at present, many don’t want to sell because they would rather delay paying tax on any gains. Getting rid of this barrier would increase the supply of properties, helping first time buyers and bolstering economic activity. Britain did not tax capital gains until 1965 so scrapping the tax is hardy a leap in the dark; the only difficult bit is that its repeal would have to be accompanied by an explicit crackdown on avoidance, with clear guidelines to prevent people passing off income as capital gains. But even if some income tax receipts were to vanish as a result, it would be a price worth paying for the massive economic boost delivered in return.

The combined static hit to the Treasury from these two tax cuts would be about £25bn. I’m confident that the increase in investment and activity that would result from the enhanced incentives would significantly reduce this number even in the first year, by bolstering other taxes but, even at face value, such a drop in receipts would be manageable. Nominal GDP will be £1.62 trillion next year; so the sweeping change I’m advocating would be worth just 1.5pc of national income at worst.

The Chancellor has already lost his grip on the public finances: the budget deficit is rising again, gilt yields are increasing, the pound is tumbling and Britain is likely to be stripped of its AAA-credit rating later this year. With the UK’s reputation for fiscal rectitude already in tatters, a deficit that ends up a little larger than previously thought, in return for stronger growth and a more competitive economy, would therefore be a price worth paying.

But, to reassure markets, and to make sure these supply-side reforms are not incorrectly perceived as a doomed Keynesian-style attempt at boosting demand by borrowing even more, the Chancellor’s spending cuts, currently pencilled in over a number of years, should be accelerated. Instead of cutting real spending by around 1pc in 2013-14, the Chancellor should aim for 1.5-2pc.

Managing decline should be anathema to any serious government, especially given that there is still all to play for. It is time for the Chancellor to jettison his fiscal conservatism and to embrace supply-side radicalism instead. He is likely to be pleasantly surprised by the results.

Allister Heath is editor of City AM