The Later Thatcher Episode: Squeezing in Recovery

The second fiscal squeeze in the 1980s that shows up from the reported financial outcomes data analysed in Chapter Two was very different from the Thatcher Government's first-term squeeze. It included a long-drawn-out 'soft' spending squeeze between 1983/84 and 1988/89, producing a balanced budget in 1987-88 and government spending falling relative to GDP but not in constant prices. Along with the soft spending squeeze went a soft revenue squeeze, in that revenue rose in real terms but not relative to GDP. But as mentioned earlier, the special conditions producing that revenue outcome mean it is debatable how far that 'squeeze' involved pain inflicted on mainstream voters.

Within that overall picture, a closer analysis reveals an uneven time-pattern related to the election cycle, with spending cut in real terms as well as relative to GDP (that is, 'hard' in our terminology) in most policy domains in 1985/86 and 1988/89, but much less severe cuts in all areas of current spending except defence in FY 1986/87 ahead of the 1987 general election. On the revenue side, the only area in which there are signs of the electoral cycle punctuating the soft squeeze is that of taxes on income and wealth, the revenue from which fell in 1986/87 and 1987/88 while rising in real terms for all the other years of the episode.

This second Thatcher squeeze involved an exceptionally long period of continuous economic growth (indeed, the longest continuous period of growth for over half a century at that time, ending only in 1990), mostly combined with low inflation. A squeeze on public spending began barely a month after the 1983 general election, with the new Chancellor, Nigel Lawson, announcing cuts in planned spending that led to accusations that the Conservatives had misled the voters in that election (given that the Party's 1983 manifesto had not explicitly indicated that public spending would be cut).[1]

The plan for public spending to decline relative to GDP as GDP grew was a strategy that Nigel Lawson first formulated publicly in 1983 and described as more politically 'realistic' than the frustrated attempts to cut real public spending in a recession in the Thatcher Government's first term (Lawson (1992): 191). That approach was enshrined in another Medium Term Financial Strategy announced in 1984, aiming for public expenditure to remain relatively flat in constant-price terms at 1984/85 levels while GDP rose.[2] Moreover, during this economic growth period, the strategy adopted by the Thatcher Government of uprating pensions and other welfare benefits in line with prices but not earnings meant that over the years spending on such items—40 per cent or more of overall government expenditure—fell relative to (rising) GDP. At the same time, reported unemployment began to fall towards the end of the government's second term (although the official numbers were heavily disputed), which served to reduce spending on welfare and related work programmes. Further, the accounting practice of counting the proceeds of asset sales through privatization (running at approximately ?5bn a year at this time) as negative public expenditure also contributed to the reported spending outcomes shown in Chapter Two, such that the depth of this spending squeeze episode would be about one-eighth lower without such asset sales (see HM Treasury (1994) Table 1.1: 8).

On the revenue side, yields rose overall in constant-price terms, but the Chancellor (Nigel Lawson) repeatedly claimed, for example in his 1988 budget speech, that 'income tax has been reduced in each of the last six budgets—the first time this has ever occurred'.[3] The standard rate of income tax was indeed cut from 30 to 25 per cent in stages between 1983 and 1988 and in 1986 the government claimed credit for raising the main thresholds and allowances by 20 per cent above the rate of inflation.[4] Moreover, Lawson claimed credit over this period for abolishing several taxes introduced by Labour over this period (including the National Insurance payroll surcharge, the income tax surcharge on investment income, Development Land Tax, and tax on lifetime gifts) and reduced or abolished higher rates of income tax and inheritance tax, in the face of strong protests by opposition parties about what they saw as the distributional unfairness of such changes.

So why did overall revenue increase in constant-price terms at this time? One reason, already mentioned, was the effect of North Sea oil in adding an extra ?6bn or more a year to the revenue base (for example, a much-trumpeted but unexpected budget balance achieved in 1987-88 was mostly down to oil revenues exceeding expectations by some ?2.5bn). A second was the effect of falling unemployment, which halved between 1986 and 1989. And a runaway debt-fuelled consumer boom coming towards the end of the period (despite the government's earlier professed belief in monetary restraint) boosted revenue in various ways, for example, in VAT receipts from imports bought on credit.

Moreover, along with the successive reductions in income and corporation tax rates highlighted by Nigel Lawson went some notable (if perhaps less noticeable) increases in other taxes, including higher compulsory National Insurance contributions by employees and employers, higher excise taxes, particularly on road fuel, and (a sign of things to come in future decades) new taxes on pension funds in 1987. Over this period numerous tax offsets or allowances were also removed or reduced, notably investment allowances (removed in 1984) that enabled firms to set investment against Corporation Tax, the removal of tax relief on non-charitable gifts by covenant in 1988 and on life insurance premium payments in 1984, and less generous tax allowances for company-provided cars and other in-kind benefits.

Less clear as a factor that might account for the growth of revenue in real terms during this period is the so-called 'Laffer curve' effect mentioned in Chapter Two, in which reduction of nominal tax rates is said (within bounds) to have the effect of increasing tax paid as a result of making tax avoidance and evasion less worthwhile. Such effects were certainly claimed by the Thatcher Government, for instance, over the much greater yield from inheritance taxes in the late 1980s levied at much lower nominal rates than the Capital Transfer Tax introduced by its Labour predecessor in the 1970s.[5] To the extent that 'Laffer curve' effects contributed to real-terms revenue increases during this period, that again makes it problematic to construe that outcome as a tax squeeze in a meaningful sense. And even if this period did constitute a tax squeeze in a meaningful sense (albeit of the soft variety), it was decidedly different in style and content from previous revenue squeeze episodes (including 1980/81 to 1981/82) discussed earlier in this book.

The long period of economic growth that accompanied the soft squeeze on revenue and spending in the Thatcher Government's second term and the beginning of its third term was punctuated by at least four major shocks affecting revenue or spending or both, but none of those shocks had a sufficiently deep or long impact either to trigger recession or to undermine the conditions for that real-terms revenue increase and relative reduction in spending. On the political front, the two major shocks were the cost of the unexpected Falklands War of 1982, and a bitter and unexpectedly drawn out coal miners' strike in 1984/85 which threatened power supplies and forced the government to borrow an extra ?2.75bn to cover the extra public expenditure associated with the strike.[6] On the economic and financial front, one of the major shocks was a market collapse in 1986 which took oil prices back down to their 1973 levels and thereby unexpectedly halved the UK's tax take from North Sea oil (from ?11.5bn in 1985/86 to approximately ?6bn the following year), such that the government had to resort to other taxes and extra borrowing to fill the gap. The other shock was a world stock market crash in 1987, which was feared by some at the time to presage a 1930s-type world slump but in the event did not do so.

Politically, the Thatcher Government during this period was challenged on the left by trade unions, notably in the public services and state-owned enterprises and especially by coal miners in the 1984/85 strike. The government was also challenged by several local authorities controlled by the Labour left, particularly in London and some other major cities, which opposed the government's successive attempts to limit local authority spending. But while these challenges put significant pressure on the Thatcher Government— notably in public order policing during the 1984/85 coal miners' strike and in battles with local authorities including the outright abolition of the Greater London Council in 1986—they do not seem to have seriously threatened that government electorally in its second term and may even have boosted the Conservative vote. And there was nothing quite comparable to the 'austerity' debates of the early 1980s described earlier, in which the government's fiscal and monetary stance had been argued to be counterproductive and a recipe for producing mass unemployment by serious professional economists as well as by the Conservatives' normal political enemies.

The Thatcher Government was certainly accused during this time by its political opponents of fiscal and economic mismanagement in various ways— notably, of 'frittering away'[7] the once-for-all revenues from North Sea oil on current spending rather than devoting those revenues to investment; of selling public assets to produce once-for-all revenue at the cost of sacrificing longterm income streams (Neil Kinnock, the Labour leader at this time, compared it to selling an owner-occupied house to live in rented accommodation);[8] and of promoting a consumer boom based on unsustainable levels of debt. The government's critics also argued that it had done too little to reduce unemployment, particularly in former mining and manufacturing areas; that it had not increased health care spending sufficiently to prevent waiting lists for treatment from lengthening; that despite its tax-cutting rhetoric, the tax burden on the average household actually rose by about 10 per cent between 1979 and 1987 as a result of increased National Insurance contributions, VAT hikes, and increases in domestic rates (the local property tax); and that by the later 1980s retirement pensioners were far worse off as a result of the 1979 move to remove the link with earnings.[9]

However, the Thatcher Government again did not suffer substantial electoral punishment in the 1987 general election after this four-year 'soft' squeeze. After a pre-election budget (described by the leader of the Opposition as a 'bribes budget'[10]) which cut the standard rate of income tax from 29 to 27 per cent and was presented with triumphalist rhetoric about steady growth, low inflation, and fiscal prudence, the Conservatives secured a third victory with a comfortable overall majority, albeit with a slight loss in vote share, a loss of some twenty-one parliamentary seats and a further geographical polarization between the Conservatives' electoral heartlands in the South of England on the one hand, and Scotland, Wales, and Northern England on the other.

So again, any electoral punishment for this second-term 'soft' squeeze was quite muted. And the final post-election budget of the 'soft squeeze' period, in 1988—introduced among tempestuous scenes in the House of Commons as opposition parties protested about what they saw as its social unfairness— applied the previous recipe with even sharper effect. It continued the pattern of cutting income tax rates for the sixth year in succession (with the basic rate of income tax cut from 27 to 25 per cent, and all higher rates of income tax above 40 per cent abolished), while some tax allowances were removed and the overall tax burden was not planned to fall relative to GDP.[11]

  • [1] The election manifesto said, 'We shall maintain firm control of public spending andborrowing ...Less spending by government leaves more room to reduce taxes on families andbusinesses.' But it did not mention any specific spending reductions. Conservative ElectionManifesto 1983, 'The Road to Recovery',
  • [2] Financial Statement and Budget Report 1984 HC 304 1983-4: 8-9.
  • [3] Nigel Lawson, budget speech, HC Deb 15 March 1988, c. 1006.
  • [4] Nigel Lawson, budget speech, HC Deb 18 March 1986, c.182.
  • [5] Budget speech HC Deb 17 March 1987, c.826.
  • [6] Budget speech HC Deb 19 March 1985, c.783.
  • [7] A phrase used by the then acting Liberal leader, Jo Grimond, commenting on the 1980budget. See HC Deb 26 March 1980, c.1499.
  • [8] HC Deb 17 March 1988, c.1021.
  • [9] Neil Kinnock, leader of the Opposition, claimed that in 1988 a single pensioner would gain an80p pension increase as against ?7.20 under the pre-1979 'double-lock' system. HC Deb 17 March1988, c.833.
  • [10] HC Deb 17 March 1987, c.829.
  • [11] Budget speech HC Deb 15 March 1988, c.996 and 1006.
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