Home Political science A Century of Fiscal Squeeze Politics : 100 Years of Austerity, Politics, and Bureaucracy in Britain
The Two Labour Squeezes of the 1960s
The pattern of squeezes in the 1950s—heavily governed by the need to protect the currency in the fixed exchange rate system, against a background of low unemployment and inflationary pressures—continued under the Labour Government elected in 1964 under the leadership of Harold Wilson, one of the spending rebels in Labour's 1951 budget battles.
The Conservatives' 1963 budget had reduced income taxes at the lower levels and announced plans to scrap income tax (known as Schedule A) on owner-occupiers of residential property in 1964—the year in which the next general election had to be held according to electoral law. But National Insurance contributions were also raised in 1963 and in the general election year of 1964 (in the face of a major anticipated balance of payments deficit that would require loans from the IMF to stabilize the currency) the preelection budget by the then Conservative Chancellor (Reginald Maudling) did not follow the pre-election giveaway pattern of 1955 and 1959. Indeed Maudling increased taxes on tobacco and alcohol before the election, while announcing increases in virtually every domain of public expenditure premised on highly optimistic expectations of 4 per cent annual growth in GDP over five years. In the event, the Conservatives narrowly lost the 1964 general election to Labour, which won a miniscule overall majority of only four.
James Callaghan, the incoming Labour Chancellor, dramatically deepened Maudling's tax squeeze in an emergency budget a month after the election. The new government declared this budget to be necessary to tackle a balance of payments deficit that they put at some ?800m (a figure claimed to be exaggerated by the Conservative opposition) and to levy over ?400m in extra taxes. Those extra taxes were intended to fund some ?345m of extra public spending the Party had promised in the election campaign, notably higher retirement pensions and welfare payments, plus other measures such as raising the school leaving age from fifteen to sixteen and abolishing the NHS prescription charges that the Labour Government had finally rejected in 1951 and which the Conservatives had subsequently imposed. That emergency 1964 budget levied surcharges on most imports, and brought about a big rise in road fuel tax, a steep rise in National Insurance contributions, and a rise in income tax rates to take effect the following April. These measures helped the government to negotiate loans totalling ?857m from the IMF in 1964 and 1965.
With an overall majority of four, Wilson's Government never expected to survive a full electoral term, and faced problems both of parliamentary management and of aligning fiscal policy to the electoral cycle. The government's second budget in 1965 continued the revenue squeeze with further increases in taxation of about ?250m, including tax rises on tobacco, alcohol, and vehicle licences, reduction of income tax allowances, and a new capital gains tax replacing an earlier system for taxing short-term gains. Those tax increases coincided with cuts in defence spending, which included withdrawing from Aden, phasing out a major aircraft carrier programme, cancelling a big contract for a new fighter aircraft (TSR-2) intended to save some ?35m, and a defence review intended to contain future defence spending at roughly the FY 1964/65 level.
Labour did badly in local government elections in 1964 and lost a byelection that cut its overall majority to only two. By 1966 its majority dropped to one and the prime minister called a general election at which the Party faced the voters having raised taxes but also increased welfare spending while cutting defence—meaning it had applied a tax squeeze to fund a spending increase, the opposite of spending squeezes to fund tax cuts.
In the election campaign, Labour claimed credit for halving the balance of payments deficit while maintaining full employment and thus successfully managing a severe economic crisis, which it blamed on its predecessor's economic mismanagement and on speculation by international financiers, summed up as the 'Gnomes of Zurich', in a famous and much quoted phrase coined by the Labour heavyweight George Brown. The Party manifesto claimed any cut in taxation would be irresponsible at that time, but the Chancellor presented a 'mini-budget' at the start of the election campaign in which he said 'I do not foresee the need for severe increases in taxation.' He also presented plans for subsidizing mortgage payments by house-buyers on incomes too low to benefit from the tax relief then applying to mortgage interest payments, to be funded by a new tax on betting and gaming to be introduced after the election.
This approach paid off electorally in that there was a 3 per cent swing to Labour in the 1966 election, which increased its overall majority to a comfortable ninety-six. And a post-election Budget continued the revenue squeeze by announcing measures designed to increase revenue by a further ?386m in FY 1966/67. Those measures included the promised new betting tax, but most of the extra revenue was to come from a new payroll tax on employers in services and construction (Selective Employment Tax) which, unlike the Betting Tax, had not been mentioned either in the pre-election mini-budget or the Party's 1966 manifesto. That new payroll tax, which was intended to raise some ?240 a year and was paid by employers through the National Insurance system, was a variant of an earlier idea of a surcharge on employers' National Insurance payments which the previous Conservative Government had given itself powers to bring into effect by order, but never did. Another serious balance of payments crisis occurred in mid-1966, leading to an emergency summer package of measures including a policy of general wage standstill and subsequent restraint (backed up by statutory powers for government to hold down wages) and a 10 per cent surcharge on surtax for higher incomes. But the 1967 budget did not deepen the tax squeeze, and although the budget speech mentioned a possible squeeze on public spending, the Chancellor boldly stated: 'I sum up the prospects for 1967 in three short sentences. We are back on course. The ship is picking up speed. The economy is moving. Every seaman knows the command at such a moment, "Steady as she goes".'32
That famous or notorious claim was soon overtaken by events in the form of yet another major currency crisis in late 1967, which forced a devaluation of the currency in November (along with a commitment to cut defence spending and capital spending of state-owned enterprises, an immediate review of public spending to make further cuts, and a 'Letter of Intent' to the IMF pledging to limit net borrowing and therefore to raising taxes). It also ended Callaghan's Chancellorship (Callaghan, along with Wilson, had repeatedly ruled out devaluation as an option in the same way that Cripps had done in the 1940s), and heralded a new phase of squeeze in which the emphasis shifted to restraining public spending as well as raising taxes.
On the spending side, in January 1968 the prime minister (who, it will be recalled, had resigned from the Labour Government in 1951 over Gaitskell's cuts in health spending) announced the results of the post-devaluation spending review. This announcement reflected high political cost because the cutback package broke or at least postponed several promises made in Labour's 1964 and 1966 election manifestos, notably in education, health, and housing. The new Chancellor Roy Jenkins expanded on those plans the following day, foreshadowing a 'hard budget' to accompany the spending cuts, to be followed by 'two years of hard slog'.
The spending cuts were concentrated on defence in the medium term (accelerating the closure of military bases in the Middle East, Far East, and South East Asia, cancelling a major new fighter aircraft (the F111), phasing out an aircraft carrier force, and building fewer nuclear submarines), but the costs of cancelling contracts meant there would be no net savings in defence spending in FY 1968/69. On the civil spending side, further uprating of welfare benefits was postponed until 1969, and education spending was cut by delaying capital spending in higher education and postponing for two years (to 1973) the rise in the school leaving age which the Party had promised in its 1964 manifesto. Civil defence was to be cut back completely to a 'care and maintenance' basis, and planned spending on roads and housing was to be reduced (the latter in spite of Labour's promise in its 1966 manifesto to make housing its 'first priority'). Further—crossing another important political Rubicon for the Labour Party—some selectivity was to be introduced into health and welfare benefits by 'clawing back' an amount equivalent to announced increases in Family Allowance (welfare payments to mothers with children) from standard-rate income taxpayers. Finally, the charges for NHS prescription medicines that Labour had promised to abolish in its 1964 election manifesto (and had done so in 1965) were to be reintroduced, albeit with numerous exemptions.
Jenkins' 1968 budget proceeded to institute another major revenue squeeze, with tax increases intended to raise almost an extra ?1bn a year. The Conservative Leader of the Opposition (Edward Heath) claimed that amount was 'more than two and a half times the maximum which any Chancellor of the Exchequer has ever imposed in one Budget before'36 and pointedly contrasted those tax increases with James Callaghan's statement before the 1966 general election (as mentioned earlier) that he foresaw no need for major tax increases. On the direct tax side, the squeeze took the form of the extra charges on standard-rate taxpayers to recover the cost of increased Family Allowances,37 a special one-off levy on higher investment incomes and an increase in the rate of Corporation Tax from 40 to 42.5 per cent.
On top of that, the payroll tax (Selective Employment Tax) was raised by some 50 per cent and there was a swathe of indirect tax rises, on tobacco, spirits, fuel, vehicle tax, and Purchase Tax.
Jenkins followed up this 'hard budget' the following year by more tax increases aimed to raise an extra ?340m a year—including higher rates of road fuel tax, Selective Employment Tax, and Corporation Tax (the latter raised from 42.5 per cent to 45 per cent, a rate the government claimed to be in line with that charged by other competitor countries in the developed world at that time). The 1969 budget speech also announced a plan to raise National Insurance contributions to pay for a major increase in state retirement pensions, such that pensions would be some 20 per cent higher in real terms by the time of the following election than when the government had taken office. Jenkins' 1970 budget, introduced two months before the prime minister called a surprise early general election in mid-1970, effectively ended the revenue squeeze, though not by as much as his party colleagues were said to have wanted. Jenkins' pre-election budget left indirect taxes, the payroll tax, and Corporation Tax unchanged, but substantially raised the thresholds for income tax and surtax, which he claimed would benefit some 16.5 million voters.
The Wilson Government was defeated in the 1970 general election, confounding opinion poll predictions, and the Conservatives (supported by the Ulster Unionists) won an overall majority of thirty-one. The Conservative election manifesto made much of what was claimed to be ?3bn of extra taxes imposed by the Labour Government, contrasted that increase with what was claimed to have been a ?2bn reduction in taxes under Conservative rule between 1951 and 1964, and promised to cut taxes, giving first priority to income tax reductions (promises denounced by Labour as 'irresponsible tax bribes' and 'crude electoral manoeuvres' likely to worsen inflation). On the spending side, the Conservatives highlighted Labour's failure to achieve its 1966 election promise to build 500,000 houses a year by 1970, which had been a casualty of the post-devaluation spending cuts package of 1968, and promised to do better. It is debatable how far these fiscal squeeze-related issues affected the election result as against other factors in play, notably the anti-immigration rhetoric of Enoch Powell, then a leading figure in the Conservative party (Hansen 2000), rising prices, the announcement of adverse balance of payments and unemployment figures just before the election, even matters such as the defeat of the England football team in the World Cup before the election. All that can be said is that the Labour incumbents' campaign cannot have been helped by the tax and spending squeeze imposed during 1968 and 1969.
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