The UK just elected a left-wing party, the Labour Party, to run its government. A consideration is whether the new leaders will spend more, increase taxes, and have a major impact on the country’s economic performance. Yet historically, we do not see much evidence of this. First of all, the budget deficits normalized as the ratio to GDP has been worsening almost linearly over time ever since 1948. This has been true regardless of which party was in power. Even replacing it with the debt-to-GDP ratio does not make much difference, as it shows a similar trend as deficits.
One might wonder whether Labour would build a bigger government than Conservative and tax more. Historically speaking, the evidence on this is unclear as well. On income tax, the basic rate has gradually declined from the peak of 35 percent in the mid-1970s to now at 20 percent, while that of the “higher rate” has dropped from the peak of over 80 percent to now at 45 percent. Corporate tax has been falling similarly from 52 percent to 30 percent recently. Both parties had, respectively, two episodes in rule, which were obviously unrelated to the general downsizing of government.
The extent of interventionism is not readily seen merely from the party label. Although the tax rate set can quantify this, the general downtrend over decades makes it difficult to tell which party tends to set it higher. While intention is one thing, the outcome is another. Tax revenue is not linear to the tax rate, which is due to the famous Laffer curve, because a higher tax rate might jeopardize the economy, thus resulting in fewer people paying tax and, hence, a lower tax revenue. In reality, the tax rate has been steadily declining while tax revenue has not.
The honest fact is that fiscal status is not easily controllable by the government. Instead, it is the economy that decides how much the government can tax. The accompanying chart shows clearly that from the postwar era to now, the fiscal balance (positive surplus, negative deficit) to GDP is by and large proportional to real GDP year-over-year (YoY) growth. So far, so good. Despite, failing the ratio scale, where the left and right axes are scaled at a one-to-one distance, meaning that a 1 percent change in real GDP growth is associated with a 1 percent change in fiscal balance to GDP.
Notice that the persistent worsening of fiscal balance is in the same shape as GDP growth. This means that if fiscal balance is not readily controllable by the government, neither is GDP growth. In fact, whichever party was in power, the GDP growth downtrend persisted over the longer run. This suggests that although there could be lots of conjectures or hypotheses about the parties’ fiscal policies or economic policies, data do not lend much support. To the bottom line, neither of the two parties could successfully counter the downtrend of real GDP growth nor the fiscal balance to GDP.
The difference between what parties did after their election might be much less than what they said before. The impact of politics is often overestimated, and that of economics is underestimated.
