Bruce Anderson: There is an opportunity as well as pain in spending cuts

A crisis can break a premiership. It can also be a rocky path to greatness. In the case of Britain's public spending crisis, there is no middle way. David Cameron has said that he will have to sort out the deficit. He is right. There is no hope of ducking that challenge, any more than there is a simple solution to it.

On one point, we can be clear. The present position is dire. An annual deficit at twelve per cent of GDP, the National Debt heading towards eighty per cent: that is unsustainable. Unless the markets were convinced that an incoming government was serious about cutting the deficit, it would face a sterling crisis and a gilt-buyers' strike. The consequence would be very high interest rates, killing off any recovery – plus inflation, as the government was forced to print the money which it was unable to borrow, plus higher taxes.

That would mean stagflation, for an indefinite period: worse than the Seventies. As economic activity imploded and large sections of the City migrated, many of our ablest youngsters would conclude that there was no future in the UK, while many of the less able started rioting. The SNP and the BNP would thrive. For the rest of us, it would not be pleasant to live in a failing, demoralised, angry Britain. So let there be no illusions. This is the economic equivalent of 1940.

A new government would start with an intellectual problem. But it could finish with an opportunity. The problem is easy to describe and hard to solve. Mr Penpush of the Circumlocution Office performs no useful function. His post enables him to prodnose into the activities of useful persons, causing obstruction and adding to costs. His latest proposal would make it a criminal offence for any adult who had not been expensively vetted to talk to any child, ever. His department was set up when Gordon Brown was diverting resources from the wealth-creating private sector into the public sector, in order to build up a client base of Labour voters. He is an obvious economy.

But in the short-run, any economic activity is beneficial. Mr Penpush pays taxes; the government needs the cash. He spends money, thus injecting demand into the economy. He is paying off a mortgage, thus helping to stabilise the housing market and his building-society's balance sheet. If he were sacked tomorrow, all that would be jeopardised, while he received a redundancy cheque and welfare payments.

There are similar problems about tax increases. They, too, would reduce private sector demand and some of them could be especially damaging. Though many voters approve of a fifty per cent rate on high earnings, they are wrong. A generation ago, an American economist made a crucial contribution to economic theory in an improbable manner. In a doodle on a paper napkin, Arthur Laffer devised his immortal curve. It dealt with the relationship between tax rates and tax receipts. According to the curve, lower rates would yield higher receipts.

At the time, this was widely derided, as not worth the napkin it was doodled on. But during the Eighties and Nineties, it became clear that the Laffer Curve was a sound guide to policy. All over the world, cuts in tax rates produced higher receipts and happier tax-payers. Low-tax economies flourished.

In Britain, the Laffer doctrine still applies. It is vital that the financial services sector should pay a lot of tax. But it is a mobile industry. There is no use in demanding extra money from people who have moved to Frankfurt.

The fifty per cent rate was a shabby manoeuvre by a discredited government, desperate for political advantage, heedless of the long-term consequences. Given the – current – low inflation rate and the competitiveness of the British retail sector, a VAT rate of twenty per cent would be the safest way of raising real money. Even so, it would deflate demand; it is not as if there are many spare billions lying around the place.

We cannot deal with the deficit purely by cutting public spending and increasing taxes. To some extent, we have to grow our way out of the crisis. So the necessary cuts have to be implemented without imperilling growth. That will be a difficult feat of economic navigation and there are no models or formulae to guide the men on the bridge. We need a judicious blend of Maynard Keynes and Montagu Norman, but in what proportions? If government spending were cut by ten per cent over three years while higher VAT raised £12.5 billion, and assuming that economic growth was running at around two and a half per cent by year three – would that be enough?

If so, it is probably a minimum, and cuts of that magnitude will not be easy to achieve. In previous, and smaller, culls of public expenditure, governments have usually started with the low-hanging fruit: postpone capital programmes and freeze recruitment. Although it is unlikely that this can be avoided, it is a crude solution. Even if a scythe may be necessary, there ought also to be some more sophisticated tools. This is where the opportunity can arise.

Until the due allotted day for his electoral execution, it looks as if nothing but dynamite will extract Gordon Brown from No.10. The Tories ought to use these last months in Opposition to start a radical process of hard thinking which can carry on in government: nothing less than a fundamental appraisal of the British system of government. If we were establishing it tomorrow, ex nihilo, what duties would it perform? What powers would it have? What money should it spend?

In all this, the Tories should make it clear that their target is neither the front-line public services nor their dedicated employees. It is the uncontrolled growth of the public sector in recent years. That has endowed us with a government which is simultaneously weak and authoritarian. We are unable to control our borders, yet we have councils banning conker-collecting and proposals to harass millions of parents who would just like to put` something back into the community.

What happened to the active citizen? He was banned, by the hyper-active bureaucrat. In Britain today, large parts of the machinery of government seem to be out of control: acting on no rational basis, responding to no public need. If we could put a stop to that, the deficit would be reduced and the country would be better-run.

There is also waste. As soon as the Tories come to power, every division of every government department should be required to submit proposals for three per cent, five per cent and ten per cent cuts in costs. Traditionally, and with the connivance of ministers - including Tory ones - civil servants have used the 'bleeding stumps' tactic to deflect such requests. A three per cent cut in health would mean the closure of all cancer wards; in education, all primary schools; at the Home Office, all police stations – and so on. The new government should make it clear that it requires flab, not blood; that officials who cooperate will flourish: that those who try to protect waste will end up in the waste disposal.

This will require hard pounding. Hating the whole business, the public sector trade unions will take any chance to trip up the new government. David Cameron and his colleagues will need to find a way of retaining public support. Blairite spinning will, of course, be out – but what is an uncontaminated way of saying 'narrative?' The Tories also need some inexpensive but popular policies, to make it clear that not everything has to be blood, sweat, toil and tears.

Out of crisis, opportunity. If that becomes the master narrative of the 2010s, the Cameron government will triumph. Otherwise, God knows what chaos awaits us.