The Coalition must do Something Radical for the Economy. Anything.

The UK has officially re-entered recession for the first time since Autumn 2009. This has coincided with a collapse in the popularity of the Coalition government. Unsurprisingly. The 'double dip' of 2012 is far more important than merely being a problem for the government, or even temporary unwelcome news for the country though. It shows that the British economy is in far deeper long-term trouble than anyone could have thought even in the bad days of 2009. Hopes that the economy would just spring back from recession, the way it did in the 1930's, the 1980's and early 90's have vanished. Inflation has been higher, borrowing has been higher and growth lower than anyone predicted from 2008 to early 2011.

The Government's economic plan, known as Plan A, has failed. As far as most people are aware Plan A just means large spending cuts. But Plan A was never just cuts. Cuts would secure confidence in the government's control of the deficit and lower inflation, thus securing low interest rates and allow monetary stimulus to work, bringing money into the economy, allowing banks to rebuild their balance sheets and increase lending. Sharp devaluation in the currency and corporate tax cuts would tilt the economy in favour of exports and business investment, helping to drag the economy back to health. And increases in VAT and bank taxes would further encourage re-balancing away from financial services and consumption while also providing tax revenue to cut the deficit.

This plan has not worked though. Whether due to fear of cuts or the reality of higher inflation or fear of the eurozone crisis, business confidence collapsed. The eurozone crisis has made export led growth an impossibility. Rock bottom interest rates and massive quantitative easing have been tried for years but have not made enough difference. Increased capital requirements designed to make banking safer have led to lending contracting even in the face of QE and considerably high inflation has cut consumer spending much deeper than anyone expected. But that means things are even worse than we feared. We've tried running a massive deficit, and it hasn't been enough. We've tried printing hundreds of billions of pounds and it hasn't been enough. We've tried a huge devaluation of the currency and we've tried bailouts and we've tried subsidising lending, and we've tried raising taxes and we've tried cutting interest rates and none of it has worked. We've run out of buttons to press and levers to pull in an attempt to push the economy back to health and none of it has worked. The only possible conclusion is that the economy is in much worse fundamental health than after any previous recession.

Nor is there any simple Plan B alternative to austerity. The deficit is already sky-high leaving little room for further stimulus, and the deepening euro-crisis both sign-posts and increases the dangers of the markets losing confidence in the state's ability to pay its debts. The UK is a small, open economy with a floating exchange rate meaning any stimulus would just leak abroad, even before the danger of increasing interest rates. The facts don't support blaming austerity for poor economic performance anyway. The reality is that state spending has increased in both real and cash terms while the Coalition has been in power, adding to GDP in almost every quarter. The problem isn't the lack of growth in state spending, it is the fact that the wider economy has become unproductive. From 1999-2010 state spending grew 6% a year in real terms, and still overall growth fell from 3% to 2%, even ignoring the period actually in recession. A short-term fiscal stimulus can't solve these long-term problems even if we could afford it.

What that means is that the situation is not just going to get better on its own. With the failure of Plan A the government seems to have been reduced to just sitting there and hoping things turn out alright.  But this cannot work.  It was hoping that just managing the recovery would be enough to win the Coalition the next election.  But the recovery has failed, and this means that just managing the decline will lose the next election.  This cannot be stressed enough.  Unless the government does something dramatic, anything, then it is a dead certainty that Labour will win the next election with a decent majority and both the Lib Dems and the Conservatives will be devastated. However scary radical action may appear at this point, and however many people it annoys in the short term, is irrelevant for both Lib Dems and Conservatives because without it they are going to lose anyway.

They have to do something.  But fiscal stimulus and monetary stimulus have both been maxed out. There is no extra money to spend. The only thing the government can do is undertake radical reform to make the UK economy more efficient. To attempt to squeeze more bang out of each buck we do have. There are clear ways of doing this. Clear ways that the government can boost and liberalise the economy, show that it has not run out of ideas, and thus also support wider confidence. Each possible measure will annoy certain groups of people very vocally. But neither the Lib Dems or Conservatives have a choice, because without such radical reform they are definitely going to lose. With radical reform there is hope.  Even if these measures do not save the economy, they may save the government. The public are not unreasonable. A government can get re-elected with a weak economy, but only if the public can visibly see that the government has done everything to help that it could do. Governments lose when either they are blamed for causing it or they visibly have no ideas how to fight it.

If we wish to support a large welfare state with high taxes it becomes even more important, not less, to make sure the entire economy is functioning at peak, responsive efficiency. This is the major lesson to be learned from the Scandinavian countries, which are often held up as paragons of successful Socialism. These countries are not socialist countries in the way Britain was in the 1970's: ridden by restrictive practices, inefficient nationalised industries, powerful vested union interests etc. They are highly liberalised, solidly free-market economies just with high levels of taxation and public spending. On every measure of economic freedom they regularly score as well or better than the UK or the USA, apart from on measures of taxation and spending alone. Of course these measures are a drain on the economy, and that means that they can only be sustained, as they have been in Scandinavia, if the rest of the economy is operating at pitch efficiency.

Too often the argument about a growth plan oscillates between crude left wing demands for high public spending, without any regard for how efficiently that money is spent or raised, and crude right-wing demands for deregulation, without ever specifying what deregulation or how particularly this will benefit the economy.  In reality there are a wide range of possible radical measures that could help make the UK more responsive and more productive that come neither under the heading of slashing worker protection or just opening state money taps.The government has already previewed some of these ideas, but they have then gone quiet.  They seem have rejected them as too difficult to bother with.  But in our current situation nothing can be rejected out of hand without good reason. And now is the time to bring in reform, if there is any hope either that the country will see the benefit in the next 5 years or for the government to get re-elected. There are many such possible measures.  But they all involve various common themes, which I went into on my previous posts about pro-growth measures. Increasing investment, making government policy more responsive, reducing the distortions on incentives created by government action, ensuring stability etc.

On investment the government could engage in a below the surface stimulus. That would mean spending the same amount of money over-all, but shifting significant money from current to investment spending.  Basically that would mean cutting spending on government departments, programs and welfare and spending the money on infrastructure investment. Government estimates suggest that investment spending has 3x the benefit to growth of current spending. Britain's economy has suffered from chronic under-investment throughout the post-war era. Shifting £10 billion a year from current to investment spending could have a significant economic stimulus. Of course the downside is this requires deeper cuts in current spending.

The government could introduce immediate local differences in rates of public sector wages, the minimum wage and benefits, within some maximum variation of, say, 10%.  All these measures would face fierce opposition from those who lost out, but they would all make the UK Labour market more responsive and flexible to local conditions, which should produce a significant over-all gain. And much of the criticism could be muted by guaranteeing that no region will lose out monetarily over-all, either by ensuring money saved on wages or benefits remains within the region to be spent in other areas, or by deliberately increasing investment spending in those areas hit by a fall in wages.

Reform in the private sector could concentrate on boosting competition and ensuring markets function correctly. Those large banks under government ownership should be split up with the deliberate attempt to create more viable competitive retail banks.  It should be made an immediate legal requirement for current accounts to be fully transferable the way phone numbers currently are, to encourage consumers to switch bank. Legal measures should be introduced to remove all future possibility of bank bailouts, to allow failed banks to go broke like all other businesses. A FAT (financial activities tax) should be introduced for financial services, removing their VAT exemption and bringing their tax treatment into line with other businesses, and cutting the cost of financial services for businesses. Capital requirements should be temporarily reduced to encourage lending.

The manner in which we structure utilities should be broadly reviewed for value for money with the aim of boosting productivity.  This should cover both transport utilities, such as road and rail, and utilities such as gas, electric, water etc, as well as power generation.  All these utilities function as markets to the extent whereby competition is possible.  In gas and electricity competition is real, if limited, and legal efforts can be made to force greater transparency of tariffs and to make it easier for people to switch supplier. For rail there is competition from other transport options, but rail providers have local monopolies and the system of franchises has been claimed to cost the taxpayer and commuter vastly more than public ownership ever did. Options could include merging track and train ownership, mutualising network rail, cutting subsidies, increasing investment, fines for service disruption, or even wholesale re-nationalisation.  Road is the only one that is currently entirely publicly owned.  There should be consideration given to boosting investment through either privatisation or long-term leasing, or other options, and the introduction of road pricing on all motorways and major cities, with a corresponding cut in petrol duty, to take account of the cost of congestion. Speed limits on motorways could be raised to 80mph with a corresponding increase in the limit for HGV's. Water operates under a system of local monopoly with fixed prices.  There is claim and counter-claim as to whether this means improved, stable investment or just increased profits for monopoly providers. This should be reviewed with the aim of speeding up investment, renationalising bodies, or conversely, if possible, increasing the possibilities for competition along the lines of gas and electricity. Compulsory metering should be introduced. Etc.

Another area that could see wholesale reform is the structure of UK taxation.  Income tax and Employee NI should be merged immediately producing one single progressive tax on all income. CGT should also be merged with income tax in terms of rates and thresholds, with the exception of an annual rate of return allowance to avoid taxing purely nominal gains. This should also be applied to personal savings. This would massively simplify personal taxation, reduce distortions, cut admin costs and increase the transparency of how much tax everyone is paying. Housing and Land taxation could be massively overhauled removing stamp duty and establishing flat housing and land taxes for domestic and business property respectively, instead of the mess of regressive, our of date taxes and transaction taxes we have at the moment. VAT should be broadened to reduce distortions and reduce the economic impact of the tax system, as shown by OECD research. Corporation tax should be reformed to remove the tax incentive towards debt financing and incentivise investment in a clear manner.

If all these measures were introduced before the next election it would constitute a big bang in favour of growth and efficiency in our economy.  These measures may not begin to bear visible fruit by 2015 but it would certainly demonstrate that the government was doing everything in its power to reform Britain and improve our economy, while tackling fundamental inefficiencies and unfair distortions. And if not these measures, then others. The point is that there are options for radical action.  The only thing there isn't is politically cost-free options. But business as usual has fundamentally failed economically, and will therefore fail politically.  The government has the choice between doing nothing, and going down to defeat, or trying something, and possibly succeeding. This choice is the most important facing our government, dwarfing all others. The Coalition surprised observers by starting in 2010 with a burst of radicalism. Now in 2012 that radicalism has been worn down. The Coalition needs to find new radicalism, it needs a new landmark agreement to get it through the 2nd half of this parliament, for the good of the political parties and the whole nation. And given the failure of the economy then a radical growth package must be the heart of this new agreement.  If either party will not accept this then the government has no purpose anymore and a general election should occur. If it cannot agree on the radical action that we need, any radical action, then it has no point, and better to lose an election now and have it replaced by a government that may be willing to do something, than a zombie government that will coast through to 2015 before going down in defeat while Britain goes down the drain with it.

The UK Needs an Economic Growth Strategy . . . . so here it is! (2nd half)

This is a continuation of Part 1, found below. Basically, it's widely admitted that our economy is faltering and the government needs to do more to boost growth. I think it needs to do this, but in a manner that stays within the plans for cutting the deficit that is current government policy, the so-called Plan A. I've tried to cover every major area the government could act on to boost and secure long term growth in our economy, to give the (also so called) Plan A+. If there's anything I've missed or where you disagree with me, let me know.  What do you think?  


6) Radical Tax Reform.

Spending money efficiently is one side of the equation. Raising it efficiently is the other.  40% of UK GDP goes through the tax system every year. With £600 billion a year going through the tax system how efficiently this is done makes a difference of many billions of pounds a year. Because tax rates are so high their application to some economic areas but not others can have a powerful effect, distorting price structures and skewing economic activity on no particular rational or even deliberate basis. Almost all other public services in the UK have been thoroughly critiqued and over-hauled numerous times over the last 50 years.  Our tax system, on the other hand, has not. As it is not something that is tangible, and because it so directly involves money, which means with any change the losers shout a lot more loudly than the winners, there is a powerful incentive to not look at it too closely, and to not change it. This is the so-called tyranny of the status quo. This means our taxation system is a mix of what is practical with layers of historical accident and political expediency plastered on top.

This is not necessary though. IFS, the renowned think tank, has conducted a comprehensive assessment of the UK tax system, recently published as the Mirrless Review, looking at how the tax system could be designed to raise revenue with the minimum distortion to the economy while still retaining most of its traditional structure, and while achieving objectives of redistribution most efficiently. It outlines significant changes to Income Tax, VAT, Corporation Tax, Council Tax, Business Rates, Capital Taxes and the taxation of savings and financial services. These would remove numerous distortions thus saving the economy several billion pounds and raising billions more in additional revenue. They would also cohere remarkably with many of the other measures I have mentioned. Changes to Income Tax and NI would complement deregulation saving businesses hundreds of millions in costs; the over-haul of council tax and business rates would complement planning reform driving more efficient use of land and property; rationalisation of green taxation would cut the cost of Green Policy; a Financial Activities Tax would cut the cost of finance for businesses while making it more expensive for individuals to get into debt. In fact the possible effects of these changes are so considerable, especially with our current deficit crisis, that I mean to go over them in detail in a future article.        

7) Secure Radical Banking reform.

The ease of access to money makes a huge difference to the real economy and in a modern economy the circulatory system that disperses the supply of money is the banking system. The global recession was begun by a credit crunch that unsurprisingly most badly hit the heavily indebted developed economies. This disaster was compounded by the necessity of investing vast amounts of public money 'bailing-out' some of the major banks. To secure a reliable stream of finance for businesses, to ensure a healthy financial sector (a significant part of the economy), and to ensure that the disastrous bailouts are never repeated, radical banking reform is an essential pro-growth measure.

The government's program of banking reform has three branches.  The Bank Levy to raise extra tax from the financial sector, to disincentives the riskier forms of funding in  major institutions. The 'Merlin' agreement to go some way to reigning in bank bonuses and securing lending to the real economy, and the Vickers Report to reform the structure of the banking industry.  This report has recommended the 'Ring-fencing' of major banks, separating retail banking from investment banking. Retail banking is storing saving and lending money from and to individuals and businesses, what most of us think of as banking. Investment banking is the more high-octane, esoteric end of banking, investing in funds, shares, Derivatives, CDO's, currency and commodity speculation etc, often involving large amount of money being bet for very brief periods to secure very low margins of profit, but done over and over again making vast amounts of money very fast. Separating investment and retail banking will remove the risk of having to bail-out investment banking in order to secure the essential retail functions they are attached to. It would also incentivise major banks to shift emphasis onto retail banking and away from investment banking, due to the implicit government guarantee attached to retail and not investment banking and thus should increase the flow of funds to retail banking and thus reduce the cost to customers, i.e. the wider economy. It is essential these measures should be pushed through and implemented.  There is also a possible argument that more needs to be done to reform accountability and transparency in pay and bonuses in the wake of the decidedly mixed impact of 'Project Merlin', but I don't have anything particular to say about that.      

8) Secure Greater Investment: Including Green, Big Society and Regional Investment Banks.

One of the issues consistently raised as holding bank the economy is the difficulty small and growing businesses face gaining finance and investment, especially in developing industries and more deprived areas. Various proposals have been made to help rectify this problem by setting up various small, dedicated investment banks that would be commercial banks, initially funded by the state, that would be focused on leveraging funds to invest in certain industries or areas. The government has already committed to establishing a Green Investment Bank and a 'Big Society' Investment Bank.  The first would be focused on investing in green technologies, especially for power generation, and the second would focus on investing in social enterprises and socially responsible projects.

Various think tanks have suggested setting up regional investment banks to help fund private sector growth in particular regions. They would focus on financing sustainable growth in their particular region, with the suggestion that people in those regions would be more willing to place their savings with such a bank, knowing it went back into financing the economy in their own region. This would follow a similar model used with success in various European countries such as Germany. One question these ideas bring is how would these banks be initially financed? There has been considerable discussion among government about whether the Green and 'Big Society' Banks should be true Banks, able to borrow and lend and leverage their initial capital. There has been reluctance to let them do this for fear these debts would be added to general government debt. This seems a slightly odd objection though. When the bailouts occurred the government and ONS started quoting (for the first time) a figure for government debt specifically excluding financial interventions, and this figure has been used as the 'proper' national debt ever since. There's no obvious reason why such a distinction couldn't be made for these targeted investment banks, assuming they would pass into mostly private ownership as their success occurred.

Quantitative Easing has been suggested as a further, more radical solution for funding. The Bank of England has already run £200 billion of Quantitative Easing, basically printing money electronically. The BoE's previous scheme involved buying government bonds from various banks. There are question marks as to whether this actually worked though. Banks largely took the money to bolster their assets, rather than actually increasing lending, a phenomenon Keynes called 'pushing on string'. With the economy struggling so much again there have been calls for further QE. The problem with QE is that it also raises inflation, which is already high at 4.5%. One possible proposed solution is to engage in more limited QE but aim it more directly at the economy. A £50 billion QE program could be lent directly to businesses through a government investment agency, either a new fund or the government's existing network of regional development agencies, or more radically using it as original capital for the 'Big Society Bank', 'Green Bank' and a network of regional investment banks that could then leverage out that money to raise further finance. This would hopefully have a greater economic impact but because of the smaller over-all amount of money a considerably smaller impact on Inflation.          

9) Boost Government Investment +£5 bn
(Possible Business Investment +1£bn. Possible Science Investment +£1bn).

The measures so far outlined involve cutting costs to the economy, boosting the efficiency of public sector spending, boosting the supply of finance and lending to the economy and loosening monetary policy. All possible within the confines of the spending cuts and tax rises of the Coalition's Plan A, without any problem. Slightly more difficult policies that start to scrape up against the edges of that plan are also possible though. It is widely agreed by economists that government Investment is by far the most economically efficient from of government spending when it comes to boosting the wider economy, both in the short term and in improving the long term capacity for growth. In particular most of the loss of output in the recession came from a collapse in private Investment. If the government is going to undertake any financial stimulus at this point as the economy struggles then it makes a lot of sense to do it through boosting Investment.

The government's original spending plans contained some £17 billion of cuts to investment, about a 25% cut. This is somewhat understandable politically, as people don't tend to complain about possible future construction projects not happening, compared to schools and hospitals having their budgets cut. But economically it's silly. The government is already talking about straining every sinew in Whitehall to bring forward infrastructure projects to begin as soon as possible. But it's still rejecting boosting the spending available. This makes no sense. If there are identified projects that would boost the economy, in transport infrastructure, power generation, etc, then they should be begun now, especially if it makes the difference to the economy falling back into self-reinforcing recession. The government could increase investment by £5 billion each year to 2015, boosting the economy now and our capacity for growth in the years to the future.

Obviously pulling back on spending cuts threatens to break the confines of Plan A. But not directly. The government has two 'Plan A' fiscal targets that it has committed to meeting.  Firstly, balancing the structural, current budget; And secondly, debt falling as a percentage of GDP, both by 2015-16. The structural, current budget is the budget excluding 'cyclical' spending (the result of short term increases in unemployment caused by economic slump), and excluding investment. In other words the government can increase Investment spending without affecting this target. Obviously increasing investment spending risks missing the target for debt to be falling as % of GDP. But if the extra spending boosts growth and hence GDP, especially if the economy is teetering on the brink, then it may actually help hit that target both in year and through boosting the capacity for growth in each year to come.

There are other possibilities for boosting our core capacity for growth. Instead of, or in addition to, boosting state investment the government could take measures to boost private investment, such as increasing the generosity of tax credits offered for investment, in the hope this would encourage cautious firms to invest. Another suggestion has been boosting the Science budget, regarded as key to future innovation, development, research etc. Currently it has been protected in cash terms, meaning a roughly 10% real cut to 2015. It could be protected in real terms (a relative boost of £800 million) or increase it further (by say £1 billion). Both of these measures would possibly boost long-term growth, but they are more difficult because they are both current, rather than investment spending and hence risk both of the government's targets, unless they contribute a significant boost to GDP over the next 4 years.  

10) Rush Increase in Personal Allowance to £10,000.

If increasing Investment spending is not enough there are one final group of possibilities for boosting growth, and that is increasing government spending or cutting taxes. But obviously this goes straight against the confines of Plan A. But there are ways of minimising the danger of missing those essential government targets while supporting demand and confidence in the short-term. Research indicates that the most effective forms of stimulus are investment and tax cuts directed at poorer workers, as the poorer you are the higher proportion of your income you spend rather than saving and hence the more money actually spreads into the economy.

This offers an obvious solution to stimulate the economy in a manner that coheres with the Coalition's already stated aims. That is raising the Personal Allowance for income tax to £10,000. Now there is no space in the financial calculations, but the government could still push on with this extremely popular policy. They inherited an allowance at £6,500 and they've already increased it to £8,000, but they could announce in the Autumn financial review that immediately from 2012 the allowance will go up to the £10,000 target. They could also use the mechanism, used before, of reducing the 40% rate threshold by an equivalent amount so the top 15% (in income) don't benefit. This would give a £400 tax cut to millions of working households and cost about £9 billion. (Or if they don't think they can afford that raise the allowance by £1000 giving everyone a £200 tax cut and costing £4.5 billion.) I would also suggest at the 2012 budget following this cutting the top rate of tax from 50%->45% (assuming the forecasts for its revenue are accurate), in order to remove the possible damage caused by this uncompetitive rate of tax.

This would give a roughly £10 billion stimulus to UK consumption, which could give consumption the shot in the arm it needs to avoid collapse and, due to its crucial role to supporting the economy in general, the wider economy as well. The question is how this can be justified without breaking apart the essential constraints of Plan A. Firstly, the government currently has some leeway on this. Last estimates state that the government will hit its target a year early in 2014, and by 2015-2016 will overshoot it by 0.6% of GDP, about £8 billion. The government could formally abandon this aim to hit the target a year early, shift its aim to 2015, and spend that putative £8 billion overshoot now. It could also commit to making up the £10 billion committed now through the proceeds of the radical tax reform already outlined; immediately beginning the preparations needed to merge NI and Income Tax and bring in new House Value Taxes, A Business Land Tax, and Financial Activities Tax in 2014; to replace taxes currently on land, property and financial services, boosting revenue in time to hit the government's targets with new, economically efficient, rationally designed taxes, replacing the rubbish we currently have. Other moves could include looking again for cuts to such areas as generous benefits for the elderly that have so far escaped the axe.

All this would act essentially as not so much a genuine fiscal loosening but only a net shift of tax rises, from the start/middle of the Plan to nearer the end 2014 or so, when hopefully the economy will be in better shape to supply the tax revenue necessary, and doing so in manner that coincides precisely with the Coalition's already stated promises and objectives. These calculations also ignore any hoped for stimulus effect. If the economy is on the edge of decline these measures may be enough to hold it steady, and in that case the £10 billion (hopefully temporary) fiscal damage would do much less damage than a genuine second economic slowdown.  The government has made much of denying charges of economic dogmatism, claiming there is 'flexibility' in its plans.  Well, if that is true now is certainly the time to use it. Some government spokespersons have characterised this flexibility by saying the government would allow the natural stabilisers, rising welfare spending due to unemployment, falling taxes, etc, caused by a slowdown to occur.  But this is to have everything backwards. What point is there spending more money to slow the economy's descent once it has started falling? Surely it is better to spend the same money now to try to stop it from falling in the first place? (If we are currently convinced that we will have to spend the money one way or the other.)

11) One final thing: Co-ordinated International Action.

This last heading is so obvious that it almost doesn't need mentioning.  The major threat to our economy currently doesn't come from our own spending cuts but from the poor state of the world-wide economy.  A rising tide lifts all boats. A receding tide leaves everyone stuck in the mud on the bottom.  The largest cause of instability in the world economy today is the Eurozone debt crisis. Since the initial bold moves in May 2010 there has been no solution worthy of the name to come out of the Eurozone as the crisis deepens and deepens. Either Greece must be allowed to default, or it must be given the money it needs for as long as it needs it until it can restore growth. There is no 3rd option, and the failure to whole-hearted commit to one or the other, or indeed both, is what is doing the most part of the damage. Markets are forgiving of a good plan or a bad plan. What they scare at is prevarication, hesitation, being told things that everyone knows to be unsustainable nonsense, or the obvious sight of no coherent or credible plan at all. And bits of each of these is precisely what the EU has given them to the point where it is actually threatening the entire world economy.

So, firstly, the Eurozone nations need to get off their backsides and commit absolutely unequivocally to one of these solutions f they want to protect the Euro, or they must eject Greece as soon as possible. Secondly, the USA's politicians need to come down to planet earth, admit that the fear that the USA will be unable to repay its debts is the biggest threat to their recovery, whether that comes from future unsustainable spending, or madmen bringing their country to the edge of default in the here and now. Agree a serious long-term deficit reduction plan that includes both major tax rises and spending cuts and start to take a systematic look at the economic health of their country, rather than promising simplistic, magical solutions whether of one off stimulus bills or pointless tax cuts. To be honest in both cases politicians need to admit that it is their incompetence that has allowed things to get so bad, and that they need to massively shape up.

If that wasn't enough miracles to be hoping for at once: thirdly, Global leaders should agree a massive global, selective stimulus, re-balancing plan, whereby surplus, or low deficit, fiscally stable countries boost spending and their deficits and high-deficit, fiscally unsustainable countries cut theirs. Ideally by sufficient amounts to equal the reduction in demand in countries like the US, UK, Greece, Ireland, Portugal etc; or if this can't be achieved, by as much as possible. Now obviously the UK government does not get to decide whether these do or do not occur, so it is perhaps slightly unfair to file them under the heading of a growth plan.  But it can certainly throw its considerable international weight behind calling for them, and hence perhaps offer some of the global leadership that has been so sorely lacking recently.

Conclusion

With that I think that I have covered about every single major area of policy that the government could and should cover.  In fairness in many of these things are stuff the government is already trying or considering doing, but many are not. None of these things are particularly esoteric, but they will all annoy someone and involve fighting political battles, but the government cannot afford not to.  If the economy tanks again they will go down with it, and so will we all (to a degree). But follow through on all these areas and the government will put us in the best economic shape to face the 21st Century we can be in, for better or worse. But what do you think? Do you agree or disagree? And do you think there are any obvious areas I've missed?

Dealing with the Deficit (4) - Tax is always bloody taxing.

On Tax Avoidance, Robin Hood, Bashing the Bankers, VAT, cabbages and Kings (and why the sea is boiling hot and whether pigs have wings - well, not really.)

This article follows on from previous articles outlining the economic arguments around the Coalition's budget plans, introducing the structure of the public finances and the plans for reducing the deficit, and looking at the feasibility of closing the deficit by cutting military spending. It's followed by a final article on the distributional impact and fairness and (my) opinion of the government's plans.  I've separated them out to try to keep them shorter.

In dealing with our country's financial problems taxation is the obvious other element of the equation, along with spending and borrowing.  Even if we as a country manage to agree how much and how quickly we should reduce the deficit there is still the question of Tax; how big a contribution it should make to deficit reduction and what taxes should be raised.  The government does not currently get enough money in taxes, at previously agreed rates, to pay all its bills.  It must, hence, tax more, or spend less, or go on borrowing forever.  But no-one really thinks that last one is a viable option. In one form or another this is one of the eternal issues of politics, seeing as it relates to one of the most important things in human society: money.  It is one of the fundamental arguments of the Left and Right in politics.  Pretty much wherever you are, and whatever the precise figures and names involved, those on the right will be arguing that we should be taxed less and those on the left will be arguing we should be taxed more.  And this is one of those occasions, though the exact details are, as always, considerably more complicated.

The first question that must be answered is the extent to which a change in tax policy is required.  Most of the £155 billion deficit the UK currently has exists because tax revenues have collapsed due to the recession at the same time as spending on social services and welfare have dramatically risen due to the increase in unemployment.  Taxation is generally a skimming off the surface of economic activity.  It is the icing on top of the cake.  Things that are taxed strongly are things like profits, employment, income, capital gains, luxury spending, rather than the underlying substance of economic transactions and existing wealth.  Because of this when recession occurs and economic activity falls the decrease in tax revenue is proportionally much larger.

However, this in itself is not necessarily a good reason to increase tax rates, because after the recession economic activity will return to previous levels, and tax revenue accordingly. If this was all that happened then we could just borrow to make up the shortfall in the meantime until economic activity and tax revenues returned to normal and closed the gap. Unfortunately there is more to it than this. A deficit of this type, caused by a temporary fall in economic activity is the cyclical deficit, as it is caused the temporary affects of the economic cycle rather than any intrinsic mismatch between taxation levels and spending commitments. It is estimated that this accounts for around £50 billion of our deficit. The Other part of the deficit is the structural deficit, so called because it is down to the structural feature of our tax and spending system, rather than a transitory effect of the recession. This part of the deficit will not go away when the economy returns to normal. It must be dealt with either by raising tax rates permanently or by cutting spending. This is the serious part, and it is estimated that it is about £100 billion. But where has it come from?

Firstly, we were running a £30 billion deficit even before the recession. Secondly, the realisation that the boom in the housing and banking sectors was in fact an unsustainable bubble. Thus meaning the record tax revenues from these industries were also a bubble that will not be returning, lowering the estimate for the sustainable tax revenues under the current system.  This is about another £30 billion. The final element is the interest payments for all the debt we've built up due to the recession, which even if we eliminate the deficit we have already piled up and hence must pay interest on until we ever pay the debt off (unlikely), and which hence sucks up tax revenue we could otherwise use for services. This spending has increased from about £30 to £60 billion.  I have gone into this all in a bit more detail here. So that is the structural deficit. And it is what we cannot rely on a return to economic growth to remove. We have to cut spending commitments and projects and/or raise tax rates to get this hole filled in future. So what is the current role of Tax rises in the government's deficit reduction plan?

The government plans £110 billion of 'fiscal consolidation' over the next 5 years, of which £29 billion is tax rises and £81 billion is spending cuts.  That is a ratio of 24% tax rises to 76% spending cuts.

These figures are not in nominal money terms (actually figures spent), or in inflation adjusted real terms, but rather in real terms in comparison to current expectations if current policy is not changed.  In terms of the actual figures of pounds and pence the government plans to spend the plan is quite different.  Spending is forecast to rise by £70 billion from today.  Even in real terms this is equivalent to spending falling by only £25 billion, a fall of about 3.5%.  Tax revenue on the other hand is forecast (in nominal terms) to rise by £170 billion.  In other words the plan is to hold overall spending as roughly flat as possible, bringing it down slightly in real terms, while waiting for the economy to recover to bring tax revenues up until the point where they close the gap. This plan seems very different to the position in the popular media understanding, where 'savage cuts' are going to bring down the deficit.  The truth is though, that this plan does require hefty cuts, just to keep spending level, due to the constant upward pressure on government spending from changing demographics, the constant demand for more resources and rising interest payments.  Even under this plan many areas of spending will continue to naturally expand, thus necessitating the deep cut in programs and jobs to hold spending down sufficiently in some areas for it to naturally rise in others.

The Coalition is planning £29 billion of tax rises, which involves taking the £21 billion of tax rises Labour planned and adding £8 billion onto them.  Labour's plan basically involved whacking the rich with various schemes that massively reduced the generosity of pension rebates, removed personal allowances, and brought in a 50% tax rate; and pushing up NI, Labour's tax rise of choice, roughly from 11->12%.  NI is the 2nd largest tax in the UK and is very useful for raising money because it is paid by everyone and, in fact, paid twice for each person, by them and then again by their employer.  Hence raising NI brings in lots of money, and does it without raising the headline rates of income tax or VAT.  To this mix the Coalition kept all Labour's taxes on the rich, but removed part of the NI increase, while adding the increase in VAT (Britain's 3rd biggest Tax), a hike in Capital Gains Tax and a Bank Levy.  On the tax cut side they cut Corporation Tax, NI for businesses outside the South and raised the income tax threshold, giving a net increase of £8 billion on Labour's plans.