Written by Robert Lee
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This article was first published in Briefings for Britain and we republish it with their kind permission
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Internal UK Treasury plans to raise taxes to reduce Covid-19 related debt levels have recently received influential support. These proposals must be resisted. The country instead needs to reduce future debt burdens over time by raising productivity and the sustainable economic growth rate. Such ‘austerity’ tax increases, would achieve the opposite. The country needs radical tax reforms to boost the supply side of the economy, not counter-productive tax rises.
In early May a leaked Treasury paper showed that a series of tax increases and spending cuts was being contemplated in order to reduce the high deficits and debt levels consequent on the Covid-19 pandemic. In the paper the Treasury forecast a “base case” scenario in which the 2020/21 UK fiscal deficit rises to £337bn – from a forecast £55bn pre-crisis – and a “worst case” scenario where the deficit is £516bn. In the base case tax rises and spending cuts of £25-30bn are recommended, while in the worst case the package would “need” to be £80-90bn. On the menu of austerity choices were: an increase of 1p in the basic income tax rate (£5bn), an end to the pensions triple lock (£8bn), a two year public sector pay freeze (£6.5bn), and unspecified rises in VAT, national insurance and company tax. New taxes such as an income tax surcharge to fund the NHS or taxes on property and wealth were also contemplated.
The proposals received a lot of criticism and the PM and Chancellor seemed to signal that such measures would not receive their backing. However, in recent days a number of influential organisations and individuals – including the OBR (Office of Budget Responsibility), the IFS (Institute for Fiscal Studies), the Resolution Foundation, the Chairman of the Parliamentary Treasury Committee, and former Chancellor Norman Lamont – have either advocated or forecast significant tax increases. The Labour Party is pushing the introduction of wealth taxes. The Chancellor has now initiated a review of capital gains tax – could this be a precursor to raising revenue raising measures?
Where to start with this madness? In the first instance I retain my relative optimism about the UK’s recovery prospects. The Treasury also produces a “best case” scenario –in my view the most probable – which sees the economy recovering most of its lost ground within 12 months. In that case the 20/21 deficit is “only” £207bn, and even the hair-shirt Treasury sees no need for renewed austerity in this case. However, the Treasury’s base case scenario envisages the massive drops in GDP of the first half of 2020 are only followed by a weak and hesitant recovery. Business and consumer confidence would then remain very low. Swingeing tax rises and spending cuts in those circumstances could only have the effect of weakening the recovery or pushing us back into recession. The impact on the deficit and on future debt growth would then be entirely counter-productive. In the worst case scenario, in which the economy hardly recovers at all, much bigger tax increases and spending cuts are stipulated. This defies all common sense and economic logic, not to mention political reality.
The Treasury seems to have failed to notice that we live in a world of very low interest rates, one in which the dynamics of public debt have become very different. The most authoritative exponent of this more benign attitude to public debt is Oliver Blanchard, former IMF Chief Economist. He argues that in conditions where interest rates on government debt are lower than the nominal economic growth rate – as they are now – public sector debt expansion may have little or no fiscal cost, where fiscal cost is defined as the need to raise taxes in future because debt raised now cannot be rolled over. As a long time fiscal “hawk” I have been fully converted to this view (as set out in a previous July 2019 Briefings paper called “The Case for Fiscal Expansion post-Brexit”). Many fiscal conservatives have been similarly converted, but the memo has not been received in the Treasury’s mouldering Ivory Tower.
This is not to argue that there are no longer term dangers or threats arising from very large deficits and/or high and rising government debt to GDP ratios. However, these threats and dangers are not germane in current UK circumstances. The interest rate on ten year UK government bonds is currently a miniscule 0.12%, having fallen during the lockdown from an already incredibly low rate of 0.75%. Yields on UK bonds with maturities in the 1-7 year range have actually gone slightly negative. The nominal GDP growth rate will be very negative in Q2, but as UK broad money supply growth is rising sharply and the BoE is committed to a substantial bond buying programme the nominal GDP growth rate should return to trend in the medium to long term.
(To be continued with Part 2 in tomorrow’s issue)