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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(You can read Part 1 here)
The Treasury seems to envisage a funding crisis akin to 1976 when the UK was forced to go to the IMF for a “rescue” loan. This is a fantasy scenario. The UK entered the Covid-19 crisis with a deficit of around 2% of GDP. The UK government debt ratio was just over 80%, lower than the equivalent level in the Euro area (84%), well below the USA (107%) and many individual EU countries (France 98%, Italy 135%) and positively tiny compared to the Japanese outlier of 238%.The average maturity of UK debt is also high by international standards – some 15 years compared to around 10 years in the EU and only 5.75 years in the USA. All of these countries have taken strong fiscal measures to counteract the crisis and all will see big increases on deficits and debt levels. There seems no reason why UK’s fiscal position and outlook should worsen relative to international norms – it is more likely to improve its standing.
The biggest negative for the UK’s international credit rating is large and sustained current account deficits – averaging 3.9% of GDP over the last ten years. One beneficial consequence of the crisis is likely to be a marked fall in the current account deficit. The crisis is causing a marked fall in world trade. Since the UK is a large net importer of goods, as a matter of simple maths an equivalent % fall in UK exports and imports would result in a lower deficit. The shutdown in international tourism will also cut the deficit as the UK normally spends more than it receives. The very large falls in oil and gas prices will also improve the trade account as the UK is a large net importer of oil and gas.
The UK is therefore unlikely to struggle to sell its bonds to international investors. Furthermore, the BoE will be a massive buyer of UK bonds while the crisis lasts. The new BoE Governor has also made it clear that he does not foresee the need for new austerity measures. From what we know of the new Chancellor he also seems likely to resist these policy proposals. He is however young and only five months in the job, so may find it difficult to overrule his advisers. The role of the PM is therefore crucial. Fortunately, everything we know about the PM tells us that renewed austerity in these circumstances will be complete anathema to him. Such measures not only go against all his instincts but would drive a coach and horses through the Conservative Party manifesto upon which he was decisively elected.
With the PM’s backing the Chancellor should tell his senior officials to scrap these ideas – though there is a strong case for changing the pension triple lock given the lockdown’s impact on inflation and wages – and instead work on finding supply side initiatives to boost the sustainable growth rate. The government already has an agenda which aims to boost productivity and growth – a large investment programme in transport, housing, and 5G broadband, promotion of science and research and of SME’s, the introduction of free ports – and these have become even more important. In selected areas the crisis has stimulated accelerated cooperation between the private and public sectors, and rapid and effective deregulation, with some spectacular results. These can provide templates for future policy. The Covid-19 crisis has also greatly accelerated some pre-existing trends – such as increased digitalisation, home working, online retailing – which may materially raise future productivity levels.
Rather than raising taxes the Chancellor should make tax reform a new centrepiece of the growth agenda. The UK has one of the longest tax codes in the world, a dense thicket of allowances, exemptions, deductions, loopholes, incomprehensible rules, and a myriad of small and counter-productive tax wheezes. In spite of occasional good intentions every Chancellor since the radical tax reformer Nigel Lawson has added significantly to the tax code mountain. I am no tax expert but the outlines of such a programme are clear. First, stipulate that the initial objective of the reforms is not a reduction in the tax burden but to make the tax system much simpler and more efficient. Second, eliminate or reduce the majority of deductions, allowances, exemptions, and minor taxes. Lastly, set the remaining tax rates at the lowest level possible while keeping the package revenue neutral.
A number of policy research bodies have published detailed tax reform programmes along these lines which can form an initial template. The problem has never been devising a tax reform package, but having the political will to implement it. Although the whole economy will benefit from a more efficient tax system, the gains are widely diffused but the losses are highly specific. Every change will be noisily opposed by highly organised lobbies. Many officials (especially in the Treasury) and politicians will oppose such reforms because it removes power from them (a major benefit of the reforms!).
It will never happen without the PM and Chancellor backing it to the hilt. However, the opportunity to do it is more promising than for many years. The government has a large majority. It has a strong mandate to oppose tax increases. The Covid-19 crisis has created a sense of urgency that is making the previously impossible seem doable. The Treasury itself has created large new programmes to assist the economy at a speed unthinkable a few months ago. And the prize is great, because tax reforms along these lines could markedly raise productivity and the sustainable growth rate. The additional deficits and debt caused by the Covid-19 recession could then be brought under control without tax rises or spending cuts. In the longer term tax cuts would become possible. How about it Chancellor?
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Robert Lee is the Former Chief Economist, Board of Executors (South Africa), Economic Consultant (UK), and private investor.