Alternatives to Hunt/Sunak Strategy

This note roughly costs some policy alternatives to the Sunak/Hunt approach .  It supplements my previous post that examined the implications of the Chancellor’s autumn statement. That included some suggestions for an alternative strategy. This post tries to put some rough numbers on their potential impact, looking specifically at:-

  1. A closer relationship with the EU, broadly equivalent to re-joining the single market.
  2. A set of tax changes along the lines proposed by TaxJustice.UK.

Estimates of the impact of BREXIT on the UK economy vary widely though most economists acknowledge that it has been negative and significant. The OBR estimates that the UK economy by the end of the decade will be 4% smaller because of BREXIT. I have assumed that a decision to re-join the single market would boost GDP growth sufficiently to recover this, reaching a level of GDP in 2007-8 that is 4% above the level forecast by the OBR if the Sunak/Hunt proposals are implemented. The boost amounts to an average increase of 0.75% p.a. over the five-year period. The implicit assumption is that any costs of re-joining have been netted out from this figure. That is not unreasonable given the very high cost of additional administration to undertake roles that were not required when we were members.

With tax: GDP unchanged from the OBR forecast, the higher GDP growth from a decision to re-join the single market would on these assumptions raise Government revenue by amounts rising to £47 bn by the final year of the forecast (see Table).

TaxJustice.UK estimate that the UK could raise £37bn per annum from a range of tax measures primarily aimed at the better off, and particularly at wealth and at capital gains. These include introducing a wealth tax (raising £10 billion per year), taxing capital gains at the same rate as income tax (£14bn), applying national insurance to investment income (£8.6bn), reforming non-dom status (£3.2bn) and closing inheritance tax loopholes (£1.2bn). I have assumed that the additional taxes would be implemented in full by 2024-25, and revenue would then grow in line with nominal GDP. The TaxJustice.UK analysis usefully illustrates that increased revenue raising from those who could most easily bear the burden is feasible on broadly the scale proposed.

Revenue Impact of Re-Joining the Single Market and Implementing TaxJustice.UK Proposals

£ Billions, Cash

Financial Year ending2425262728
Re-join EU single market: Additional tax revenues from increased GDP growth4.7512.3622.9934.5746.96
Additional Revenue from Tax Justice proposals18.0037.0038.5540.4642.47
Total increase in Government revenues (£Bns)22.7549.3661.5475.0389.43
Equivalent to a % increase in Government spending of:1.9%4.2%5.1%6.1%7.0%

The additional revenues could be used to fund any combination of higher public spending, reduced taxes on the lower paid, or faster progress towards reducing the deficit and hence the cost of servicing it. The additional revenue builds up to be equivalent to 7% of the currently proposed level of public expenditure in 2027-28.

The analysis is very crude. It will doubtless be argued that the assumed growth boost is on the high side. On the other hand, the estimate does not take account of some other significant positive impacts. For example, higher growth will reduce pressure on the benefits system, releasing resources for other spending. The post also ignores the potential impact on the cost of Government borrowing. It could be plausibly argued that markets would be reassured by a commitment to policies that will raise economic growth and do away with the need for public expenditure cuts that are economically damaging and politically unrealistic. A 0.5% cut in borrowing costs would save an additional £14 bns per year but would still leave HMG borrowing costs above those of Germany and France.  

Though crude, the post illustrates that resources could be generated that would be sufficient to transform the miserable outlook currently facing those on middle and lower incomes. We could improve the safety net, shield them from increased taxation, and still have resources left to begin to address the need for higher public spending.

The Autumn Statement: clever politics but dreadful economics

Summary

This summary just states my main conclusions- the evidence to support each point follows below.

  1. The UK faces deeper economic problems than other developed countries.
  2. The blame rests squarely on major and predictable policy mistakes made by conservative Governments since 2010.
  3. Restoring market trust after the disastrous Truss premiership required the Chancellor to promise harsher measures than would otherwise have been required.
  4. He has tried to minimise the political cost by delaying painful measures until after 2024- gambling that the markets will be satisfied by promises that the next Government will have to deliver.
  5. The specific measures in the Autumn statement appear at first sight to be well targeted: increased spending on health and education, updating benefits and the minimum wage to protect the poor and vulnerable, while the identified tax measures focus on high income earners and substantial additional revenue from windfall taxes on profits. However, the impression is misleading.
  6. On the revenue side, the largest single contribution to growth in tax revenues over the next 5 years comes from the freezing of tax thresholds. These stealth taxes will require millions of low and middle income households who are already experiencing declining incomes to pay significantly more tax.
  7. The increases in public spending over the next two years are welcome but totally inadequate to deal with the cost pressures that have built up over 12 years of neglect.
  8. The biggest single risk is that cost and wage pressures will make the assumed public expenditure cuts that are envisaged to take place after the 2024 election impossible to achieve- perhaps less a risk than a near certainty.
  9. An alternative strategy is feasible. It would involve re- joining the single market ( the most obvious near-term way to increase economic growth), introducing a significant wealth tax and other measures to raise revenue from those best able to pay. This would finance a more realistic response to public expenditure cost pressures, help reduce the impact on living standards and still keep the debt burden to a manageable level, with the prospect of a falling debt:GDP level in the medium term.

UK Economy is in worse shape than other developed countries

Compared to other G7 countries, the UK suffered by far the steepest fall in output during the pandemic with GDP falling 11% in 2020. Some of this was recovered in 2021, but the Ukraine crisis has again found the UK the least able to cope:- we are in recession with output 0.4% down over the pst year, while the Eurozone has grown by 2.2% and the USA by 4.2% (House of Commons Library, International Comparisons, Key Economic Indicators, 11November 2022). The UK is the only G7 country that has not yet recovered to pre-pandemic output levels. The OBR forecast that living standards will fall by 7% in the current and following year, and will be no higher in 2024 than a decade earlier. Recovery after that remains painfully slow:living standards as measured by real disposable income per person are projected to remain below pre-pandemic levels until 2027-28 (OBR forecast).

The Conservatives are to Blame

The war in Ukraine can explain why the global economy has slowed, but not why UK performance relative to other developed countries has been so poor. This is not a new phenomenon. UK economic performance has stagnated since the 2008-9 financial crisis.

During the 1997-2007 period, UK productivity growth of 1.9 % per annum was second only to the USA within the G7. This was achieved while also investing more in health and education and reducing poverty. From 2009-2019, productivity growth fell to 0.9% p.a., below the G7 average with only Italy performing worse (Office of NationalStatistics, based on OECD data).. Our relative performance subsequently deteriorated further due to the grotesque waste and mismanagement during the pandemic. After growing faster than our competitors and closing the productivity gap during the Labour years, the conservatives have presided over a long period of relative decline.

Previous posts on this site have looked at the policy errors that contributed to our inadequate growth performance.

BREXIT has caused a significant increase in the cost and difficulty of trade, and is estimated to have permanently reduced GDP by 4% (OBR, October 2021).

The rot however started before BREXIT. Austerity and increased inequality have both damaged the economy and increased poverty, as set out in detail in the excellent report Stagnation Nation produced by the Resolution Foundation.. The poor state of our infrastructure and public services make us an unattractive location in which to invest. Because of the poor growth performance, austerity was not even able to restore the public finances, leaving us to face the pandemic with a small and debt burdened economy, collapsing public services and rising levels of poverty.

Is the pain really necessary?

Government debt approaching 100% of GDP is high though by no means unprecedented. The problem is the increase in interest rates. Higher interest rates account for two thirds of the £75bn deterioration in the projected FY 26-27 Government deficit if no further action is taken (OBR forecast). The other factors are the energy price shock and the inflation driven increase in welfare payments.

The Government needed to convince the markets that debt would not spiral out of control. They needed to be convinced that action would be taken to ensure that debt:GDP would peak within the next 5 years, and would then begin to come down.

The OBR forcast shows that, with no further action, Government would still be borrowing 3.7% of GDP in FY 27-28.. With real GDP growth of 2.2% and inflation on target at about 2%, the cash value of GDP would grow by more than 4%. This would be just sufficient to ensure that debt would begin to decline as a share of GDP, even if Government took no further action and was still borrowing 3.7% of GDP. The markets might well have reacted calmly to this scenario had it not been for the ludicrous policy turbulence of the last few months. A new Government with a reputation for honesty and competence might still be able to be convincing.

The Conservatives probably had to do more. The poor reputation our Government has for economic competence is reflected in the’moron premium’, the extra interest that HMG has to pay in order to borrow money. The increased cost of Government borrowing has come down slightly from the premium demanded when Liz Truss was in charge, but it remains significant, reflecting the perceived risk of lending to an unstable and unpredictable Government. The implicit interest rate on 10 year bonds issued by HMG is currently about 3.2%, having peaked at 4.5%. It is perhaps no surprise that stolid and dependable Germany only has to pay 2% on 10 year bonds, but France is able to borrow at 2.5%, still much more cheaply than the UK (rates checked 20 th November). This matters: according to the OBR, a1% increase in borrowing costs adds £25 bn to the annual deficit in FY27-28, equal to one third of the increased deficit that made the autumn statement necessary.

HMG are Delaying some of the pain

Measures in the Autumn statement actually increase public expenditure in the current and two subsequent years, with increases focused on health and education. Significant cuts in spending are envisaged from 2025-26, but these are not specified and will be for the next Government to decide and implement. They are planned to be very steep: holding current budgets to a 1% per annum increase, rather than the previously planned 3.4% while capital budgets are maintained in cash terms, implying a real terms cut in both.

On the revenue side, the big tax increases that are explicitly identified are targeted towards windfall taxes on energy companies, and higher taxes for high earners.

The most politically challenging of the explicitly identified measures is the change to the energy price guarantee in FY23-24, implying a £500 increase in average bills, but the £14 bn saving is offset by £12 bn of targeted support for the poor and vulnerable in cost of living payments to pensioners, the disabled and those on means tested benefits.

While disguising and shifting the blame for most of the pain

The autumn statement contains a detailed table setting out the impact of each of the policy measures in the statement. On the face of it, this appears to show very little impact on the tax that most people will pay. The decision to freeze the income tax and NI thresholds for two further years is shown as raising just £1.26 bn, and that in the final year. The reduction in the additional rate threshold is more significant in money terms, but is better targeted, hitting those on relatively high incomes. However, the table is entirely misleading.

The decision to freeze the tax thresholds was made when inflation was far lower. The acceleration in inflation has massively increased the yield of this stealth tax. Supplementary tables published with the OBR forecasts show that income tax is forcast to increase by £97 bn between FY21-22 and FY 28-9, accounting for 34% of the forcast increase in receipts over the period. Most of this is the result of higher incomes with unchanged thresholds dragging more people into paying tax and subjecting existing taxpayers to pay tax on a higher share of their incomes. In the period from FY20-21 to FY 28-9, the economy is expected to grow by about 12%, but income tax receipts will increase by over 20%, adjusted for inflation. These tax increases will fall on households who have experienced a prolonged period of falling incomes as wages have failed to keep pace with inflation.

The public expenditure increases to address pressure on education and health and social care are welcome, but fall far short of the amounts needed. Average pay awards of 5% across the public sector are not fully funded when budgets have been increasing by only 3%, and they involve a real terms cut when inflation is at 10%. The NHS confederation estimate that the NHS needs an additional £4bn just to make up for inflation in the current FY 22-23, before considering the cost of tackling the backlog of maintenance, the staff shortages, the waiting lists, and the social care underfunding. The £5-6 bn p.a. extra over the next two years will not address these problems. Similarly, school funding restores FY 20-21 per pupil funding, but it remains significantly below 2010 levels in real terms.

For local Government, the cap on rate increases has been raised to enable local authorities to finance higher expenditure. This may be astute politics, with brutal implications. Wealthier authorities with mostly conservative controlled councils will be able to raise more and improve services. Poorer local authorities will struggle to raise more revenue, and will face resentment for the state of public services, but the conservatives will hope to place the blame on the party that controls the council- which in most cases will not be themselves.

Risks

The biggest risk is that the envisaged public expenditure cuts from FY 24-25 will not happen. Indeed, that is a near certainty given the dilapidated state of our public sector after 12 years of austerity. The growth and inflation assumptions are also subject to wide margins of error. The OBR forecast is for average growth of about 2.5% per annum over the last three years to FY 27-28, in line with most other forecasts but more optimistic than the Bank of England.

Does it matter if events do not turn out as forecast? Probably not very much. The key point is that the statement commits HMG to targets to reduce the deficit below 3% of GDP and begin to reduce the debt: GDP ratio by FY 27-28. Forecasts are a polite fiction, setting out a plausible scenario for how this might be achieved. In present circumstances, I doubt that anyone is paying too much attention to them. The key point is for the Government to convince the markets that it will take necessary action to manage the public finances and meet the targets in the light of whatever circumstances it finds itself in.

What is the alternative?

An alternative strategy with less pain is feasible.

It would include a closer relationship with the EU, preferably including a commitment to rejoin the single market. When both major parties acknowledge the importance of restoring growth to the economy, it is bizarre that neither will support the one measure that would do most to achieve this quickly and at minimal cost.

Public expenditure plans will need to be increased in order to address the many legacies of past neglect. In a situation where dire poverty also afflicts so many households, the safety net which is currently one of the least generous in Europe needs to be enhanced.

Increased growth alone will not be sufficient to pay for this without spooking the markets. We will need increased taxation to come from somewhere. The obvious source if we are concerned to shield lower and middle income households is to implement a wealth tax. The wealthy largely escape tax by declaring low incomes, letting wealth accumulate, and financing their lifestyle by borrowing against their assets. Detailed proposals for raising large sums by taxing wealth have already been prepared setting out how a wealth tax might work (Wealth Tax Commission: A Wealth Tax for the UK, LSE 2020). There may also be scope for raising taxation of Bank profits that have been swollen by higher interest rates, and for saving money by cancelling some of the large scale mega projects and focusing instead on supporting local initiatives.

An increase in the tax GDP ratio in the UK would raise it to a level that would be high for the UK, but not out of line with successful European countries. The tax:GDP ratio is projected by the OBR to reach 37.1% in FY 27-28, which is high for us but compares with 45% in France and 39% in Germany according to OECD data for 2019. Loading more tax onto an economy in such a weak state would only be reasonable if it is targeted towards those best able to pay- hence the attraction of a wealth tax.

The positive attraction of this alternative is that faster growth and higher taxes paid by the wealthy should enable us to reduce debt and the interest burden sooner. The earlier we can implement higher taxes, the sooner we can begin to reduce the interest burden and create the scope for spending more on public services. We are currently in a doom loop, where slow growth and high interest payments swallow money that could be used to restore public services and reduce the high tax burden on struggling households. Reversing this can potentially create a virtuous circle with earlier action both reducing the debt and encouraging the markets to reduce the premium they charge on our borrowing.

Digging our way out of the mess we are in will not be easy. But for a credible Government, it need not be quite as difficult and painful as implementation of the Tory Autumn statement will prove to be.

BREXIT and our current economic problems

Before discussing future economic policies, it is important to recall when we last had a successful economy, and to understand how we arrived at our present chaotic mess. Data to support most of the points made can be found in Stagnation Nation, the excellent interim report published July 2022 by the Resolution Foundation.

The Labour Government that took power in 1997 is the only post war UK Government to achieve faster economic growth than the average of the developed economies. It achieved this while also sharing the benefits, with major reductions in poverty (especially child poverty) and big improvements in public services including access to education and the performance of the NHS.

The progress was interrupted by the financial crisis of 2007-8, but it was the years of unnecessary austerity that followed that did the most damage.

George Osborne argued that the deep cuts aimed at reducing the debt to GDP ratio were ‘repairing the roof while the sun shines.’ It turned out that nothing much was repaired during those years. Austerity in practice meant that problems were simply deferred, resulting in a mountain of costs for a future government:- neglected maintenance of schools and hospitals, failure to train enough doctors and nurses, local authorities starved of cash resulting in fewer and poorer quality services, collapse in the value of benefits resulting in increased poverty, and a mounting pressure for public sector wage increases after a decade of relative decline. The main effect of the policy was to slow economic growth- with the tragically ironic consequence that the pain and suffering that was inflicted did not even succeed in reducing the debt burden. Net public debt to GDP actually increased under the coalition government.

A key point is that the subsequent economic shocks of BREXIT, the pandemic, the Ukrainian war, and the calamitous policies of Liz Truss hit an already enfeebled economy suffering stagnant growth and rising poverty, with public services under visible distress.

In the current economic crisis, a partial reversal of the most damaging aspects of the extreme version of BREXIT is one of the few areas of economic policy where the UK can take back control ( I think I might have heard that phrase before somewhere).

We have little control over the war or it’s economic consequences. The period of economic lunacy under Truss was brief but resulted in an expensive loss of control over our economic policies. The measures that had to be brought in to try to restore market confidence are significantly harsher and more expensive than they need have been, reflected in higher borrowing costs than other major economies and a weak exchange rate. Replacing irresponsible tax cuts with Austerity 2 may calm the markets, but will do nothing to increase economic growth and will further exacerbate the already critical state of our public sector.

It is bizarre that both major political parties ignore the one economic strategy that offers the fairly certain prospect of boosting economic growth and improving the public finances, at minimal cost ( or possibly negative cost if we are able to save on the army of public employees doing jobs only necessary because of our divorce from the EU). I refer of course to improving our trading relationship with the EU. The strongest single conclusion from the literature on economic growth is that more open trade policies boost the growth rate.

It is beyond dispute that leaving the EU has made trade in both goods and services more expensive and more difficult, resulting in a precipitous 9% decline in trade openness from 2019 to 2021, far steeper than the 2% decline in France (Resolution Foundation, op cit). Cutting ourselves off from the EU has made trade more difficult in all markets, not just the EU, because we are no longer covered by the many EU trade deals with third countries.

The second strongest conclusion from the growth literature concerns the importance of investment in human capital through education, training and research. Here also we have severely damaged our prospects by cutting ourselves off from collaboration in research through the EU Horizon programme and making ourselves a more difficult and less attractive place to live, research, work and invest.

It might not be politically realistic to argue for re-joining the EU and overturning the referendum result. However, the case for far closer trading arrangements is overwhelming, and how far we can and should go deserves to be at the centre of our political discourse.


The dirty secret behind low UK productivity growth: Low Pay is the cause, not the result

This is a revised version- comments on the previous one made me realise that in trying to be brief I had instead just been confusing.

Productivity is usually measured as the value of the output produced by a worker in an hour. At national level, it is total GDP divided by the number of hours required to produce it. For a manufacturing economy this is conceptually easy to visualise (though not easy to measure). It conjures up comparisons between highly productive German workers with lots of shiny machinery producing more widgets per hour than British workers with older machines and fewer of them.

The problem is that we are now largely a service sector economy, where the concept of output per hour is harder to measure, the meaning of productivity is less clear, and the social benefits of alleged ‘productivity improvement’ can be ambiguous .

In the public sector, output is not sold and ( for international comparisons at least) we simply value the output according to how much it costs. If Government spends more but employ no more labour hours, then measured productivity increases. Of course output may have increased, perhaps as a result of spending on improving technology , but it could equally be the case that Government simply paid the cost of a wage increase and nothing changed at all, other than happier workers.

Productivity is also a tricky concept in the private sector and in the murky grey areas of public financing but private provision. If Government increases the minimum wage, for example, the outcome depends on whether firms are able to raise their prices. If they raise their prices by the full amount, then measured productivity will increase even if the same workers are delivering the same number of packages, or the same care workers are providing the same level of care to the same number of people. Higher prices raise the recorded value of output, and will be measured as a productivity improvement, even if the same workers are doing the same job in exactly the same way.

In practice the price increase is not the only change that will happen. There might be some fall in demand because of the price increase- which may mean some people losing their jobs because the enterprise they work for cuts costs or goes out of business. The loss of the least productive firms will raise the average productivity of the sector . There might be some increase in the actual output per hour as firms cut staff and remaining workers are made to take ever shorter breaks and given more challenging targets. Both the job cuts and the increased pressure to make those who stay work harder will be measured in the data as improvements in productivity, though neither is necessarily desirable. The firms that remain may be those that survive by cutting corners and over-working their staff. Reducing standards in care homes to avoid going bust is not what people usually think of when asked to describe productivity improvement.


The key point I want to make is that low productivity work exists because workers are willing to work for low pay in poor conditions. They are willing to do that because they have no alternative that offers them a better standard of living. The low productivity work at the lower end of the income scale will cease to exist if the state provides a reasonable safety net through a combination of benefit payments and/or the enforcement of minimum wages and conditions.

In the Labour years 1997-2007, the UK productivity growth measured by output per hour worked was second only to the USA among the leading economies of the G7. This was the period of increased minimum wages and improvements in the social safety net that dramatically reduced poverty. In the subsequent period of Tory Government, only Italy had slower productivity growth. This was the period of austerity when that safety net was allowed to collapse. The deterioration in relative productivity growth in the latter period is not an accident. It is a consequence.

The low level of unemployment in the UK is also a consequence of our inadequate safety net. As I have argued elsewhere in this blog, unemployment is a luxury good. Rich countries pay people to be idle because they are not willing to tolerate the levels of poverty that result if people are forced to subsist on the income from poorly paid jobs in harsh conditions.

Summarising, low productivity jobs are only profitable for employers if the cost of employing someone is lower than the value of what the worker produces. Stagnant productivity growth is a by-product of low wages, which are in turn made possible by the lack of a safety net that would have given workers a viable alternative.

If the Government is serious about driving higher economic growth based on improving productivity, then a good place to start is by improving the welfare safety net, raising the minimum wage, improving employment conditions . Average productivity will rise . Unemployment may also rise as workers are no longer forced into jobs at poverty wages.

Closing the option of making high profits by paying low wages to workers who have few choices does not necessarily result in firms deciding to invest instead in the technology of the future- though it probably makes it more likely. The growth agenda still needs support- as I argued in the previous post this is about supporting trade openness and improved education and training. However, improvement in productivity that is meaningful for the majority of the workforce also needs to encompass improvements to the safety net and to working conditions-the exact opposite course to the one the Tories are embarked on.

Why Tory Policies Will Not Raise Economic Growth – and the alternatives that would

Liz Truss hopes to raise economic growth through a combination of tax cuts and further deregulation.

The UK is already one of the most lightly regulated high income countries in the world, both in product and labour markets (Martin Wolf, Financial Times, 20 September).

Tax cuts can have a positive effect on economic growth, but probably not in the middle of a crisis where public services are collapsing and borrowing and debt are already at high levels. Moreover, the UK is not a high tax economy:- the corporate tax rate rise that the Government has decided not to implement would still have left our rate below that of most wealthy countries, while income tax and social security contributions as a share of wages are lower than every major high income economy apart from the USA (OECD, Taxing Wages, 2022). Taxation of the wealthy is arguably too low and not in need of further reduction. The rich can avoid taxation by borrowing to fund their spending, declaring low incomes while avoiding capital taxes by just letting the wealth pile up.

The specific measures so far outlined by the Government will not raise the growth rate. Ironically, the policies that would raise it have all moved in the wrong direction under this Government.

Numerous studies find that macro-economic instability, with high and unpredictable inflation, has a strong negative impact on growth. Wang et al in a cross country study find an impact of 0.5% per annum(NBER Working Paper 16390, September 2010). Any positive effect of the tax cuts has been more than offset by the negative impact on living standards of higher interest rates and a depreciating exchange rate. The Government have created precisely the conditions of uncertainty and chaos that drive investment away.

According to a 2014 IMF discussion note by Ostry et al, economic inequality also has a negative impact on economic growth. Despite the UK already being the most unequal major developed economy apart from the USA, Truss has introduced measures designed to raise inequality further. Far from making the poor better off through trickle down, this will have the double negative impact of both reducing the future size of the cake, and reducing the share going to those most in need.

The largest and arguably most studied pro growth policy is trade openness. Lower tariffs and easier transactions are found in the same cross country study by Wang et al to add about 0.65% per annum to the growth rate. In the UK, since BREXIT we have of course been going in the opposite direction, making all trade transactions both costlier and more difficult.

Another major driver of economic growth is investment in human capital- education and training. This is another area where we are going backwards. After 12 years of austerity schools were already in crisis, while exclusion from EU wide research programmes is damaging our higher education. A health sector in crisis not only has major impact on welfare, it also has negative impact on economic growth as Ill health reduces productivity. The fiscal consequences of the tax giveaway to the rich will make things very much worse. Government spending will be even more severely squeezed by the increased cost of servicing Government debt and the even higher inflation caused by the collapse of sterling.

There is a credible way out of this mess. Cancel the tax cuts. Focus support during the cost of living crisis on those who need it, and use windfall taxes to part fund it. There is a case for providing support where possible to incomes rather than fuel prices, allowing increased fuel prices to encourage investment in fuel efficiency and alternative sources.Government needs to get behind a major program of investment in energy efficiency including household insulation. More generally, Government needs to rebuild public services and the value of public sector wages.

In order to convince the markets that the Government is on a path towards fiscal sustainability, and can afford the spending that is needed, a realistic pro growth strategy is required . It needs a fully articulated fiscal framework that avoids taking reckless risks with macroeconomic stability . A significant part of the growth agenda should be a closer relationship with the EU, reversing the damage from extreme BREXIT.

Truss of course will do none of this. The longer she remains , the wider and deeper the suffering caused, and the more difficult the task facing the next Government.

Kamikaze Economics

Truss is crashing the economy, taking us with her. Only the Government and their rich mates have parachutes: they can make money in a crisis . Maybe Truss knows the 2024 election is lost, and is ensuring that Labour inherits such a mess that they appear to fail, enabling the Tories to return to power in 2029. The only other plausible hypothesis is that Truss and her colleagues really are as thick and ignorant as they appear.

Do tax cuts increase economic growth?

I didn’t want to clutter my post on PM Truss’s economics with detailed references but in case anyone is interested:-

A paper ‘Do corporate tax cuts boost economic growth?’ in the August 2022 European Economic Review by Sebastian Gechert and Philip Heinberger found no evidence that they did. Instead they found evidence of a publication bias, with positive results more likely to be published. The authors point out the complexity of the relationship and therefore the lack of surprise that it is difficult to find a straightforward causal relationship. In the UK context, my view is that it is very unlikely that cutting our rate will have anything but a negative impact: our corporate tax rate is not high compared to other countries, and cutting it in the midst of a full blown fiscal crisis is unlikely to boost investment or growth.

The evidence on personal tax is even clearer, as David Hope of LSE argues in a December 2020 paper: ‘Keeping tax low for the rich does not boost the economy.’

Trussconomics

Liz Truss says she wants to overturn Treasury orthodoxy on economics- but where on earth did she find anyone who thinks her alternative prescription makes sense?

We have high inflation- higher than other countries similarly affected by energy prices. Living standards are falling further and faster than at any time in living memory.

We have a high level of Government borrowing, adding to a public debt that is already at historically high levels relative to GDP.

We have a large balance of payments deficit, and declining exchange rate.

Financing these deficits has been relatively cheap but that is changing, with higher interest rates and a declining exchange rate both raising the cost of Government borrowing.

After 12 years of austerity there is a massive backlog of public expenditure costs that will have to be addressed. Almost every area of public spending is in crisis, before even considering the intense pressure to begin to restore the value of public sector pay.

All this follows a prolonged period of slow growth and declining real wages since the conservatives took over in 2010.

Her solution to this perfect storm of economic problems is to cut taxes and cut public spending.

In normal times, there is no reason to believe that this would increase economic growth. In a situation where the Government already faces high inflation and large fiscal and balance of payments deficits, it will have the opposite effect. Irresponsible economic management will drive investment down even further.

There is a narrow path out of the problems. It requires higher taxes on the better off ( preferably on wealth which largely escapes tax), support targeting those on low incomes, and a rebuilding of public services including local Government. It requires serious policies to rebuild economic growth- including a closer economic relationship with Europe. It doesn’t require the Government to throw more fuel on the fire through unnecessary tax cuts for those who don’t need them.

It beggars belief that she was employed as an economist.

The Cost-of-Living Crisis: How could Government help, and how could it pay for it?

How can Government help?

Rapidly rising prices are causing real hardship in the UK- especially for the poorest. Fully compensating everyone for the cut in their real living standards would cost £50bn and is neither feasible nor affordable. A more manageable goal would be to maintain the value of welfare payments by making timely adjustments to reflect increases in the cost of living. This would cost roughly £12bn. It would not only maintain the incomes of those wholly dependent on benefits, it would also support the incomes of many workers who have their income topped up by universal credit[1].

How can help be paid for?

Government can find the money to pay for more help to those in need by borrowing more, cutting spending in other areas of Government, or increasing taxes.

A fourth option is to raise economic growth – increasing the size of the cake available to be divided. Labour have rightly made the point that our difficulties are in part due to low economic growth, part of which is self-inflicted by conservative economic policies. Policies to raise economic growth will not provide a solution to how we finance emergency spending this year, but they are the key to how higher spending can be sustainably funded into the medium to long term.  An additional 1% of GDP would generate about £9bn per year in additional tax revenues, as well as reducing expenditure by taking more people out of the welfare bracket. A good place to start looking for a growth bonus would be by improving our economic relationship with Europe: the OBR report says explicitly that the impact of the hard BREXIT remains a significant brake on growth. Rejoining may be off the table, but there remains scope for short term benefits by moving closer to the single market.

Increased Borrowing: unwise at present?

Turning to the three options for financing extra spending in the short term, increased Government borrowing appears unwise at present. Debt interest on Government debt is forecast by the OBR to increase by £30bn in the current financial year, more than double the cost of inflation proofing all welfare payments, and has reached £83bn, equal to 7.6% of Government revenue. The OBR expect this to be a temporary blip, but that depends on the current inflationary episode being quickly controlled and any period of significantly higher interest rates being short lived. Both assumptions already look optimistic.

Spending in other areas needs to be increased -not cut

There is also no scope to finance increased welfare spending by cutting Government spending in other areas. After a decade of austerity, many areas of Government spending were already desperately underfunded before the COVID crisis. The most recent OBR report argues that an additional £5bn is required to make up for the impact of cost increases on other areas of public expenditure.

Taxes are high by UK standardsbut not compared to other countries

That leaves increased taxation as the only realistic option for financing increased spending to help households cope with rising prices. This is difficult for both major political parties. The Conservatives already face backbench grumbles at the increasing tax burden, and Labour remain anxious to avoid being labelled as the party of high taxes and spending. But is the hysteria of the tabloid press about high taxes justified?

Taxes are forecast by the OBR to reach 36% of GDP by F2026-27. This is high by UK historical standards, but not by international standards. The institute for fiscal studies, an organisation deeply opposed to irresponsible tax and spending policies, describes such a tax rate as ‘middling’ compared to other wealthy countries in the OECD and EU. The tax: GDP rate is mainly increasing because of sluggish GDP growth for the next few years, held back in large part by the self-inflicted wounds of BREXIT. An exceptional increase in taxes to help us get through a major international crisis would not be unreasonable, and the tax: GDP rate will fall back as economic growth recovers. An extra £17bn of tax financed spending would be equivalent to just 0.7% of GDP. It would still leave our tax: GDP ratio in the middling range, especially as other countries face similar fiscal pressures, and will also be likely to respond with similar measures.

How should extra tax be raised?

Labour has proposed funding additional support to households via a windfall tax on the profits of energy companies. This is a reasonable idea, but it would only raise £2bn – a fraction of what is needed.

Several major reviews have argued that the UK tax system gives excessively favourable treatment to taxation of business and of capital gains, relative to income from employment. The difficulty of taxing capital gains is perhaps the major anomaly. Capital gains tax raises less than £15bn per annum in the UK. The wealthy increasingly fund their expenditure by borrowing against the value of their assets. Borrowing is not income and therefore escapes income tax, while capital taxes are only incurred if assets are sold at a profit. This ability of the rich to avoid tax is both manifestly unfair, and economically inefficient.

Reforming the tax system along the lines recommended by the Mirlees[2] report should be a longer-term aim. However, to help meet the costs of the COVID pandemic[3], The Wealth Tax Commission developed detailed proposals for a one-off wealth tax on individuals that could quickly raise significant sums from those best able to pay. As just one example, the Commission estimate that a tax of 5% of wealth levied only on individuals with assets in excess of £10 million would raise £43bn. Because it is a one-off tax, it avoids many of the complications and potential tax avoidance that come from having to assess gains and losses each year. It seems well suited to dealing with a national emergency in a way that ensures that those best able to pay bear the biggest burden. An individual with assets of £10million would not face significant hardship in paying £50,000 especially if, as proposed, the payments are spread over 5 years.

Conclusion: Help those who need help, by modestly raising taxes on those who can afford to pay

 In conclusion, the Government could afford to finance full inflation proofing of welfare payments, plus other compensation schemes, by raising more tax, with the burden focused on those best able to pay.

One attractive idea would be to implement the proposal for a one-off wealth tax. This is not the only way of raising the relatively modest additional funds required, and the conclusion that spending more is feasible does not depend on the introduction of a wealth tax. The current Government of very wealthy individuals is unlikely to implement such a tax -but opposition parties might want to take note.


[1] Based on data in the Office for Budget Responsibility Economic and Fiscal Outlook, March 2022.

[2] Tax by Design, James Mirlees et al, Institute for Fiscal Studies, 2011; and other more recent studies by Stuart Adam, Helen Miller and others available at ifs.org.uk

[3] Wealth Tax Commission, A wealth tax for the UK: Frequently Asked Questions, Arun Advani, Emma Chamberlain and Andy Summers, LSE, 2020

Boris and the Civil Service

This post provides some facts to illuminate the discussion that the Tories have initiated on the size and efficiency of the civil service. All of the data used is from official Government statistics.

The number of non-industrial civil servants (the main target of Tory rhetoric) has been on a declining trend throughout the post war period. The Labour Governments of 1997-2010 started and ended with about 480,000 full time equivalent civil servants.

Under the conservatives, the full time equivalent civil service was cut by 20% to 384,000 between 2010 and 20016. The population per full time civil servant increased from 131 in 2010 to over 170 in 2016. This implies a massive increase in workload, because the main driver of much of the work that the civil service does is the size of the population they must deal with.

The subsequent increase in civil service numbers to 465,000 in 2021 was the direct result of BREXIT (well over 50,000 civil servants recruited to negotiate and then carry out functions previously performed by Brussels) and the pandemic. The increase reflects civil servants being recruited to do jobs that would have been entirely unnecessary in the absence of BREXIT and the pandemic. Further strains will since have been added by the cost of living crisis.

The civil service represents only 10% of employment in general Government. Looking more broadly,  the 1997-2010 Labour Governments expanded both local and central Government employment, with two thirds of the extra staff being employed in health and education. This restored the pre-Thatcher ratio of one public employee per 11 people. The conservative led Governments from 2010 then cut numbers back to a ratio of 1 per 13 people, lower than under Thatcher.

The big story however is the catastrophic cuts in local Government employment since 2010. Employment in central Government was broadly stable at about 2.8 million during the coalition, before growing rapidly in response to BREXIT and the pandemic. Local Government employment in contrast has fallen from 2.9 million in 2010 to just 2 million in 2021 – a loss of close to one in three of the workforce.  Some of this may be the result of changed responsibilities (e.g. the growth in academy schools). Nevertheless, the catastrophic scale of the cuts is just one indicator of the extent to which the conservatives have severely damaged the capacity of local Government. Many of the services on which the population depends are most efficiently planned and delivered locally, as pandemic experience has illustrated.

 In Conclusion: if anyone in the UK Government is lazy and useless, it is not the civil service. The Prime Minister could not be bothered to find out the facts before throwing baseless allegations at the increasingly hard-working civil servants on whom his Government depends. The drive to reduce numbers further will be yet another self-inflicted wound. Civil servants of worth and integrity are already leaving in droves to avoid having to work for this Government of incompetent liars prone to blaming anyone but themselves for their failures. A drive to reduce numbers will assist even more of the experienced and competent ones to leave.