Thursday, March 31, 2011

The Big Society Credit Card

If you haven't yet read Duncan's False Economy piece about how Osborne's plan have a read, it really is very good. Here's a snippet:
Back in June last year, before Osborne’s policy changes, the OBR forecast (pdf) that public sector net debt (government debt) would be £1,294bn in 2013/14. After two budgets and a spending review they have revised that (pdf) to £1,251bn – a reduction of only £43bn.

Change in debt by 2013 under Osborne's plansHere we can clearly see the impact of Osborne’s changes over the next three years: public debt down by £43bn BUT private household debt up by £245bn – five times as much

So, we'll still be picking up debt it's just that instead of it being the government's debt, it'll all be our own private debt. I herby call dibs on the term Big Society Credit Card.

Tuesday, March 22, 2011

Problems and Solutions on the Deficit

Unless you've been living in a cave for the last few years you'll undoubtedly know that the country currently has a rather large deficit. What I'd like to do with this post is spell out the dangers and the arguments on how to deal with the situation. It's intended as a response to the gentlemanly @Parlez_me_nTory as to why us lefty economist* types don't want to see the deficit cut to rapidly.

The Dangers of the Deficit
The first danger is the obvious one, by taking on a greater stock of debt we are commiting ourselves to larger interest payments. This means tax money going on interest rather than schools and hospitals and such.

The second danger relates to the bond markets, for the government to borrow there need to be investors willing to put up the cash. These investors will only do so if they believe that government debt provides good value for money. Traditionally the strength of government debt has been that it is very safe, if lenders start to believe it isn't, they'll start by demanding a higher interest rate and in extreme circumstances they may outright refuse to lend.

Structural and Cyclical Deficits
A lot of discussion at the moment has centred around the ideas of structural and cyclical deficits.  To explain this we need to look at what traditionally happens in a recession, that is that tax revenues tend to drop at a far greater rate than the loss of output from a recession. GDP might drop by 2% but taxes are likely to drop by far more. Equally, when the economy recovers, taxes tend to rise quite quickly.

To show this, check out the change in spending versus the deficit in the 1990s where the deficit dropped despite increased spending.

The point of this is that it's often the case that an awful lot of the deficit will take care of itself, this is what we call the cyclical deficit. The other part of it is the structural deficit. This bit of the deficit is basically the bit that would sill be there once the economy was back up to speed. There's currently a considerable amount of debate about just how much of or current deficit is structural.

The National Debt and Growth
As a final bit of background, we also need to consider the role of the national debt in all this. In the past 63 years there have, the government has only run a surplus in 14 of them (6 Tory, 8 Labour). Despite this, the trend for the national debt (until recently) has very much been a downward one.

This is of course because this graph judges debt as a percentage of GDP. The reason we use this measure is that GDP can be seen as a reasonably decent approximation of our national income, it makes sense to judge our debts according to our ability to pay. The reason Labour politicians like to make the case for growth is that if we have a vibrant economy, the debts no longer matter as much.

The Case for Deficit Reduction
The case for deficit reuduction is simple enough, it's basically that we are buliding up a level of debt that will at some point become unsustainable and also that if we don't show a willingness to deal with the problem our creditors will no longer lend to us (because they don't think they'll get it back). At this point we face a situation where there simply won't be anY money to pay government employees.

The Case Against
The case against deficit reduction is based around the idea that a public sector worker is also a private sector customer who is spending their money with various private sector shops and businesses. This means that a reduction in public spending will have an impact on the revenues of private sector businesses.

We can generally assume that the private sector will slowly expand creating new jobs which will leed to a virtuous cycle of spending an growth. If cuts our made too rapidly, there is a risk of halting private sector growth which could lead us towards the dreaded double dip recession. It's further argued that even if we don't see a double dip, we will see slow growth meaning that although we may have less debt, that debt will be more of a burden on account of the poor growth.

*Just to be clear, I'd classify myself more as in interested amateur rather than a proper left economist.

Monday, March 21, 2011

On Merging Income Tax and NI

It appears that a good few Tory friendly papers and organisations are being briefed that George Osborne intends to eliminate Employees National Insurance and merge it with income tax. From an entirely practical point of view this strikes me as a good move, politically I think it's a masterstroke.

From a practical point of view there is no real reason why we need to have two separate income taxes operating with different sets of rules. There's no real difference between how the revenues from the different taxes are spent, it all goes into the same pool. What we ultimately get from all this is an easier to administrate taxation system, which is good for both the HMRC and employers more generally. A problem that would need to be worked out is that this kind of change could hurt pensioners who might end up with a higher tax bill (since they don't pay NI), but this would not be a hugely difficult thing to implement.

Politically though it's more interesting, because George Osborne has found Labour's achilles heel. In 13 years Labour steered well clear of income tax, the basic rate only ever went down, the higer rate wasn't changed. When Labour needed to raise the equivelant of a penny on income tax, it did it through raising NI, not income tax. The only time Labour ever increased income tax it went horribly wrong (the 10p tax scandal a few years back). It's an unfortunate truth that Labour is scared to death of being seen as a tax and spend party.

By merging income tax and national insurance Labour no longer have the easy option of raising national insurance, it has to commit to raising income tax. For a Labour party still scarred by it's election loss in 1992, this is a frightening prospect. That said though, from a personal point of view, I'm not quite so worried. If we really needed to pull the wool over the taxpayers eyes to implement our policies, we've already lost the argument. The Labour party will need to get better at making the case for higher taxation, but I don't necessarily see this as a bad thing.

On Arguments about Interest Rates

There's an argument that I've heard quite often recently that a major factor in the recent financial crisis was loose monetary policy and low interest rates. This argument is particularly popular among conservative lunatic fringe. Witness Allister Heath (Chair of TPA Tax Comission, daddy is a TPA director) here or Dan Hannan over here as an example of this kind of thinking, there's more in the form of Derek Scott at the Telegraph.

Thing is, I'm not sure that this is entirely resembles what actually happened. A quick comparison of recent and historical interest rates reveals that bank interest rates were not really well below any kind of historical average. Another key point to make is that around 2006/07 mortgages could easliy be obtained at well below the bank base rate.

To foist the blame onto the base rate ignores other important factors. We have for a long time had a financial system that has allowed money to flow freely across borders. This has meant that our banks are free to borrow on the international money markets.

This change has reduced the effectiveness of the bank base rate. While it's true that many mortgages do track the base rate so a rise will squeeze spending among those consumers with tracker mortgages. The effect on the supply of consumer credit will be reduced because banks can seek an alternative to borrowing from the Bank of England at the base rate.

The point I think it's worth making here is that you can't really put the blame on interest rates set by the Bank of England while ignoring the developments that occured in the financial markets.