Monday, 22 October 2012

Has the countdown for tax cuts started?

Recent debate on the economy has centred on the fiscal multiplier and the IMF's estimate that austerity may be sucking more out of GDP than is saved in public spending. This has understandably led to a rash of "told you so" comments by the anti-austerian camp, however they should be cautious about the implications. Showing that austerity is self-defeating does not automatically leave us with a better policy response. Larry Elliott in the Guardian summarises the current options: a government-led fiscal stimulus, along the lines of the Roosevelt New Deal in America during the 1930s; or continued loose monetary policy, guaranteeing low interest rates and pumping liquidity into the banking sector through such mechanisms as quantitative easing and the funding for lending scheme.

The Tory government is flatly opposed to direct intervention and public investment, even though this would be the quickest route to getting unemployed youth into work. There are cogent arguments to be made that the New Deal was ameliorative at best, and that the recovery from depression was mainly due to war, but amelioration would still be a good thing both economically and socially. The return on investment, both in terms of infrastructure and human capital, might take at least a decade, but there would be a return. Unfortunately, this is beyond the horizon for any party calculus, which is why it probably isn't going to happen. It would also require a major volte-face, by all those hitherto committed to the neoliberal orthodoxy, to challenge the entrenched power of corporations in creaming off public funds. When Virgin, a voracious brand that has enjoyed recent success in using the law to impose on government, decides to challenge Birmingham Council for having the temerity to invest in their own broadband network, you know that an effective New Deal would require nothing short of the criminalisation of much of modern corporate behaviour. In practice, our political representatives are collectively so ineffectual that we can't even get multinationals to pay a proper rate of tax.

Cheap money will remain the default option for now, even though almost everyone accepts this is already suffering the law of diminishing returns. The casting about for additional monetary policies is bringing some strange creatures of the deep to the surface, including calls for the abolition of fractional reserve banking (the ability of banks to create credit ex nihilo), while a return to the gold standard has once more crept in from the loony fringe. In this company, a straightforward debt jubilee looks like the acme of responsibility.

If monetary policy runs out steam, and the real economy does not perk up beyond the fillip provided by the Olympics, then Milton Friedman's "helicopter drop" may be considered, i.e. additional money could be created by the government and introduced to the economy via consumers rather than banks. This could mean tax cuts, though for political reasons (the run-up to the 2015 election) these would probably be targeted at median-income "strivers" rather than top-rate payers, helping the increasing number who rely on housing benefits to make up for low wages and offsetting the effects of increases in the costs of utilities, food and fuel.

Just as the multiplier in respect of spending cuts may be greater than 1, so the government may be able to argue that the multiplier in respect of tax cuts is greater than 1 as well (much as they argued that the reduction in the top rate of tax would produce greater tax receipts in aggregate). This is actually dubious in the case of a benefit for the rich, as they tend to either save the money or spend it on (often imported) luxury goods, but there is strong evidence that money in the hands of the poorest does quickly and overwhelmingly spread into the local economy. Of course, if political bias resulted in the bulk of the benefit going to the Tories' middle class constituency, through a cut in the basic rate of income tax, then the desire to pay down personal debt or save the money in the expectation of future mortgage interest rate rises might erode the multiplier. That's why I suspect that either a cut in VAT or another increase in the tax-free allowance are more likely, though this time the Tories would presumably wrest the political credit for it from the LibDems.

A victory for Romney in the US might even embolden Osborne, giving him some grounds to believe that faced with sluggish growth the electorate may be open to the idea of tax cuts, however much that may appear to flout his own insistence that reducing public debt is paramount. The circle can be squared if the "undeserving" are further isolated as the drag holding back both debt-reduction and growth. The recent ideological out-rider by the Tory Britannia Unchained group, claiming that Britons simply don't work hard enough and that we're in a zero-sum race with developing nations, may be a foretaste of what is to come.

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