Monday, November 17, 2008

Should tax cuts be the priority?

Wherever you look in the news - on TV or in the papers - the general consensus is that tax cuts are the priority for getting our economy back on track in the short term. The question for me is - should they be?

Forget all the talk about macroeconomics, Laffer curves and what have you - the economy of a nation is little different to that of a normal family. There are four basic elements to the economy.

1/ Savings - in the family case this is usually savings accounts, but for a government it amounts to the gold reserves.

2/ Income - this is what you earn. The income you receive from employment, interest on savings or dividends on investments. In the government's case it is the tax revenue it raises.

3/ Expenditure - this is what you spend. The combined costs of your regular payments - mortgage, household bills, credit card payments, etc - as well as your other irregular costs - food, clothing, a new washing machine etc. For the government it is the cost of maintaining the public sector (regular costs) plus the irregular costs of capital projects. On top of that is the cost of paying interest on the debt the government accumulates - much like our credit cards.

4/ Debt -this is what you owe. The total of your accumulated debt - mortgage, credit cards, HP purchases, car loans and so on. For a government it is the national debt.

Now, when times are hard we all know that there is a simple equation - you have to balance what you spend against what you earn. You can either increase your earnings or reduce your expenditure. Generally, what most of us try and do is reduce our expenditure as it is easier than increasing income. If we are successful at doing that, the next thing we do is use any money left over to reduce what we owe - as this reduces our expenditure further.

General tax cuts alone won't work. First of all, this would mean the government voluntarily reducing its income. Would you do that?

I know the argument is that with reduced tax people will spend more - so the government earns more through tax on consumption, but this is pie in the sky for the very reason I've pointed out. If people have more money in their pockets through a tax cut, they will not spend it on purchases but will use it to reduce debt. More Britons than ever have more debt than ever - tax cuts will not produce the fiscal stimulus required.

Worse still, a reduction in income will mean an increase in national borrowing and debt. This is essentially the same as us taking out another loan or a new credit card to enable us to maintain the same level of spending despite a reduction in our income. However, our spending would not stay the same - it would increase as we need to pay off that loan or credit card. Who would do that? Only the very very desperate.

I can see the case for targeted tax cuts - for lower income families and, most of all, for small to medium sized businesses - but a general tax cut will not work UNLESS the government first take steps to drastically reduce expenditure.

That should be the priority - reducing the public sector - because they are a net cost to government. Any tax lost from cutting public sector jobs will not negatively impact the government's revenue, because the wages for the public sector come from that revenue in the first place.

The only income the government actually has comes from the private sector. Tax revenue from the public sector is still a net cost because if the government is paying someone £400 a week and getting back £100 a week in tax that is still a net cost of £300. The loss in consumption tax is irrelevant because they are not spending on consumables at the moment anyway.

The priority has to be cutting public expenditure and that means public sector jobs. There is plenty of scope - what with five a day coordinators, smoking cessation officers, bin inspectors, street scene directors and so on. Even now, in my local paper, the bulk of jobs on offer are in the public sector and the Guardian still carries pages of public sector jobs.

The government need to do three things immediately. First, they should impose a complete freeze on public sector recruitment.

Secondly, they should instruct all local authorities that they have to reduce their employment levels by 20% while maintaining the essential services.

Finally, the government should lead the way by cutting 20% from the funding of quangos immediately.

Public sector costs have to be the priority right now - and then tax cuts. Yes, it will be tough on a lot of people, but they've had it too easy for too long and the chickens were always going to come home to roost eventually. All of this, however, requires tough government - and I am not convinced that this administration has the gumption. I'm even less convinced that a future Cameron Tory government would have the balls either.

Until we have a government that is prepared to make the tough choices then we are destined to remain in a long term slump. There will be brief periods of growth - largely faked - but on the whole living standards are set to go into an ever increasing spiral of decline until we have a government that is prepared to clamp down on expenditure.

This government is like a family in denial that has been living on credit cards for too long - switching from one to another, transferring balances and so on. But now all those credit cards are maxed out and there is a choice to be made. Get more credit cards - at even higher interest rates - or make the tough choices which are necessary if they are to ensure long term prosperity.

Now is not the time to take out more credit cards.

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