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Bloody George's Budget: How bad is it really?

Maybe not the end of the world after all

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So what we've got is a rebalancing, from taxes which cause lots of damage to growth to taxes which cause less damage to growth. Which, when we're trying to grow our way out from underneath a mountain of debt seems like a pretty reasonable idea.

It should be said here that there's nothing exciting or odd about this idea: it's absolutely straight, middle of the road, economics of taxation. Which is why those Nordic social democracies like Denmark and Sweden follow much the same path: lower capital and corporate taxes than the UK, higher VAT than the UK. Free lunches are very rare in economics but this is one of them. By changing the structure of the tax system we can both raise the money we need and also have higher growth: perhaps not the most palatable of lunches but a free one all the same.

The final interesting snippet to me is that someone, somewhere, seems to have been doing some heavy thinking about what led to the financial collapse and what we might do about trying to stop it happening in future. No, it wasn't greed or stupidity: these are hardly new either to the human race or financial markets. Someone, at least, seems to have been reading quite the most perceptive book on the whole thing so far, Gary Gorton's Slapped by the Invisible Hand.

The basic contention is that banking systems which do not have deposit insurance are subject to runs. As we all know, when we put our money in the bank it does not sit there in the vaults: it is lent out to someone else. We might have access to our money any time we want: the bank cannot get the money back it has lent out on a 25 year mortgage any time it wants.

Nor can it force the business to flog the large machine the bank agreed to finance for five years. Indeed, this is the very thing we actually want banks to do, this is their purpose, to borrow short and lend long (and please, no comments about 100 per cent reserve banking: this prevents banks from doing just what we want them to do, arbitrage intertemporal desires for savings and investments). If you borrow short and lend long you're a bank: if you don't, you're not.

However - and here's the problem with the system - if all the depositors turn up at the same time and demand their money back, as they've every right to do, the bank cannot pay them all. It goes bust, not because it is insolvent (it will get those long term loans back eventually) but because it is illiquid. The solution to this is for the government to provide deposit insurance. This stops bank runs stone dead: before deposit insurance we used to have bank runs, after we had it we didn't.

At least, that was true until just a couple of years ago and the reason for that is the growth of what is called the “shadow banking system”. Banks began to finance themselves, not from their own depositors, but from the wholesale financial markets. Commercial paper, short term loans from other banks, overnight markets and the like. And these people didn't have deposit insurance.

So, if there was the sniff of a run these people would be yanking back their money quickly as electrons could move. Which is exactly what did happen in fact. This is exactly what was happening as Northern Rock, Bear Stearns, Lehman Brothers and so on were falling over. It was a wholesale, rather than a retail, bank run.

What has this to do with the budget? They have proposed a bank levy. A levy which would be a small charge, an insurance premium really, on all those liabilities (to a bank, this is the money that other people have deposited with them, equally, the money the bank has borrowed from other people) which are not already covered by other deposit insurance schemes. Exactly what Obama is proposing in the US in fact. We thus solve, at least as far as we can, our problem.

Banking systems which do not have deposit insurance are subject to runs. Therefore, if we have this new wholesale or shadow banking system, one which does not have deposit insurance, then it will be subject to runs. And if we'd rather not have runs on the banking system then we need to have a deposit insurance scheme.

And yes, emphatically, the banks should be paying a decent wedge, a proper sum, for this insurance policy. Which seems to be exactly what Osborne is proposing.

So, to sum up, this is a budget that has more real Keynesianism in it than Brown or Darling ever managed; we reduce income tax on the poor and thus make shallower the benefits trap; we get CGT to where it maximises revenue rather than pushing it up to punitive (and ineffective) rates out of spite; there's good sense on the tax mix (and Polly Toynbee should love that part as we'll be More Like Sweden!); and finally, something sensible about the financial markets, something which actually addresses the real underlying problem.

It may be a budget by a Tory named Gideon... but it's not all that bad really. ®

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