Original URL: http://www.theregister.co.uk/2010/06/22/budget/
Bloody George's Budget: How bad is it really?
Maybe not the end of the world after all
Analysis Oooh, I do love a good budget. It's an opportunity to poke fun at all the nonsensical misunderstandings of economics that politicians are prey to. Even if someone proposes something sensible you can be sure that the opposition to it will be rooted in a misconception of reality. So, what does this budget have for us today? Anything actually useful or interesting to technical types?
Looking at the document itself, the first thing is that a company called Issuu (eh?) seems to have convinced the Treasury of their worth. Previous budgets have been, under l'ancien regime, huge great big .pdf files. This one seems to be altogether much cooler and easier to use. Not that that is really necessary in a Budget but it's good advertising no doubt for the company. They listed yet?
There will be endless pieces where you can see what the tax or spending changes will be: what I'll do here is have a look not so much at the numbers but at the economic logic behind what they're trying to do. And no, not just that Tories are baby eaters who want the poor to starve. There's actually some rather more interesting stuff in this.
The first thing of course is all this talk about the “structural deficit”. Yes, we've a yawning great black pit of debt mounting up as the government spends nearly 25 per cent more than it receives in taxation. No, almost none of this is as a result of bailing out the banks: although some of it is indeed to do with the recession which, to taste, you can say was caused by the banks or led to the banks being bailed out.
While it's rather difficult to estimate how much of this borrowing is part of a reasonable reaction to the recession (that's the “cyclical” part of the deficit) and which is structural the basic difference holds. We shouldn't have a structural deficit at all. Or, maybe, if you really want to, then you can have one of a little bit less than average long term growth: one or two per cent of GDP each year. More than that and the debt will rise faster than the size of the economy and eventually we're all owned by China.
The cyclical part is what Keynesianism is all about. Yes, when the economy's in the toilet having the government boost spending can be a good idea. But there's a lot of weight resting on that “cyclical” bit. When we're not in recession that deficit should go away: if there's any left then this is our structural deficit.
In a way, if you squint a little, you can actually say that Osborne here is being more Keynesian that Brown or Darling were. He's not trying to cut that cyclical deficit, that deficit that we arguably should have in a recession. He's trying to cut the structural one, the one we shouldn't have at all.
The reason we do have it is because Brown and Darling, at the very peak of the longest boom in the country's history, were still running budget deficits. They set up the spending system for when we had rivers of gold running through the Treasury... instead of doing what Keynes actually said we should do, which was at such times save a bit of it and pay back old debt; both to avoid a structural deficit in the first place and also to preserve some firepower for the recession which would inevitably turn up someday.
So it's not all that easy (not that this will stop the Guardian tomorrow) to attack this budget on Keynesian grounds. The deviation from Keynes is not in the current attempt to close the structural deficit, but in the previous failure to have a cyclical surplus in the good times.
On purely technical matters they've junked the tax on landlines to pay for universal broadband roll-out. They have said that there will be a universal standard of 2 Mbits and that in remote areas this will be funded by the money the BBC isn't swallowing in the Digital TV switchover. You all will know more than I do about what this will mean.
Child benefit is going to be frozen for several years: the money thus saved will be used to increase child tax benefit. This seems like a reasonable enough change, what money there is to spend on children should probably be spent upon those that really need it rather than Tobias and Jocasta's second pony groom.
The basic allowance for income tax, that £6,475 a year you can earn without paying income tax, will rise by £1,000 with the aim of getting it up to the Lib Dem idea of £10,000 a year (pfft, we at the Adam Smith Inst want it to be £12,000). The simple point being that there's very little point in saying that people are so poor they need tax credits, benefits, housing allowances and all the rest and then charging them income tax on the pittance they do earn. Getting the working poor out of the income tax net is a worthy and desirable goal: even if one that cannot be immediate. It also helps with, although does not solve, the tax and benefits trap.
This is the sad but true fact that for some people - people on very low incomes - working more to earn more simply doesn't work. For of each extra pound you earn through more hours or a pay rise (or, heaven forfend, getting a qualification and thus a better job) the taxman takes 20p in tax, then 11p in national insurance, then the benefits people take another 30, 50, possibly even 80p in reduced benefits (yes, there really are a few poor souls who can end up worse off after earning more). This is inevitable in a system where the tax and benefit systems overlap but the rise in the allowance will at least reduce this a bit.
Just before the election this desire to raise the personal allowance was attacked from the left (well, Left Foot Forward, a slavishly pro-Labour blog/campaign site) as being an inefficient use of scarce resources. If you raise the personal allowance then all benefit: even the rich get to pay less tax! This has been neatly solved by reducing the amount you can earn before paying higher rate tax: those who do pay higher rate will not benefit at all.
There are two sets of changes which will have all sorts of people shouting and screaming but both of which seem entirely sensible to me. Again, no, not because I'm some righty who loves torturing kittens, but because they make economic sense.
The first of these is the change to the Capital Gains Tax rate. With some allowances for entrepreneurs (the amount you can make before you have to pay goes up to £5 million in a lifetime) the rate will rise from 18 per cent to 28 per cent. There have been those insisting that it should go up to marginal income tax rates: 40 per cent, even 50 per cent.
However, and here's something that many find hard to swallow, there really is something called the Laffer Curve. There really are tax rates above which revenue collected falls, not rises. This rate will be different for each different tax in each different society and may well vary over time. But there's an interesting little HMRC chart here (pdf). (Boring technical guff: these numbers are not inflation adjusted and they are stepped a year. For CGT is payable a year after the gain is made, not when it is made.)
What that chart shows is that when Lawson raised the CGT rate to 40 per cent back in 1988 the amount collected in CGT then fell for the next decade and a half. In fact, adjusting for that inflation, the yield did not reach earlier levels until 2006: by which time the rate had been lowered again.
As Osborne said today - and he may or may not be correct on the exact rate - higher than 28 per cent CGT would actually mean losing revenue, not gaining it. Certainly 40 per cent lost it.
The second thing that will cause screaming is the joint lowering of the corporation tax rate and the raise in the VAT rate. The general consensus here, at least on the left side in this country, is that companies should pay lots and lots of tax while VAT is regressive and thus should be as low as possible. Well, yes, but this slightly fails the basic tests of a desirable taxation system. We do know that all and any taxes (yes, I'm sure there will be a land taxer among you - LVT does this the least which is why it is the most desirable of all taxes) create distortions. Distortions can reduce the future growth rate.
And we do indeed want to have as much growth as we can while still raising the money to pay for the things we want from government. That's as a simple, basic rule, quite apart from the fact that the more growth we have the more the debt shrinks as a percentage of the economy and thus the easier it is to deal with.
Not only do we know that all taxes cause distortions and thus reductions in growth, we know that different taxes have different effects. There's an OECD paper on that here (pdf, page 13 for the table). And what we know about these different effects is that consumption taxes, ie VAT and excise taxes on booze and baccy, have the least effect upon growth for the money they raise. Then income taxes in the middle and the two taxes which are worst for the negative effects they have on growth compared to the amount they raise are capital taxes and corporate profit taxes.
(This is quite distinct from the obvious truth that while companies can collect taxes they can't actually pay them. Corporate taxes are paid by some combination of the shareholders, customers and workers: in the UK at present the best guesstimate is that 70 per cent of corporation tax is paid by the workers in the form of lower wages.)
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. ®