Does the Treasury really want a death spiral?

Does the Treasury really want a death spiral?

by Ewen Stewart
article from Friday 4, September, 2020

WELL PLACED LEAKS suggest HM Treasury is indeed looking at the ‘traditional response’ to try and plug a £350bn plus covid-19 induced hole in public finances by raising taxes. According to reports the Treasury is considering a range of tax rises ranging from increasing corporation tax and capital gains tax and an online delivery tax and reducing the tax benefits of pension savings amongst other revenue raising measures.  

Is the Treasury mad?  

If the Chancellor gives in to these demands he will kill the only hope of recovery and strong long term public services – private sector growth

A good place to start is some context. Britain’s public debt is out of control. The Treasury believes the problem is cyclical and covid-19 induced. Sadly while the pandemic has clearly exacerbated the problem and caused the current crisis the real issue is structural with the complete inability of politicians to resist wasteful spending, meddling, micro-managing and generally complicating problems.  

Consider this. Between the Napoleonic Wars and the Millennium year Britain’s accumulated debt was £375bn, or just 27 per cent GDP. Blair and Brown started to blow the budget and by the time they left office, in 2010, just 10 years later, debt had almost tripled to one trillion pounds and as a proportion of GDP grown to 69 per cent.  

Today, just another decade later and Government debt has just topped two trillion pounds at 100 per cent of GDP. Within five years I sadly predict the three billion threshold will have been breached. Government debt to GDP is heading to 150 per cent by 2025. 

Even discounting my forecast relative to the size of the economy debt has increased fourfold in just 20 years.  Never, outside warfare has such a sorry state of affairs taken place before. 

But it is worse than that. It took Osborne and Cameron a decade of alleged austerity, significant tax increases and major political upset to almost stabilise the finances after a GDP decline of just 6 per cent. The lockdown has resulted in a GDP decline of over 20 per cent this time and while some of that lost output is bouncing back much is lost forever.  

As a result of the Government’s exceptionally generous lockdown related support public spending will top one trillion pounds this year, almost 20 per cent higher than the previous year. To put one trillion pounds in context that is over half the entire current output of the UK economy. Thus while public spending continues to rise the productive element of the economy, which creates the wealth to pay the taxes is being crushed. 

Tax receipts even before covid-19 raised £738bn in 2019. This year it will be around £75bn less due to the impact of the lockdown. Income tax, the most significant revenue raiser for the Treasury raised £153bn last year. Thus the entire income tax take will be well less than half this year’s deficit. One does not need to understand the Laffer Curve effect to appreciate no amount of tax increases will plug that gap.  

The problem is exacerbated by covid-19 but even if complete normality resumes let’s not kid ourselves the UK is going to be borrowing at least £200bn for many years to come. This is because of the base line effect where underlying public spending is on a compounding escalator while tax receipts have missed a beat. The deficit is thus embedded. Moreover, if growth falters £200bn per annum will be a significant under-estimate. 

The truth is Britain, in common with much of the developed world, is living well beyond its means (in Scotland the position is even worse). This might be possible for a short period, and the Treasury seem to be assuming the covid-19 impact is short lived, but it ignores the structural scale of the deficit exacerbated by substantial Keynesian style infrastructure spend and generous pay rises to public sector workers whose performance over this crisis has, in my view, been mixed, at best.  

£200bn, of annual embedded deficit in the medium term, which is my very best case scenario, is over 10 per cent GDP. Tax as a proportion of GDP is already at the highest level since 1984 with the top 1 per cent of earners paying 28 per cent of all income tax and the top 50 per cent paying a staggering 90.8 per cent. Simply put this is not sustainable. 

All the push back, from all the major opposition parties is for more tax and more redistribution as if the current system already was not heavily redistributionary. The treasury, civil service, and public broadcaster seems to articulate the same ratchet.  

The truth is something is going to give. No amount of wealth taxes, redistribution, regulation or centralised direction has a hope of addressing a hole in the public finances of this scale. Any attempt to tax the nation’s way out of this will be totally counterproductive.  

Frankly while Covid-19 has exposed the delusionary promises of our politicians the stark truth is for at least thirty years now Britain has adopted the jam today strategy of promising plenty and forgetting it has to be earned. Politicians act as fairy godmothers, outbidding each other, but as they do so they undermine the very fabric of the economy (for the SNP this is clearly not a worry). 

We are where we are but the financial health of the nation hangs by a thread. For now Sterling’s value has held fairly firm as other countries also adopt novel and untested monetary measures to shore up unsustainable deficits. But if Britain is to have any future as a front rank wealthy nation we need an urgent plan to address this deficit. 

Increasing taxes by sufficient levels to control the public finances is out of the question. Even if income tax was doubled, which it clearly could not be without destroying the economy, the deficit would still be material.  

The Treasury’s proposals to raise £20-30bn are chicken feed given the scale of The Exchequer’s problem but highly significant to the individual or company. There is a genuine risk that the mobile will leave. The only chance is to grow the UK economy out of this terrible mess.  

If this Government is to stabilise the ship it needs a fourfold plan. He is our broad outline. 

First, it needs a far more coherent lockdown strategy based on trusting the people, informing them of evolving and best medical advice and allowing them to make their best-informed decisions. Some will stay at home for understandable reasons, others may choose to go out. Continuing a climate of fear and stop-start lockdown will simply risk the entire economic edifice of the nation and may well end up costing more lives. Put simply, Sweden GDP down 8.3 per cent, UK’s down 20.4 per cent, and Scotland with its ultra-lockdown even worse. Health outcomes in those areas have not been markedly different.  

Second, understand that selected tax cuts can actually grow the cake. In the round tax is at the highest level in two generations. Further increases will be counterproductive. Focus on selective simplifications. Abolish a plethora of new and novel tax from insurance and aggregates levies, airline passenger duty taxes. Simplify and reduce the great mobility tax, stamp duty to get people moving again. Promise the gradual direction of tax travel will be downwards. These measures will increase the cake and raise revenues in the medium term, also unleashing more private investment.  

Third, use the new post Brexit powers to make Britain the competitive hub of the world. Regulation is tying us in knots. The industry I work in, financial services, has seen an EU-inspired explosion of regulation. To be fair this explosion has often been cheered on by the UK’s own regulators. This regulatory flood has been the case in many spheres of life. Clearly there is a balance but the untrusting, centralised and expensive regulatory approach is creating an illiberal leviathan from which there is increasingly no escape. A serious plan of reversing regulation back to the levels of a generation ago must be the ambition. 

Lastly set out a plan for monetary normalisation. Regrettably, given the scale of the problem, quantitative easing (QE) is probably the least painful method of funding the deficit. There are toxic side effects notably asset price distortion, the undermining of prudent savers and the crowding out of the private sector as Governments are encouraged to spend yet more, apparently cost free. I estimate, even if semi-economic normality returns in early 2021 that Covid-19 will end up, by 2025 costing the Exchequer over one trillion pounds, or 50 per cent GDP. We should, therefore, agree a one-off QE jubilee up to £1tn by Act of Parliament to be drawn down over the next five years (it will happen by stealth anyway -£300bn has been done already) but with the critical quid pro quo that the central Bank is tasked with a gradual normalisation of the yield curve by 2025. The current approach by stealth is effectively designed to camouflage and offers no hope of normality any time soon. 

Covid-19 has been a global disaster at many levels. Let’s turn disaster into opportunity. To do that we have to grow our way out of this mess. Taxing till the pips squeak may appeal to the levellers but it would only be counter-productive and undermine the very people it was designed to help. Plus ca change. 

Ewen Stewart is a City Economist whose career has spanned over 30 years. His consultancy Walbrook Economics specialises in the interaction of macroeconomics, politics and capital markets and advises major pension funds, asset managers and hedge funds. He is Director of the think tank Global Britain and his work is widely published in economics and political journals.  

Photograph by Thomas from Adobe Stock


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