Monday, November 24, 2008

The Monday morning blog: tax cuts, tax rises and tax spin

New Labour is dead. Long live New Old Labour. Well not quite but we could be forgiven for thinking so. After all, this is a government that continues to spin like there's no tomorrow (and borrow like there's no tomorrow as well). And spin is what we are getting as the major feature of the Pre-Budget Report. We are, I saw from the BBC last night, to have an additional higher rate of income tax for the highest earners. It will not, however, come in until after the general election. The talk is of a 45p rate on incomes above £150K.

I guess the first thing I will do when I get to the office is to dust down all those Labour leaflets from the last general election predicting the end of the world, death, destruction, pestilence plague and a variety of other improbables were the Lib Dem policy of a 50p rate to be introduced. If I remember correctly, Labour claimed that the level of revenue from this tax would be far smaller than we claimed. It is relatively easy to avoid but, so Labour claimed, would drive business people abroad thus reducing the tax take. Now Labour are set to announce a slimmed down version which will raise very little relative to the enormous black hole in the government's finances. But it does mean that Labour will go to the country in 2010 claiming that the super rich will carry the extra burden of tax to pay for the recession. Watch out for Labour spending the extra revenue predicted from this new tax many times over. It will be a bit like their claims on the Lib Dems' 1p on income tax for education in 2001. They claimed it was "magical" because, so they claimed, we spent the same money many times over. (The claim was rubbish but it never stopped them from lying.)

And so we come to VAT. Labour are set to make a temporary reduction of two and a half percent. This will not do a great deal to help those nearest the breadline. For starters, bread, like some food, is zero rated. Gas and electricity pay VAT at the lowest allowable rate of 5%. That rate therefore will remain unchanged. Public transport ticket prices have gone up above inflation and are zero rated for VAT The people who have suffered the most from inflation over the past year are those on low and lowish incomes, and fixed incomes (typically pensioners). .A much larger proportion of their income is spent on VAT free or minimal VAT goods and services. A VAT cut will only help them at the margins. The big gainers will be the people buying large household goods. It looks like it will soon be time to buy that plasma screen tv you have always wanted. It's just a pity that it is likely to be imported but it is nice of the British government to be so supportive of foreign based manufacturers!

You also need to add into the equation the impact of interest rate cuts. Whilst it was right to cut interest rates to reduce the costs on business and mortgage holders, those, particularly the elderly, who have built up savings by careful financial management and a commendable desire to be self-supporting, are now faced with a sharp reduction in income. Whatever package of support is put together must take that into account. The pension credit and benefits system works against such people. That's why a significant increase in the basic pension is what is needed. Means testing works against those who try to support themselves. Means testing needs to be reduced.

So, the proposal Nick Clegg and Vince Cable have put forward to restructure permanently the tax system is also the most redistributive. But it is also the one that will help to get us out of the recession more quickly. Whether we like it or not, people are spending less because too many of them are fearful of the personal debt they have accumulated. They are desperate to pay it off and many won't start spending back at previous levels until their debt has at least been reduced to managable proportions. Even price cuts will not be sufficiently enticing to bring them back into the shops in significant numbers. They look at the state of the economy, worry about jobs, worry they may lose their home and therefore try to reduce the millstone of debt.

Once the debt level is reduced, they will start to spend. Putting money into the pockets of these people will lead to many of them reducing their debts earlier. And they then start spending again earlier. Like it or not, the people who have driven consumption to record levels have been those with the debts on the credit cards which were accumulated when they thought future prospects could easily pay off what they owe. We now need them at least with a lower debt burden for the economy to recover. Stopping the taxman from taking more of their income in the first place will he a significant help.

You only have to look back at the recession of the early 1990s. People then were worried about jobs and prospects but had built up considerable personal debts. The length of the recession was increased because people were paying off debts rather than spending. We are likely to be entering a similar period now. Getting the debts cleared as quickly as possible is now the key to getting us through the recession

Anyway, watch for lots of spin from Labour today as they project their favourite image of hyperactivity to tackle the recession. We have seen New Labour legislate by the bucket load on tackling crime (often with few results and often with the legislation repealed even before it is implemented.) New Old Labour will do the same on the economy whilst trying to portray the Tories as wanting to let the recession "take its course."

Well, it has taken me al the way from Newcastle to York on the train to write this post. Time for some shut eye (after writing my next post!)

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