“Fairer” taxes? But carry on spending!

Vince Cable, the Liberal Democrat spokesman on finance, says he wouldn’t increase total taxes to help deal with huge projected government deficits. Instead he wants “fairer” taxes – meaning the wealthier paying more and the poorer paying less. This is the cry of demagogues across the ages, as Aristotle pointed out two and a half thousand years ago.   

There is no limit to proposals for this sort of “fairness”. In any change in total taxes, either up or down, one can always argue that the rich should pay more and the poor less. The aim is often to hurt the rich, rather than to help the poor. Yet the experience of the past two hundred years shows that the poor can gain far more from economic growth than from redistribution.

Cable says he doesn’t want to put taxes up overall. That’s just as well, since total taxes now take nearly 50% of the national income, compared with under 10% at the start of the twentieth century. In fact, for a truly “liberal” economy, we need taxes to come down from their present very high levels. But to achieve that, government spending has to be cut even more.

Government spending currently amounts to about £700 billion a year, with a deficit of some £170 billion forecast for the current year. In order to clear the way for overall tax cuts, without increasing the national debt to unacceptable levels, government spending needs to be cut by at least £100 billion a year. So saving £1 billion here or £2 billion there is not going to make nearly enough difference.

Vince Cable is not alone in being remarkably reticent when it comes to discussing specifics of reducing government spending. Like leaders in other parties, he talks about “tough choices” ahead. But, ahead of a general election, they all seem reluctant to be explicit about what those choices are and which way they would choose. For them, as for St. Augustine, the watchword is “Not yet”. 

In the worst public finance crisis for generations, the government has the nerve to use the “difficulty of forecasting” as an excuse for delaying the scheduled triennial Public Spending Review. That’s rather like using stormy weather at sea as an excuse for not using the compass.

I remain amazed at Vince Cable’s reputation and the fact that his views are sought on the financial crisis. His book ‘The Storm’ reads like a Labour manifesto circa 1974. Perhaps it is because he has absolutely no prospect of putting his plans into operation and so they are never scrutinised sufficiently closely.More generally, we seem to be a situation where most politicians know that severe cuts to public spending will have to be made but no one wants to be the first to provide any details and so appear hard-hearted.

I think the Conservatives have also been pretty poor on this. They have talked a lot about greater efficiency in the public sector – an objective that will take years to achieve – when in reality drastic emergency cuts are needed to head off a debt spiral. There has also been little acknowledgement of the implications of large-scale quantitative easing for fiscal policy. Running an extremely high deficit while engaging in QE is a very risky strategy for the medium term.

In my opinion the two most important characteristics in financial management are honesty and competence. As an old teacher, trying to ‘mark’ politicians on both of these, I would find it hard to give them more than 3/10 in each case.

Please try to get some facts straight:Total taxes do NOT come NEAR 50% of the national income. Try visiting this link, which is the Budget report:http://www.hm-treasury.gov.uk/d/Budget2009/bud09_chapterc_463.pdfYou may find that current receipts are about £500bn, or about 35% of national GDP. This is well below the 40 year average. I write for a liberal economic think-tank, generally opposed to using public spending as a solution to everything. But given the scale of the deficits, some tax rises are needed. We have written about it – see below. I am amazed at the lack of honesty on this subject.http://www.centreforum.org/publications/a-balancing-act.html

Giles – It depends on how one measures national income. Many economists prefer to use factor-cost GDP. The government’s preferred market-price GDP measure overstates national output because it is reported gross of indirect taxes and subsidies. Using factor-cost GDP, I think taxes were about 43% of national income in the last financial year – much closer to the 50% mark. Higher taxes are economically undesirable but nevertheless very likely in the near future. Politicians may find it easier to raise taxes than cut spending, since the latter involves upsetting various powerful and concentrated special interests in education and the NHS etc.

Giles, the idea that you deal with excessive government spending – the key problem we will be facing over the next decade – by giving government more money is just plain absurd, and stretches the concept of ‘liberal economic’ beyond breaking point. What is liberal about taking money from innocent individuals to sort out the mess caused by somebody else?

Richard, thanks for clarification. But is it logical to use GDP at factor cost in this way? A great chunk of government spending is made of up transfers, that presumably are spent by individuals at market price, not factor cost. Even when it is the government consuming, market prices are surely the significant matter. All I can say is that I do not generally see that lower denominator used in discussions.Peter, your comment begs many questions in the debate. I too believe public spending is too high. But tax revenues have just dived from £600 to £500 billion. I am intrigued by the value-laden quality of “innocent”. You may have benefited more from government spending than you know.

Giles, you’re quite right that my comments leave certain questions begging, particularly the one of where does government get its money from? My use of the term ‘innocent’ was meant to denote those not party to decisions taken within government about spending in excess of income received. I like to think I have a reasonable idea of what government spending is used for having taught in a university department of public policy for over a decade, but I’m sure I can always learn more.

Here’s some heresy: Keynesian insights make a lot of sense when rates are zero. The government’s willingness to let the deficit rise, rather than cutting it through tax rises (Thatcher 1981) or spending cuts (Healey 76), prevented an economic recession of 4-5% GDP fall and 40% debt rise turning into a 8-12% GDP fall and 60-80% increase in debt. The likely endgame had we fiscal hawks in charge rather than Darling would have been far great asset price falls and eventually inflation to wipe away a truly impossible debt burden. Given the counterfactual, I believe that most people with an economic stake benefited, regardless of the day job. There’s more in the pdf, which Sam Brittan liked.

Giles – I am not convinced by this argument and we have yet to see evidence of a sustained recovery. The government’s ‘Keynesian’ policies are likely to lower growth in the long run by increasing the structural size of the state, crowding out private investment and undermining confidence in the UK’s economic future. They also interrupt the necessary market adjustment process by which boom-time malinvestments are liquidated.There is a danger the policies will produce a prolonged Japanese-style slump, or a double-dip recession (if interest rates must rise to sell huge volumes of gilts and/or choke off inflation). There is no such thing as a free lunch.

I always thought Laffer curves were the great free lunch . . .One myth about the increase in deficits is that they are all about a structural increase in the size of the state. The truth is more boring and complex. Brown planned rises in line with NGDP. Then NGDP collapses, but to follow it down would produce horrendous multiplier effects (imagine if Darling had stood up and announced £40bn in spending cuts in November). In cash terms the collapse is all about falling revenues. Believe me, I want this government – and the next – to get spending down to 40pc eventually, for the same reason as you. But there is room for some intelligent tax rises – such as on property or inheritance

I love the way that Keynesians and monetarists play the game of “how much worse it would have been” without their measures, backed by specific numbers on it. Their portal into that parallel universe works better than mine. I assume they do this for lack of material evidence in our universe.There is a simple explanation for Vince Cable’s popularity. He is good at diagnosis but not so good at prescription (the harder part). Most of what led up to the crisis was diagnosis, and he enjoys deserved credibility for his warnings. You could say that he is good at preventive medicine as well as diagnosis. But now that the patient is critical, I wouldn’t put him in charge of the operating theatre.

Question for Giles: are you counting debt repayments as part of that 40%? Debt repayments will shortly reach getting on for 4% of GDP, thanks to the Government’s Keynesian policies. To get spending including debt repayment down to 40%, you would have to cut spending on “services” by 18%, on the optimistic assumption that spending in real terms does not rise further from here, whilst increasing tax revenues by around 20%. If you mean 40% excluding debt repayments, you’ll “only” have to cut spending on “services” by around 14%, but you’ll have to find a way to increase tax revenue by around 30%. Good luck with that.

For purposes of comparison, 18% of spending on “services” is just under what we spend on health. 14% is just over what we spend on education. The usual whipping boys – waste, ID cards, NHS database, defence – can’t yield more than a small fraction of that, and some of them are one-offs. In my opinion, defence shouldn’t yield any.The figures in my previous post were to stand still. If you want not to be spending 4% of GDP repaying government debt ad infinitum, you would have to cut or tax more.At some point, the markets are going to notice that none of our parties has a clue how to get to a balanced budget. Then the cost of borrowing will go through the roof.

Giles, I’ve had a quick look at your paper and you do seem to make some interesting points with regards to raising taxes to balance the budget in a recession as was done in 1981. However, like Bruno I am most impressed by your ability to foresee the future with complete accuracy. I’d be really interested to read your papers from 5-6 years ago predicting the present economic situation with similar accuracy. Perhaps you could provide some links?

“Vince Cable is not alone in being remarkably reticent… Like leaders in other parties, he talks about “tough choices” ahead.”I think Dr Cable has been more forthright than most in this area. While he may believe that the overall level of taxation is correct, while Dr Myddleton and I may agree that spending is too high, Dr Cable has admitted that spending must come down to control the deficit. His statements at recent Reform events have been more realistic than those of either of the other parties.

Hi JohnIt is amazing how people think economics is about forecasting. If you meet an economist who bases his credentials on his ability to forecast the future perfectly, turn on your heels. And read the recent articles by Skidelsky et al explaining how it is a social science, and not about predicting the future direction of anything with certainty. The two critical expectations I have are that Nominal GDP growth ought to eventually resume at somewhere near 5%, and that nominal government interest rates ought to be at 4-5% or so, so long as the government maintains credible policies. It is quite possible for the govt to destroy either of these possibilities through bad policy.

Bruno – the figure is meant to include debt repayments. Before debt repayments (i.e. the primary surplus), it will be possible to achieve stable debt (i.e. a fixed or falling debt ratio) with a primary deficit of 2% or so. Still a long way out, and still much pain to go – no-one denies that. All I wanted to question here is the notion of public taxes being at 50% – if they were, we would not have a debt problem (you can’t have it both ways . .. .;-))

Giles, On the question of forecasting, you are trying to have your cake and eat it. It seems that mainstream economics is capable of forecasting (”prevented an economic recession of 4-5% GDP fall and 40% debt rise turning into a 8-12% GDP fall and 60-80% increase in debt”) when the forecast is unfalsifiable (what would have been), but not when the forecast is falsifiable (what will be). Lucas (in this week’s Economist) has similar crumbs all over his fingers. We have just been through another falsification of mainstream economics and substantiation of Austrian economics. Skidelsky’s article made some good points, but where were the Keynesians before the crash?

Giles, Am I right in thinking your calculation in your 11:13 message relies on 3% real GDP annual growth-rate for a 2% deficit to be sustainable? The UK historical, long-term, real GDP-growth trend-rate is around 2.5%, and estimates for the future range from 2.75% (the Government’s figure) to 2.2% (NIESR) or <2% (the Conservative Competitiveness Review Group). The Government’s figure defies post-war trends, and yet is still lower than the figure you need for a sustainable 2% deficit, unless I have misunderstood you.

I remain amazed at Vince Cable’s reputation and the fact that his views are sought on the financial crisis. His book ‘The Storm’ reads like a Labour manifesto circa 1974. Perhaps it is because he has absolutely no prospect of putting his plans into operation and so they are never scrutinised sufficiently closely.More generally, we seem to be a situation where most politicians know that severe cuts to public spending will have to be made but no one wants to be the first to provide any details and so appear hard-hearted.

I think the Conservatives have also been pretty poor on this. They have talked a lot about greater efficiency in the public sector – an objective that will take years to achieve – when in reality drastic emergency cuts are needed to head off a debt spiral. There has also been little acknowledgement of the implications of large-scale quantitative easing for fiscal policy. Running an extremely high deficit while engaging in QE is a very risky strategy for the medium term.

In my opinion the two most important characteristics in financial management are honesty and competence. As an old teacher, trying to ‘mark’ politicians on both of these, I would find it hard to give them more than 3/10 in each case.

Please try to get some facts straight:Total taxes do NOT come NEAR 50% of the national income. Try visiting this link, which is the Budget report:http://www.hm-treasury.gov.uk/d/Budget2009/bud09_chapterc_463.pdfYou may find that current receipts are about £500bn, or about 35% of national GDP. This is well below the 40 year average. I write for a liberal economic think-tank, generally opposed to using public spending as a solution to everything. But given the scale of the deficits, some tax rises are needed. We have written about it – see below. I am amazed at the lack of honesty on this subject.http://www.centreforum.org/publications/a-balancing-act.html

Giles – It depends on how one measures national income. Many economists prefer to use factor-cost GDP. The government’s preferred market-price GDP measure overstates national output because it is reported gross of indirect taxes and subsidies. Using factor-cost GDP, I think taxes were about 43% of national income in the last financial year – much closer to the 50% mark. Higher taxes are economically undesirable but nevertheless very likely in the near future. Politicians may find it easier to raise taxes than cut spending, since the latter involves upsetting various powerful and concentrated special interests in education and the NHS etc.

Giles, the idea that you deal with excessive government spending – the key problem we will be facing over the next decade – by giving government more money is just plain absurd, and stretches the concept of ‘liberal economic’ beyond breaking point. What is liberal about taking money from innocent individuals to sort out the mess caused by somebody else?

Richard, thanks for clarification. But is it logical to use GDP at factor cost in this way? A great chunk of government spending is made of up transfers, that presumably are spent by individuals at market price, not factor cost. Even when it is the government consuming, market prices are surely the significant matter. All I can say is that I do not generally see that lower denominator used in discussions.Peter, your comment begs many questions in the debate. I too believe public spending is too high. But tax revenues have just dived from £600 to £500 billion. I am intrigued by the value-laden quality of “innocent”. You may have benefited more from government spending than you know.

Giles, you’re quite right that my comments leave certain questions begging, particularly the one of where does government get its money from? My use of the term ‘innocent’ was meant to denote those not party to decisions taken within government about spending in excess of income received. I like to think I have a reasonable idea of what government spending is used for having taught in a university department of public policy for over a decade, but I’m sure I can always learn more.

Here’s some heresy: Keynesian insights make a lot of sense when rates are zero. The government’s willingness to let the deficit rise, rather than cutting it through tax rises (Thatcher 1981) or spending cuts (Healey 76), prevented an economic recession of 4-5% GDP fall and 40% debt rise turning into a 8-12% GDP fall and 60-80% increase in debt. The likely endgame had we fiscal hawks in charge rather than Darling would have been far great asset price falls and eventually inflation to wipe away a truly impossible debt burden. Given the counterfactual, I believe that most people with an economic stake benefited, regardless of the day job. There’s more in the pdf, which Sam Brittan liked.

Giles – I am not convinced by this argument and we have yet to see evidence of a sustained recovery. The government’s ‘Keynesian’ policies are likely to lower growth in the long run by increasing the structural size of the state, crowding out private investment and undermining confidence in the UK’s economic future. They also interrupt the necessary market adjustment process by which boom-time malinvestments are liquidated.There is a danger the policies will produce a prolonged Japanese-style slump, or a double-dip recession (if interest rates must rise to sell huge volumes of gilts and/or choke off inflation). There is no such thing as a free lunch.

I always thought Laffer curves were the great free lunch . . .One myth about the increase in deficits is that they are all about a structural increase in the size of the state. The truth is more boring and complex. Brown planned rises in line with NGDP. Then NGDP collapses, but to follow it down would produce horrendous multiplier effects (imagine if Darling had stood up and announced £40bn in spending cuts in November). In cash terms the collapse is all about falling revenues. Believe me, I want this government – and the next – to get spending down to 40pc eventually, for the same reason as you. But there is room for some intelligent tax rises – such as on property or inheritance

I love the way that Keynesians and monetarists play the game of “how much worse it would have been” without their measures, backed by specific numbers on it. Their portal into that parallel universe works better than mine. I assume they do this for lack of material evidence in our universe.There is a simple explanation for Vince Cable’s popularity. He is good at diagnosis but not so good at prescription (the harder part). Most of what led up to the crisis was diagnosis, and he enjoys deserved credibility for his warnings. You could say that he is good at preventive medicine as well as diagnosis. But now that the patient is critical, I wouldn’t put him in charge of the operating theatre.

Question for Giles: are you counting debt repayments as part of that 40%? Debt repayments will shortly reach getting on for 4% of GDP, thanks to the Government’s Keynesian policies. To get spending including debt repayment down to 40%, you would have to cut spending on “services” by 18%, on the optimistic assumption that spending in real terms does not rise further from here, whilst increasing tax revenues by around 20%. If you mean 40% excluding debt repayments, you’ll “only” have to cut spending on “services” by around 14%, but you’ll have to find a way to increase tax revenue by around 30%. Good luck with that.

For purposes of comparison, 18% of spending on “services” is just under what we spend on health. 14% is just over what we spend on education. The usual whipping boys – waste, ID cards, NHS database, defence – can’t yield more than a small fraction of that, and some of them are one-offs. In my opinion, defence shouldn’t yield any.The figures in my previous post were to stand still. If you want not to be spending 4% of GDP repaying government debt ad infinitum, you would have to cut or tax more.At some point, the markets are going to notice that none of our parties has a clue how to get to a balanced budget. Then the cost of borrowing will go through the roof.

Giles, I’ve had a quick look at your paper and you do seem to make some interesting points with regards to raising taxes to balance the budget in a recession as was done in 1981. However, like Bruno I am most impressed by your ability to foresee the future with complete accuracy. I’d be really interested to read your papers from 5-6 years ago predicting the present economic situation with similar accuracy. Perhaps you could provide some links?

“Vince Cable is not alone in being remarkably reticent… Like leaders in other parties, he talks about “tough choices” ahead.”I think Dr Cable has been more forthright than most in this area. While he may believe that the overall level of taxation is correct, while Dr Myddleton and I may agree that spending is too high, Dr Cable has admitted that spending must come down to control the deficit. His statements at recent Reform events have been more realistic than those of either of the other parties.

Hi JohnIt is amazing how people think economics is about forecasting. If you meet an economist who bases his credentials on his ability to forecast the future perfectly, turn on your heels. And read the recent articles by Skidelsky et al explaining how it is a social science, and not about predicting the future direction of anything with certainty. The two critical expectations I have are that Nominal GDP growth ought to eventually resume at somewhere near 5%, and that nominal government interest rates ought to be at 4-5% or so, so long as the government maintains credible policies. It is quite possible for the govt to destroy either of these possibilities through bad policy.

Bruno – the figure is meant to include debt repayments. Before debt repayments (i.e. the primary surplus), it will be possible to achieve stable debt (i.e. a fixed or falling debt ratio) with a primary deficit of 2% or so. Still a long way out, and still much pain to go – no-one denies that. All I wanted to question here is the notion of public taxes being at 50% – if they were, we would not have a debt problem (you can’t have it both ways . .. .;-))

Giles, On the question of forecasting, you are trying to have your cake and eat it. It seems that mainstream economics is capable of forecasting (”prevented an economic recession of 4-5% GDP fall and 40% debt rise turning into a 8-12% GDP fall and 60-80% increase in debt”) when the forecast is unfalsifiable (what would have been), but not when the forecast is falsifiable (what will be). Lucas (in this week’s Economist) has similar crumbs all over his fingers. We have just been through another falsification of mainstream economics and substantiation of Austrian economics. Skidelsky’s article made some good points, but where were the Keynesians before the crash?

Giles, Am I right in thinking your calculation in your 11:13 message relies on 3% real GDP annual growth-rate for a 2% deficit to be sustainable? The UK historical, long-term, real GDP-growth trend-rate is around 2.5%, and estimates for the future range from 2.75% (the Government’s figure) to 2.2% (NIESR) or <2% (the Conservative Competitiveness Review Group). The Government’s figure defies post-war trends, and yet is still lower than the figure you need for a sustainable 2% deficit, unless I have misunderstood you.

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