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Economics no image

Published on March 30th, 2012 | by Patrick Armshaw
Image © [caption id="attachment_9470" align="alignleft" width="240" caption="George Osborne's Budget under Attack"]HM Treasury, Some Rights Reserved[/caption] Last Wednesday, Chancellor of the Exchequer George Osborne unveiled the coalition’s new budget for 2012, and almost immediately the world came to an end.  Well, not literally, but the tabloids were certainly up in arms, with notable bastions of socialism the Daily Mail and the Telegraph decrying the so-called ‘Granny Tax’: a freeze on tax allowances for those over 65 expected to raise £3.5 billion by costing 4.4 million pensioners around £323 each.  In addition, the Value Added Tax (VAT) will be raised on pasties and pies, cigarettes and petrol – a move sure to ingratiate the coalition with voters who neither eat, smoke nor drive.  Further cuts have also been outlined to welfare, but those were expected as part of the mania for austerity currently weakening the British economy.  And for what will the government be using this new income?  The personal income allowance will be raised to £9,205, saving basic rate payers £170 per year and benefitting the upper 90% of Britons, and the top tax rate will be cut from 50% to 45% - saving millionaires over £40,000.  Despite the strong opposition coming from both left and right, Martin Wolf at the Financial Times argues that the budget will actually amount to very little in economic terms, aside from the flat-out absurdity of funnelling infrastructure investment through private firms at greater cost to the taxpayer than if we’d just build the blasted things ourselves.  So perhaps the best thing to do is ask whether the shift of resources from grannies and the poor to the ultra-wealthy is likely to have a good effect. The cost of the 5% rate cut is debateable: while Osborne claims that the shift will cost only £100 million, this figure is based on the questionable assumption that the wealthy, having successfully dodged the 50% rate for the last few years, will not do the same for the 45% rate.  If they do, the cost to the treasury will skyrocket, and it will be the middle and lower classes that will have to pick up the slack.  The independent Institute for Fiscal Studies notes that the effect of this change, which is meant to be offset by a stamp duty on house purchases, are uncertain, and that it might represent a far larger gift to the ultra-wealthy than planned.   The change represents a fiscal gamble every bit as big as the political gamble Osborne is playing – and if early indications are correct, it is a gamble that is not paying off for the coalition.  The political blowback from the rate cut appears to be quite large, raising the question of why Osborne would risk such a thing in an austerity budget – nothing could have been more calculated to obliterate the coalition’s credibility when it claims we’re all in this together. But from an economic standpoint, the redistribution from the bottom to the top is particularly odd.  When people have more money, from whatever source, there are only a few things they can do with it: they can squirrel it away under the mattress (unhelpful), spend it (stimulating demand), or invest it.  What makes spending or saving better comes down to whether or not there is already enough capital for investment in the economy: if there is too little, we should encourage saving to create more; if there is too much, we should encourage spending to generate demand.  So how can we know which would be better right now?  One easy way is to look at the interest rate, which is in effect the price of capital.  When there is too little capital, interest rates are bid up by businesses and individuals, just as the price of pasties goes up when there is a shortage; when there is too much, interest rates get bid down as investors try to do something with their money other than let it rot under the mattress.  Right now, interest rates are not simply low – they are at record lows, due to the massive shortfall in demand.  Few businesses are borrowing, since there is little prospect of profit with which to pay back loans.  So we should absolutely be encouraging spending, and not savings, from a macroeconomic standpoint. And that’s where one of the problems with this budget (and the whole drive for austerity more generally) come in.  It is a well-known fact that workers, pensioners and the poor are more likely to spend extra money than to save it – you can only really start saving once your basic needs are wants are already taken care of – while the wealthy are far more likely to save than spend.  The result is a loss of aggregate demand, as money that would have been spent is instead invested.  But since the interest rate is already effectively at zero and cannot fall any further (the liquidity trap strikes once again), this extra savings cannot spur economic growth.  If it could, then the various rounds of quantitative easing the Bank of England has been engaging in would have had way more of an effect.  Perhaps the low interest rates we see will convince the wealthy to spend more rather than less.  But in that case, the boost to the economy would be far greater coming from the lower half of society buying lots of food and consumer goods than from a few extra yachts and Bentleys for the wealthy.  Either way, whatever effect these shifts in taxation and benefits have are likely to be negative – the rich will get richer, the poor will get poorer, and the rest of us will remain stuck in a low-growth and high-unemployment wasteland.

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The 5% Solution

HM Treasury, Some Rights Reserved

George Osborne's Budget under Attack

Last Wednesday, Chancellor of the Exchequer George Osborne unveiled the coalition’s new budget for 2012, and almost immediately the world came to an end.  Well, not literally, but the tabloids were certainly up in arms, with notable bastions of socialism the Daily Mail and the Telegraph decrying the so-called ‘Granny Tax’: a freeze on tax allowances for those over 65 expected to raise £3.5 billion by costing 4.4 million pensioners around £323 each.  In addition, the Value Added Tax (VAT) will be raised on pasties and pies, cigarettes and petrol – a move sure to ingratiate the coalition with voters who neither eat, smoke nor drive.  Further cuts have also been outlined to welfare, but those were expected as part of the mania for austerity currently weakening the British economy.  And for what will the government be using this new income?  The personal income allowance will be raised to £9,205, saving basic rate payers £170 per year and benefitting the upper 90% of Britons, and the top tax rate will be cut from 50% to 45% – saving millionaires over £40,000.  Despite the strong opposition coming from both left and right, Martin Wolf at the Financial Times argues that the budget will actually amount to very little in economic terms, aside from the flat-out absurdity of funnelling infrastructure investment through private firms at greater cost to the taxpayer than if we’d just build the blasted things ourselves.  So perhaps the best thing to do is ask whether the shift of resources from grannies and the poor to the ultra-wealthy is likely to have a good effect.

The cost of the 5% rate cut is debateable: while Osborne claims that the shift will cost only £100 million, this figure is based on the questionable assumption that the wealthy, having successfully dodged the 50% rate for the last few years, will not do the same for the 45% rate.  If they do, the cost to the treasury will skyrocket, and it will be the middle and lower classes that will have to pick up the slack.  The independent Institute for Fiscal Studies notes that the effect of this change, which is meant to be offset by a stamp duty on house purchases, are uncertain, and that it might represent a far larger gift to the ultra-wealthy than planned.   The change represents a fiscal gamble every bit as big as the political gamble Osborne is playing – and if early indications are correct, it is a gamble that is not paying off for the coalition.  The political blowback from the rate cut appears to be quite large, raising the question of why Osborne would risk such a thing in an austerity budget – nothing could have been more calculated to obliterate the coalition’s credibility when it claims we’re all in this together.

But from an economic standpoint, the redistribution from the bottom to the top is particularly odd.  When people have more money, from whatever source, there are only a few things they can do with it: they can squirrel it away under the mattress (unhelpful), spend it (stimulating demand), or invest it.  What makes spending or saving better comes down to whether or not there is already enough capital for investment in the economy: if there is too little, we should encourage saving to create more; if there is too much, we should encourage spending to generate demand.  So how can we know which would be better right now?  One easy way is to look at the interest rate, which is in effect the price of capital.  When there is too little capital, interest rates are bid up by businesses and individuals, just as the price of pasties goes up when there is a shortage; when there is too much, interest rates get bid down as investors try to do something with their money other than let it rot under the mattress.  Right now, interest rates are not simply low – they are at record lows, due to the massive shortfall in demand.  Few businesses are borrowing, since there is little prospect of profit with which to pay back loans.  So we should absolutely be encouraging spending, and not savings, from a macroeconomic standpoint.

And that’s where one of the problems with this budget (and the whole drive for austerity more generally) come in.  It is a well-known fact that workers, pensioners and the poor are more likely to spend extra money than to save it – you can only really start saving once your basic needs are wants are already taken care of – while the wealthy are far more likely to save than spend.  The result is a loss of aggregate demand, as money that would have been spent is instead invested.  But since the interest rate is already effectively at zero and cannot fall any further (the liquidity trap strikes once again), this extra savings cannot spur economic growth.  If it could, then the various rounds of quantitative easing the Bank of England has been engaging in would have had way more of an effect.  Perhaps the low interest rates we see will convince the wealthy to spend more rather than less.  But in that case, the boost to the economy would be far greater coming from the lower half of society buying lots of food and consumer goods than from a few extra yachts and Bentleys for the wealthy.  Either way, whatever effect these shifts in taxation and benefits have are likely to be negative – the rich will get richer, the poor will get poorer, and the rest of us will remain stuck in a low-growth and high-unemployment wasteland.

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