More UK Budget Thoughts and the Inflation figures for February

My suggestions yesterday as to what I would do in the Budget have generated a bit of a debate on the comments section of this blog, thank you to those that commented. My view remains that the UK is on the edge of a precipice and needs to announce  substantial measures going forward to make sure that events do not get out of hand. This is why I would have a rise in Value Added Tax to 20% from 2011/12 as well as looking for substantial public spending efficiencies and reductions. Over the past 2/3 years our existing government has announced all sort of efficiency measures but appears to implemented none of them, for example public sector employment was supposed to have been cut back but I suspect I was not alone in noticing in last weeks unemployment figures that public-sector employment had instead risen by 7000 since September 2009. An intriguing defence of this was that public sector employment had been affected by taking some banks into its figures, which is a strange defence as of course they have been cutting jobs, so in fact the underlying position is probably worse.

It is because we as a nation lack credibility in reducing public spending and also because we face a very difficult task where our “structural deficit” as estimated by the International Monetary Fund is virtually 10% of Gross Domestic Product that I feel a tax rise is required too. Raising VAT is not a perfect choice but all types of tax raising are flawed and I feel that this is the best choice. We also need to consider when we make changes at the moment what the rest of the world thinks of us and a rise in VAT would be understood. Please look at my section on Greece for a description of how interest rate costs on new and maturing government debt can start to get out of hand. This is a reason why my initial move on the “poverty trap” is not to look to end it immediately as I feel that we cannot afford to (sadly). I understand that this is a difficult concept to get across but having worked for many years in government bond markets I understand that if they lose faith in you it is often not a gradual fall but for ages it feels like nothing is happening and then the tipping point occurs and it is too late, again I quote Greece as an example of this.

New Suggestions

Trident

Having started on what can be done to reduce spending I have another suggestion. Scrap any replacement for Trident. I do follow analysis of our defences and plan to write on this subject but for now I can see a saving of the order of £20 billion over time with few implications. You see we have both cruise missiles on our non-Trident submarines and the Storm Shadow missile for the Royal Air Force. There is no reason why we could not put nuclear warheads on them (and may already have done so) and it would appear that cruise missiles have proved very effective when used and crucially if you buy a decent amount of them you can buy them for around £200,000 each. As we already are buying Eurofighters and the RAF is both buying more than it needs and is planning to use some of them for bombing attacks then for once we can make some efficiencies in defence spending! We may even have spare nuclear warheads for them.

The National Health Service (NHS)

There is a sacred cow in the UK that it is virtually a treasonable event to criticise or to suggest in any way that it could be improved and it is the NHS. Both the main political parties have “ring-fenced” NHS spending.This makes me think that hidden behind such an attitude is probably quite a lot of inefficient practices and may well therefore be the area where paradoxically most savings could be made. I would wish to maintain services as an my objective but increase efficiency and reduce costs. On this I have two initial thoughts.

There has been an increase in the managerial class in the NHS both in numbers and salary paid to them. At times I have met some and have been left with the feeling that those I have met are paid more than the going rate for their skills and this is before one factors in the high cost of their index-linked pensions. So I would cut salaries and numbers here.

Another more difficult area is that of General Practitioners or GPs. This is more difficult because in general these people are viewed much more favourably. But the truth is that the reforms in this area were based on targets and these targets were incompetently set (if I remember correctly Patricia Hewitt was involved at the time and at the moment she is in the news for other foolishness). So we now vastly overpay many GPs and this is exacerbated by the fact that they retire on career average pensions (which are revalued at 1.5% over the Retail Price Index for each passing year) and then are index-linked against inflation in payment. So we will be paying extra in future too when these GPs come to collect their pensions which as time goes by will be increasingly based on higher earnings levels. You see being incompetent they did not realise that if you set targets for motivated people they will set out to achieve them.

Having had faith in GPs myself I have to confess that I am starting to hear of incidents where rather than improving the service is deteriorating. The out of hours service has been weakened and criticised and indeed worked poorly for a member of my family recently, where mistakes were combined with arrogance. We have managed to pay more for less. Accordingly I feel that it is possible to reduce costs and improve service whilst still paying GPs a salary commenserate with their skill set.

With these two efforts and my suggestions from yesterday I believe that we have the basis of a credible plan. The better things go the more ammunition I will have for my attack on the “poverty trap” which so blights our tax and benefits system.

Inflation

Today’s inflation figures showed an interesting picture. I am sure many will concentrate on the fall in the Consumer Price Index to 3% in February and it may escape them to point out it is still 1% over target. They may miss the fact that the Retail Price Index for all items remains at 3.7%. Our previous measure which was used to target inflation was Retail Price Index excluding mortgage interest payment which is at 4.2% and fell by 0.4% compared with January. So it exceeds its “target” (2.5%) by more than the current measure.

We should be grateful that there has been some improvement and because of the strong effect of the change in VAT rates as we came into this year then forecasters were predicting a drop back this month. However I have been looking at the reasons for why RPI all items did not fall and the explanation is.

By far the largest upward contribution to the change in the RPI annual rate came from housing. This upward effect was driven mainly by mortgage interest payments, which fell by 0.2 per cent this year but by7.3 per cent a year ago, following January 2009’s half point decrease in the Bank rate from 2.0 per cent to 1.5 per cent. Within housing, there was also a large upward effect from house depreciation, which rose this year but fell a year ago. This reflects movements in the Department of Communities and Local Government’s smoothed house price index that is used to calculate this component.

 

You know my views on house prices. Also of the total of 3.7% on this measure some 2.1% comes from motoring expenditure. The CPI equivalent is transport which contributes 1.6% of its annual rate of 3%. It is interesting that they have quite different measures and answers. Put another way the two main parts of RPI are its measures of housing costs and fuel for motoring. Of course it actually under records housing inflation as we discovered in the run-up to the credit crunch but at least it tries to measure it.

Conclusion

The BBC records the fall in CPI as a “sharp drop”  forgetting to mention it is still over target. However a more sober analysis is to allow oneself a sigh of relief. We need some improved news, although caution should be combined with it for three reasons.

1.We are still well over target on our inflation measure (our old measure is even more over target).

2. We appear to be in the middle of a residential housing price bubble and CPI does not measure this at all which was a contributor to policy mistakes in the run-up to the credit crunch.

3. Fuel prices are rising. The Office of National Statistics also published a report on weekly fuel prices today. Over the week to March 22nd then both petrol and diesel rose by 1.1 pence per litre. Compared with a year ago unleaded petrol is 26.4 pence higher and diesel is 17.8 pence higher.

Just purely on personal experience I refuelled 3 weeks ago at 111. 9 pence for diesel and the cheapest in my area is now 116.9 pence an increase of nearly 4.5%. My brother works as a driving instructor and says that since the beginning of this year it now costs him between £10/12 extra to refill his tank which he does for obvious reasons much more regularly.

There is a planned increase in fuel duties of  approximately 3 pence per litre due on April 1st. So we are not out of the woods on inflation yet.

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14 thoughts on “More UK Budget Thoughts and the Inflation figures for February

  1. You seem to again be suggesting that the main solution to the present problems would be to increase the standard rate of VAT to 20%. You do not seem to consider introducing a new luxury goods rate, which some EU states already have? Then you remark: “With these two efforts and my suggestions from yesterday I believe that we have the basis of a credible plan. The better things go the more ammunition I will have for my attack on the “poverty trap” which so blights our tax and benefits system.”

    The problem with just increasing the standard rate of VAT is that this would hit the poor the hardest. Such a move would directly conflict with your statement concerning poverty. In that you are reflecting professional politicians! This is the sort of act which they perpetrate, because they cannot understand a total systems approach to solving problems. There is no point in taking one action to supposedly solve one problem if it directly conflicts with another objective and worsens another existing problem. What you must do is to take all factors in the system into account, and choose an appropriate action accordingly.

    Thus what is necessary in this case, if you are going to ignore the Laffer curve data, and attempt to lessen the deficit using a VAT tax increase, is to do so by introducing a new Luxury VAT rate, at such a level that it delivers the same additional revenue as an increase in the standard rate. This would not then exacerbate present poverty. However the items or classes for Luxury VAT need to be selected very carefully.

    It is not surprising that the numbers announced from the ONS this morning show a moderate fall in supposed inflation. Why do you think that the ONS conveniently (just at the right time for the last inflation numbers before the election) changed the basket of items used for sampling? It is just another example of the continuous smoke and mirrors statistical tricks! The substituted items were deliberately chosen to ensure that “inflation” numbers would “fall”. In any case it is not clear to me, with all the tricks which the ONS now uses, whether the substituted items were entered at current cost. (I suspect they were, since no data on any increases in the prices of the new items would have yet been collected. That means that the price increases on the new items over the period have been ignored, and that they have been entered at present values with no recorded increase. That conveniently reduces the supposed inflation number from what it would have been if the previous items had still been used!)

    As you observe, even then CPI inflation is still above target by 1 %, which is a large excess. In general though, you seem to have much more confidence in the inflation numbers issued by the ONS as being realistic and representative than I and many other much more knowledgeable observers than I do.

    • Hi DRF

      There is a lot to discuss around my plan for VAT and the poverty trap. One point I would make is that I am planning to reduce effective marginal income tax rates which are currently of up to 90% and the rise in VAT by comparison is 2.5%. So there is a clear difference of scale. Another is that with my merging of National Insurance and Income Tax I am looking to streamline our taxation system and another rate of VAT would add to it. It comes down to choices and there is no perfect solution, I wish there was!

      On the subject of CPI figures I am more in agreement with you than you think. When it was introduced I felt it was a retrograde step but I was a voice crying out in the wilderness! In my view it was always likely to be unrepresentative as a measure of UK inflation and it has indeed performed poorly. The gap of 0.5% between its target level and the index it replaced was too small ( I argued for 0.75/1%). It also does not reflect our housing market and therefore crucially was unable to help policy during a sustained housing boom. I suspected that it was mostly selected as the numbers it produced were lower under the ruse of convergence with Europe. An irony in this is the fact that currentlly it is highlighting the difference between our inflation experience and that of Europe as my comparison of core inflation rates showed yesterday.
      I therefore consider it to have been a failure and would return to the Retail Price Index which also has flaws but less of them and I would look at ways of introducing more of a housing component into it as for the UK it has often been significant. The previous RPI less mortgage costs (RPIX) at least also had an all items RPI which could also be looked at by policymakers.

      • Hi Shaun, thanks for your reply. I am glad you also have doubts concerning the truth and relevance of ONS inflation numbers. The problem is that even with RPI, these numbers are currently produced by the ONS and they are subject to the same political pressures to distort and manipulate as with CPI. What we really need is a body not under the control or influence of governments or politicians, to compute and publish real and representative numbers. It is interesting in that respect that all independent sampling of inflation which has been done has produced much higher inflation numbers than the official government numbers.

        I appreciate that you would propose other taxation changes in addition to an increase in the standard rate of VAT in your package, but you again do not mention any aspect of the effect of VAT increases hitting the poorest the most. At least raising the same amount of revenue from a new Luxury VAT rate on goods specifically selected as those which the relatively wealthy only buy would not further penalise the poorest citizens.

        In addition you do not seem to acknowledge Laffer curve data and its effect on the likely yield from taxation increases, when we are already beyond the point of optimal taxation yield. You do not seem to acknowledge that a package of drastic cuts in current Public spending is the only real way to reduce the deficit. Could you let us have your thoughts on these issues please?

  2. There must be big savings in simplification of the taxation system. Most working parents for example pay PAYE (at multiple rates) ,NI then receive back child benefit and child tax credit at differential rates.Surely it’s not beyond the wit of man to roll all of this into one tax code calculation and do away all these other processes. If nothing else it would lessen the burden of employers who act as an unpaid tax collector.

    That links into the issue of small business and red tape. I wonder how many sole traders would hire someone to help out if not for the onerous repsonsibilities of being an employer. That’s where a truly competant adminstration could make a difference .

  3. I think the NHS typifies where mistakes have been made and would seem to bear out the points raised before about raising public sector provision thinking income from the top of the economic cycle would continue. When Brown attacked private sector pension provision saying he was spending it on heath and education he didn’t spend it on front line services he lost it in salaries and back room job creation which added hugely to the costings going forward. I would therefore agree large savings could be found in this area.
    As for inflation I don’t think it matters how it is assessed, it is only going one way in reality. Even Merve made comment about stoking inflationary embers to keep the prospect of deflation at bay, there should be no surprise seeing it now burst into flames! Drf makes a compelling case in understanding why the latest figures are what they are, cynical manipulation.
    Andy’s comments about simplifying the taxation system would seem correct too, however just whose interests is it to keep this as complicated and convoluted as possible and thereby justify not only your own job but also the ones created around you?
    As for red tape and small businesses. I have a friend who runs a small very specialist company with 4 employees. He wanted to take on an apprentice and started the ball rolling. 3 months later he gave up due to the red tape involved. This is just daft especially at this time as not only did cost a job it cost high value training as well. Another acquaintance running a small business took on employees who had been trained, in his particular field, by one of the job centres training schemes. He found their skill levels so lamentable he had to start their training again from scratch. If these anecdotal experiences are representative then we have a much bigger problem than anticipated.

    • Yet no political party feels confident enough to stand on a ticket of economic reform. We seem to be a nation actually deeper in denial than before the banking system hit the bailout buffers.

      • I agree especially considering the planned strikes due and already started. I think we do need economic reform but if Greece and the EU have shown nothing else they have shown that economic reform necessitates social reforms as well to lead it. It might well be down to the fact that we were willing to bankrupt the country to get ourselves back into the exact same position which caused the problems in the first place.

  4. GPs do not retire on a final salary pension. It is calculated on average life time earnings adjusted for inflation.

    • Hi Roger

      Thanks for the comment and apologies for the error. However in re-examining the data on the NHS website I notice that doctors earnings are increased by 1.5% per annum more than the September to September increase in the Retail Price Index so they are favoured here. It is a complicated formula and I am sitting here thinking through whether they are likely to be better or worse off than a final salary scheme but it is getting a bit late for that! I will read it again and return to it.

      So thank you for the comment and I have corrected the relevant sentence in the article

  5. the problem is that you are dealing with false and inaccurate figures so your conclusions will be incorrect.
    the essence is no real spending cuts that matter will be made by the politicians they will not want to be blamed for the outcome or held accountable. just as brown blamed some illiterate red necks in alabama for the sub prime crisis. much easier to let the “speculators” trash the pound for them.so they can blame them just as the greek and eurozone politicians have.politicians know that 95% of people are economically illiterate.
    much easier to cut wages and costs by stealth using devaluation and inflation as usual.then blame those evil (scapegoats) speculators.”not me guv(ernment)” is alive and prospering.
    we live in a country where” lies are the new truth”.and where “sense make no sense” live by these rules and you wont go far wrong in modern britain.??????

  6. News just in that Fitch have downgraded Portugese Sovereign Debt. Despite rating agencies having no credibility markets still pay attention. Does this willingness to act suggest that a post Budget downgrade of the UK is real possibility?

    The next 48 hours could be one hell of a ride. Greece looks like it is days away from either the IMF or default.UK may soon find the market’s patience having worn thin.

    • Hi Andy

      I still think it is more likely that any downgrade of the UK would be more likely to happen post-election rather than post-budget. Of course there is the danger that Gordon Brown suceeds in pressurising Chancellor Darling which we will find out later. In recent times we have benefitted in terms of our bond yields by being out of the Euro and I think that markets seeing the shambles that has gone on there are at the moment revaluing the benefits of being able to depreciate your currency. The world at the moment is almost like the reverse of a beauty parade where various countries take their turn in the spotlight and we have avoided it for a bit!

      I have enjoyed holidays in Portugal and have friends from there so I find its current difficulties to be particularly sad…. As to your 48 hours comment we will see I have subjects I want to get onto such as Greece and Japan for example but there is so much going on.

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