The UK:What is the economics behind tonights televised debate?

Today has a clear first for the United Kingdom, the leaders of the three main political parties in the UK (Labour, Conservative and Liberal Democrat) are going to take part in a televised debate on ITV at 8:30pm tonight. There is some concern that the rules (76) are likely to take spontaneity away from the debate and restrict it. However it is an innovation and in the mess UK politics are currently in mostly due to the political expenses scandal I feel that innovations are worth trying. My aim in this analysis is to take an objective look at the economics behind the manifestos which have now been published by all three main parties. I intend to avoid the politics completely and remain impartial. I am grateful to the Institute of Fiscal Studies and the Financial Times for some of the numbers used.

The “elephant in the room”

Yesterday Vince Cable the prospective Chancellor for the Liberal Democrats used this evocative phrase to describe the question of the UK fiscal deficit and of course this also has an implied view for the National Debt. However this is an area where all three main political parties have similar flaws in their plans. If you look at the three published manifestoes there is a hole in each of them of a similar size, £30 billion. So in truth none of them are being transparent and honest in their spending pledges.  So the answer to the question what are they not telling us? Is in economic terms £30 billion. This is just over 2% of our Gross Domestic Product (GDP). Put another way it is around a quarter of the annual cost of the National Health Service.

Just to put the size of this “black hole” into further perspective none of the three main political parties have specified credible plans to cut spending by more than £10 billion. So there is quite a difference of scale here. Our political class are misrepresenting the facts and are attempting to mislead voters. This will not help you tonight in choosing but please be aware they are all dissembling. What they do after the election will not match the promises they are making now.

Taking this analysis of tax and spending pledges  forward leaves one with a  problem as  according to the Institute of Fiscal Studies as increases in debt interest payments and rising social security bills are likely to leave us with £37 billion of actual real cuts required by 2013/14 to hit the deficit targets already set by the current government. So it is clear that so far in the debate we are simply not being told the truth. Reality will be much tougher than the promises imply.

Comment

I would like to be there tonight to ask the following question, “why do you all have a £30 billion hole in your plans?” followed by “what are you going to do about it?”. It might at least lead to a proper debate on the economics rather than the falsehoods currently inherent in the parties manifestos. It is of course true that politicians have made promises before and not kept them and the debate before the 1992 election was particularly poor in this respect. However with politics and politicians currently being at a low ebb in terms of reputation and public interest this is a bad time for it.

I would like to repeat my request for future ballot papers to have the option of voting “none of the above”. It is a particular shame that a man with a decent reputation Vince Cable has made a claim for honesty and transparency and then produced a set of figures which are no better than the others.

So the true “elephant in the room” is that none of our main political parties are telling the truth about what will happen post-election.

One curiosity is that all of our three main political parties are committed to increasing overseas aid by £4 billion a year by 2013. One might think that someone would question whether in our current financial situation we can afford it, for example is it more important than schools or the NHS? As far as I can tell this appears to be the most sacred of the sacred cows.

Labour

We can look at what Labour has done in its 13 years in power. For example it had a policy from around 2002 of increasing spending substantially on health and education which sadly is one of the drivers of our current and future problems. It has raised taxes since 1997 (around £31 billion per annum) but it raised public spending at a faster rate even before the current financial crisis and is now around 48% of GDP. The Institute of Fiscal studies has estimated that in its view there have been substantial rises in public output but that there have also been falls in efficiency of £42.5 billion over the period of Labour’s tenure. To its credit it immediately identifies that these are difficult numbers to quantify and that perhaps some improvements cannot be measured. Labour’s record on keeping its manifesto promises has been sullied by promising not to raise the higher rate of income tax and then doing so.

Labour’s manifesto has in it plenty of things it would like to do but has no new detailed plans to address the deficit. Looking at its track record becoming a party of fiscal rectitude will represent quite a change of philosophy.

Conservatives

Here again we got little detail on exactly how the deficit is going to be reduced beyond a rather woolly “”to eliminate the bulk of the structural deficit over the Parliament”. The current government would also argue it has plans for most of that. They do have a committment to reduce the structural budget deficit which implies that they would cut faster than Labour over the next five years and in essence achieve Labour’s objective a year earlier. They also say that they would split reductions in the deficit using a formula of 80% spending cuts and 20% tax rises. Just as a historical note the formula that Kenneth Clarke applied fairly successfully in the early 1990s was more 50/50.

So we have a promise to cut the deficit more quickly than Labour but like Labour very little detail on how it will happen. One factor which does come into play has been a planned reversal of some of Labour’s planned national insurance tax rise for next year. Politically this appears to have been a success calling it a “tax on jobs”, however this will cost around £6 billion per year which begs the question of how this can happen and the deficit can also fall more quickly than under Labour’s plans.

Liberal Democrats

The manifesto for the Liberal Democrats does contain more detail than for the other two parties and it does contain some extra tax raising of around £2.5 billion a year. Sadly then things become much vaguer as it implies that it will reduce the deficit slightly more slowly than Labour an implication which I believe has already been modified by the party to “at least as much as”,which of course is about as clear as mud. What does appear to be clear is that on announced plans it is this party that will have the highest amount of net tax rises and therefore likely to have the lowest amount of public spending cuts.

Philosophically I have to confess I warmed initially to the idea of raising the personal allowance ( the income level at which income tax starts) to £10,000 as I am keen on measures to reduce the poverty trap of high marginal tax rates on our poorest citizens. However even with a cap at an income level of £100,000 per annum many other people who do not suffer from such high marginal tax rates will also benefit from this so the plan is very inefficient in this respect. Then when I looked at the taxes that were needed to pay for it there are simply too many particularly as in addition to them £4.6 billion is supposed to be raised by anti-avoidance and anti-evasion measures. So perhaps the best proposal ends up being funded by one of the worst examples of wishful thinking!

Conclusion

None of the parties are telling the full truth and in power the policies of all of them will not be the ones they proclaim tonight at least in terms of the economics. In a democracy political parties have considerable freedom in the policies they choose but the current level of dissembling I feel gives our political system a bad name.

I am reminded of the elections in Greece last autumn. They took place with her economic statistics being misrepresented by around 4% of GDP as the previous government had manipulated them, our politicians are sticking their heads in the sand over 2% of GDP.If this means that we will get half of the problems Greece is currently facing over the next six months or so it is a worrying prospect. My article of yesterday highlighted some differences in our respective situations but in this instance we are in danger of a parallel. This is added to by the further difficulties in the Greek bond market today.

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7 thoughts on “The UK:What is the economics behind tonights televised debate?

  1. They will all attempt to finance the £30bn by borrowing £30bn more gilts than forecast every year. Each party wants to believe that the market is a sucker for a sob story and will merrily stump up at 4-4.5% to fill the gap in our spending plans.

    Soon(ish) markets will lose patience, yields will rise quickly.This is then rapidly followed by various politicians ranting incoherently about ‘speculators’ and ‘hedge funds’ as if the market created the crisis.

    It’s our very own Greek tradegy..in theatres soon.

    On a positive note Shaun it is difficult to write in a politically divisive way, as I can’t see any division in the first place.

  2. An excellent summary of the current political absurdity, deception and lies. There is in practice now little real difference between the main political parties, and it seems that all of them are afraid (or prohibited in some way) from attempting to do what in reality the bulk of the electorate actually want! They are all squashed-up together on a small part of the political spectrum on the centre left.

    “…they would split reductions in the deficit using a formula of 80% spending cuts and 20% tax rises….” A 20 % overall increase in taxes would be a pretty big upwards move. In my opinion it would not result now in a 20 % fiscal revenue yield since we are already beyond the gradient giving proportionate yield on the Laffer curve and are probably on the gradient of diminishing yield as far as I can establish. Would appreciate your thoughts, Shaun, on Laffer curve theory related to this?

    • Hi Drf

      The 20% is of a planned reduction in the deficit that the Conservatives intend to make so its not an overall 20% rise. However it would be reasonably substantial particularly when their only real stated policy is a tax cut from 6/4/2011 of some £6billion. I am talking of a tax cut for simplicity although it is in reality a reduction in a tax increase that the current government is planning as a way of raising revenue.

      As to the Laffer curve I think that the 50% income tax rate on higher incomes has already exceeded the point where revenue does not rise following a rise in the tax rate. I expect this measure over time to raise very little at best and more likely to make a loss,although it is not easy to measure as there is no “blind” sample to compare with. The lesson of the reduction of the higher tax rate to 40% was that the total amount of tax collected from higher incomes rose as avoiding it became less rewarding. As to other taxes revenue can still be raised from say a rise in the basic rate of income tax and in effect the 2011 rise in national insurance is a rise in taxes on income. Whilst there would be some avoidance Value Added Tax is further down the Laffer curve than these two I feel and revenue would still rise pretty much as forecast if it rose to 20%.

      There is some interesting evidence emerging about taxes on petrol and diesel showing that the recent price increases are indeed reducing consumption. The implication of this is that we may also be moving up a Laffer type curve here too. So there are more than a few types of tax increase that could be made that would actually disappoint in terms of yield I feel.

      • There is some interesting evidence emerging about taxes on petrol and diesel showing that the recent price increases are indeed reducing consumption. The implication of this is that we may also be moving up a Laffer type curve here too. So there are more than a few types of tax increase that could be made that would actually disappoint in terms of yield I feel.

        I have a friend who works at an oil terminal in the North East. Since the fire at the one in the London area (can’t remember the place but oil prices were about peaking then!) they have seen a drop of about 1/3rd in quantities which has never picked up again, the result they are now closing down, ie, producing direct unemployment though too high a tax take. Got to be down to price and of course more stringent household budgets. I would suggest any upward movement in interest rates, and I think 5% is a workable figure, will impact onto any service sector devoted economy, course you have to subsidise a housing bubble to be able to pull that off so which has the greatest dangers?

    • I’m pretty sure that the “20” in “80/20” means that 20% of the deficit reduction is to come from taxes, not that taxes are to rise by 20%. So for 30B of deficit reduction, read 6B taxes and 24B spending cuts. 6B is probably a “small” (!!!) enough increment that there won’t be serious Laffer considerations. (Now I see Shaun has already mentioned this.; penalty for slow typing I guess).

      Of course the deficit is the difference of two much larger numbers (revenue and expenditures), and is therefore a very more sensitive/noisy figure. As difficult and tricky as it might be to deal with a 30B deficit, it doesn’t take a very big swing in any of the key parameters for that to suddenly be a 60B deficit.

      (Sorry for not prefacing all my figures with the Sterling symbol but I’m Canadian and that is too exotic a character for my keyboard! But being Canadian does have one advantage, while I get to watch your election with great interest I am also able to do so with a degree of detachment that I can’t seem to achieve for our own or American elections)

      Now while I’m not quite old and wrinkled, I do remember the 1970s well. I enjoyed the interesting comment on the other thread about the British “Price Check Triangle”, I had never heard of that. Had heard of the American “W.I.N. Whip Inflation Now” buttons; in Canada we had a Prime Minister of a minority gov’t campaign on the promise to not to introduce wage and price controls, who went on to win a majority government and then….. introduce wage and price controls.

      So having brought up the 1970s, please raise your hand if you think that while sub-5% long term interest rates are a godsend to governments, they are not an immutable fact of nature…

      I think that the real “Elephant in the Room” for all countries is not the current size of their deficits, serious though that may be, but how powerfully their deficit is leveraged to interest rates. And with interest rates presently at pretty-much-as-good-as-it-has-ever-been levels, pretty much any change will be for the worse. Should interest rates rise to 10%, which I submit is not a “doomsday scenario” but merely a good strong ordinary excursion for contingency planning purposes, how would things then look then? (!!)

  3. All sorts of opportunities missed by opposition parties in their manifestos. It seems that nobody is prepared to treat the electorate as adults and trust them to take a mature view of what has to be done. I can understand the Labour party thinking that way, they have no other choice at this stage, but why the other two?
    Maybe they are right, perhaps the electorate still believes in fairy tales and giveaways. It does seem to have an extremely short memory, wanting benefits but never wanting to pay higher taxes for them. Maybe short termism is so embedded in British society that we can’t deal with issues that require more than a few months to resolve, or are negative at the start but offer improved medium term outcomes.

  4. When the majority of the electorate believe that no cuts are necessary to get us out of the fiscal predicament, you can see that Politicians are stuck between a rock and a hard place.

    Tell the truth and your chances of electoral success are like a snoballs in hell.

    The British Public get the Government they deserve, and indeed elect.

    If they are too blind and stupid to work out that a pretty horrid times awaits us all after May 6th then they deserve to be lied to!

    In essence, this election is actually not really about the economy at all, its about fundamental ideologies between the three main parites.

    The economics will be largely dictaed by the markets and the fear that all politicians have of doing unpopular things.

    Ie we will probably get awful gilt sale interest in the summer, prompting a huge new round of QE, stoking inflation and devaluing sterling further, then we will have to push up interest rates to double digits or close to and the pain of the ’90’s will ensue.

    Alas if the electorate refuse to accept the harsh truth, this will come to pass, if they say “ok we had a good 13 year run, time to feel the pain” we could take the imediate actions required and get back on an even keel by slashing public spending (not really slashing, if our economy has shrunk back to 2004 levels, taking our spending back to 2004 levels does not seem exactly like madman policy!!!)

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