Will the UK be raising or reducing taxes?

The UK Public Finances data we looked at on Friday has triggered something of a policy response. Or at least some proposals, although if we look at the Financial Times the messaging has got itself in a mess.

Rishi Sunak is planning to defer tax rises and cut public spending in his Autumn Budget after delivering a further stimulus for the UK economy.

That looks a little confused on its own with its message of a stimulus followed by what looks like a lagged version of what has become known as austerity. That leads us to something of a collision between economics 101 and likely human behaviour. Let me explain with reference to the suggested plans.

The Treasury is first considering a temporary cut to value added tax and specific reductions in the rate for some sectors, according to those close to the chancellor, following significant pressure from industry and Tory MPs. A lower VAT rate for the tourism sector — including pubs, restaurants and hotels — is one option being discussed.

Okay and when would it happen?

This could come as early as July as the government prepares to scrap the two-metre social distancing rule and replace it with “one metre plus” guidelines that are likely to include further use of masks and physical screens.

Okay so there is an Undertone(s) here.

Its going to happen – happen – till your change your mind
Its going to happen – happen – happens all the time
Its going to happen – happen – till your change your mind.

Economic Impact

We do have some recent evidence for the impact of what is a change in a consumption tax and it comes from Japan last autumn. So let us remind ourselves via the Japan Times.

Japan saw a 6.3 percent economic contraction in the last three months of 2019, fueling criticism of Prime Minister Shinzo Abe’s decision to carry out the tax increase at a vulnerable time for the economy. After factoring in the early signs of impact from the coronavirus, analysts now believe the economy is falling into recession.

That is in the American annualised style and as we note the further downward revision and convert we now see the economy shrank by 1.9% in that quarter, driven by factors like this.

Like many people in Japan, she isn’t planning to splash out again anytime soon, leaving the economy teetering on the edge of recession. And that was before the spreading coronavirus gave yet more cause for caution.

“These days, I really scrutinize the price tags,” Mitsui said.

The economic consequence of this change in behaviour is shown below.

Household spending fell for the third straight month in December on the continued impact of October’s consumption tax hike together with sluggish demand for winter items due to warm temperatures, government data showed Friday.

Spending by households with two or more people dropped 4.8 percent in real terms from a year earlier to ¥321,380 ($2,900), the Ministry of Internal Affairs and Communications said.

The collective impact on the quarter was for a 3% fall in private consumption on the quarter.

So we see that a consumption tax rise led to quite a drop in the economy thus we have some hope for the impact of the reverse. Indeed the impact looks really rather powerful. This reinforces the impact we saw of the VAT rise back in 2010. One area where we have less evidence is the impact of inflation which is harder to read. I would expect there to be a welcome disinflationary effect in the UK that is stronger that we would see in Japan. Why? Well price rises in Japan tend to not have secondary impacts on inflation and of course there were two other factors. The Japanese economy was slowing anyway as the consumption tax brake was applied and now we have the further impact of the Covid-19 pandemic. The Bank of Japan calculates various inflation indices to try to suggest its policies are working but the latest release excluding the effects of the consumption tax rises suggests inflation is er 0% ( actually slightly below), so if you like what is normal for Japan.

What next?

There is a possible worm in the apple of the UK plans, so let us return to the FT.

But any move to lower VAT — at considerable cost to the exchequer — would come with a sting in the tail, as Mr Sunak works up proposals for deferred tax rises and lower public spending as part of the autumn Budget.

The message switches from “Spend! Spend! Spend!” to tighten your belts which adds a layer of confusion. For younger and overseas readers the spend quote is from Viv Nicholson who won the (football) pools which was analagous to winning the lottery now and I think you have already figured her plan.

The response seems to have been influenced at least to some extent by mis-reporting like this, which I noted on social media over the weekend.

There has been some really rather poor reporting from the BBC today with analysis by @DharshiniDavid

“UK debt now larger than size of whole economy”

There were several factors at play such as the policies of the Bank of England inflating the recorded numbers by £195.6 billion whereas even in pessimistic scenario it might not be a tenth of that. Also the numbers were not only based on a forecast they were based on a forecast by the Office of Budget Responsibility which has lived down to its reputation by being wrong yet again. How much of an influence that was in this is hard to say.

Neil O’Brien, MP for Harborough and a former Treasury adviser, said: “We simultaneously need a stimulus now to fight recession, but also need to roll the pitch so that we can deal with very high levels of debt.”

Neil seems to be trying to have his cake and eat it. An excellent idea in theory but one which crumbles in practice. However his lack of realism is typical of someone who has been involved at the Treasury. Next is an anonymous effort at sticking the boot in.

Another former Tory minister said the public finances were so stretched that a fiscal tightening would be necessary before long: “The public aren’t going to like it but it feels like either spending cuts or tax rises are going to be necessary soon.”

Comment

The situation is on one level quite simple. Will a VAT cut boost the economy? Yes it will both directly as people spend more and then via a secondary effect of lower inflation via some lower prices. The second bit is awkward for the inflationistas so we may not seem them for a day or two. The undercut is the impact on the public finances which will be added to the £8.6 billion fall in VAT receipts in the year so far. There will be some amelioration as for example people dash for a haircut or a pint of beer at their local pub, but overall receipts will be lower. The overall impact depends on the economic boost and how long it lasts and the evidence we have is positive.

Switching to the public finances the numbers are not as bad as some have claimed, partly because of a factor which should get more publicity. In the fiscal year so far (April and May) the cost of our debt fell by £1.1 billion to £8.4 billion due to lower inflation and the fact our ordinary debt is so cheap to finance. I would be switching as much debt as I could to the fifty-year maturity at a yield of around 0.5% and in fact would issue some 100 year Gilts. In the long run we will have to deal with the capital issue of the debt we are issuing at an express rate but as it is cheap the interest implications are relatively minor. What we need to squarer the circle is some economic growth. That will reduce the tax increases required.

Let me end by looking at the other side of the coin from the slice of humble pie i put in front of myself on Friday. So a slap on the back for this.

Regular readers will be aware that I wrote a piece in City-AM in September 2013 suggesting the Bank of England should let maturing Gilts do just that. So by now we would have trimmed the total down a fair bit which would be logical over a period where we have seen economic growth which back then was solid, hence my suggestion.

Because it seems to be on the radar of the present Governor.

#Monetary policy – significant change of approach suggested by #BOE governor #Bailey – says may be best for the bank to start reversing its asset purchases before raising interest rates on a sustained basis. Opposite view to that which has been held at BoE ( @HowardArcherUK )

 

 

 

 

24 thoughts on “Will the UK be raising or reducing taxes?

  1. Hello Shaun,

    bad times ahead, if you cannot get the public spending again then its a death spiral.

    a quick survey amongst friends,

    1, holidays with masks – nope forget it , its not a holiday
    2, pubs with masks – forget that too
    3, restaurants – ( laughter… )

    Many think they will not have a job to go back to either so they are batting down the hatches

    Now figure in the reports of 2nd waves – much hype over the few cases involved and the paranoia kicks in again.

    Yes, a smart move to raise VAT as we go into a spending freeze – factor in the price rises too ……..

    Forbin

    • Agree – I will not be going to restaurants or pubs until either this virus disappears or we have a vaccine. Ditto flights and foreign holidays. Would I be confident that the younger folk working in these venues have been careful and observed the best practices? Definitely not!

    • Just to play devils advocate, there will be a lot of people who have saved significant sums of money during this lockdown what with mortgage holidays and being paid to not go to work thus saving on fuel, going out, gym, childcare, etc…. once let out they’ll be doing a Viv-lite.

      Only people they can tax have to be asset owners, as the vice can no longer tighten on the testicles of the working pleb.

      My first target would be all landlords on basic rate of tax, and watch them squeal.

    • Forbin,

      Now there is speculation about a VAT cut no one will spend now, what a mess. Bear in mind VAT is 20% at the moment and the higher the price of goods and services the higher saving whatever the cut may be.

      Speculation like this is very dangerous and can have significant consequences,

      As for second waves some countries are having them now but the government not taking much notice they are already vent on more easing of social distancing bit will everyone just go to the pubs again as before?

      Some fools will but not everyone recent polls have pointed out to the public reluctance to go in shops more so for the older folk who have trust in ministers.

    • I agree Forbin, face mask fascism is going to stop things dead. And the hype over ‘2nd wave’ is just to keep the fearmongering going ( probably until a certain event in November).

  2. Not a time to destroy money ( tax rises), so VAT decrease makes sense. But not a further claw back in autumn. Agree Shaun, borrow as long dated as possible. I think some sort of living wage for everyone is going to emerge to replace furlough. They need something to stop civil insurrection in future months, especially if they engineer a ‘second wave’ fear to keep everyone in their place.

    • VAT decreases on foreign made goods just means more money leaving the country.

      Cancelling VAT on training courses would be apt with so many about to be on the dole.

      • vocational training is already exempt from VAT.

        Also, when you buy a product from abroad using GBP, the money you pay doesn’t actually ‘leave the country’. It will likely remain in a bank account that one way or another is part of the UK’s banking system. The ownership of the money changes hands, but that happens wherever the person you are purchasing from is physically located. The new holder of the GBP deposit can either spend it (in the UK) or save it. The same would be true of any holder of GBP wherever he or she is.

  3. Shaun,
    Time for HMG to fund local projects to recruit job seekers paying min wage as stepping stone back to more lucrative employment funded by NSI offerings. I suspect lot of savers looking for socially useful investments at present low interest rates .

    • Hi Chris

      That is an interesting idea as we need some new forms of saving. The only catch is that the taxpayer can currently borrow more cheaply. But a sort of “matched” deal where savings fund things that are useful ( i.e not Smart Meters) might just work. After all we both know businesses will be borrowing at much higher interest-rates.

  4. No great surprise to see the clowns in charge of our finances channeling Steve Priest again.

    Their concern is supposed to be with raising consumption demand. So, what do they do? First, they ramp up house prices and tell us they are great, because mortgage rates are so low, when the capital price rise just sucks money out of consumption into buying the asset.
    Then idiots like our current Health Sec tell us there should be an additional income tax on the over-40s to finance future social care, which sucks out more consumption to support the asset rich with what Friedman called “middle class welfare”. Then Sunak says he is going on a spending spree to indebt future generations. Now, we have a tussle over income tax and spending to sort out the mess created by laying the virus on 30 years of financial mismanagement.

    Simple solution: get tough on asset taxes including that 40,000 allowance against CGT if you rent your house and then move to a smaller one. Put windfall taxes on construction companies for rising land values and slash govt spending. Let universities go bust to reduce the number of students and tell families that granny is their responsibility. It will be a shock for welfare-addicted middle classes, but it needs doing.

    I expect we will see more borrowing, taxes on income and an economic standstill.

    • Yes … I agree. Economic standstill if they continue faking incomes for furlough and holidaying debt but also standstill if they try to tax to balance books with the debt monster. If they wanted sustainability I would not have started from here. Probably best to burst the property bubble, offer young people a reason to serve and make the boomers eat porridge as a “payback” for their selfish greedy consumption from the “magic” money tree.

      • I assume you refer to property as the magic money tree but it isn’t for the vast majority who only have one house. It is the next generation who will benefit when they inherit. The fact that my house has tripled in value is of no benefit at all unless I live in a tent in future

        • Or if you downsize. Or decide to use it as an ATM. Or as you say gift it to the kids who then dont have to work because you won the property bubble lottery.

          To claim it tripling is of no benefit to you is untrue.

          • If I downsize it will be a tent! I am not going anywhere and so the increase in value means nothing

      • As a boomer who likes porridge:o) I
        would say that for anyone who owns a
        detached home, it is worth 3 terraced
        houses and if prices fall they will fall
        on the same scale. Clearly if this causes
        more demand than supply guess what
        they rise again.
        In my view the only group of people who
        qualify for “payback” are the buy to lettters
        with manifold “Gordon Brown” mortgages they
        are the ones who deserve a haircut!
        To call people who worked for 50 years and had
        the temerity to actually have savings selfish and
        greedy is a stilted view, none of us control where
        and when we were born.
        JRH

  5. There are no Tories anymore, only socialists who wear a different a different rosette at elections, the Tories will fall over themselves to be portrayed as “caring” and not “nasty” by the media who will look for ways to twist whatever they say or do as bad for the working/middle class, homeowners, taxpayers.

    If they raise taxes they will be heartless Tories kicking the working man struggling to get by, if they don’t they will be accused of irresponsible reckless spending, they literally cannot win, so they will go for the path of least resistance and spend spend spend and raise little or no new taxes, as a result the deficit and the debt will balloon out of control the £ will continue its collapse, add in a hard BREXIT and the country will spiral towards bankruptcy and the inevitable bailout, guess what happens to the £ then anyone?This Covid furlough scheme has turned out to be the perfect introduction and justification for UBI. The two could run seemlessly into each other some time in the near future, and no one would question its introduction, what heartless dog would challenge or question the payments to those whose jobs/businesses/homes were lost due to Covid???

    Coincidentally this also helps get rid of Trump by crashing the US economy he so foolishly claimed ownership and total credit for,all the things I have been saying are coming over the last few years(UBI and an engineered financial crisis leading to a run of the £) and here they are happening now, it’s almost as if this Covid malarky were planned all along…………

  6. #Monetary policy – significant change of approach suggested by #BOE governor #Bailey – says may be best for the bank to start reversing its asset purchases before raising interest rates on a sustained basis. Opposite view to that which has been held at BoE ( @HowardArcherUK )

    I am not good with bonds, but this does appear to be the obvious way round, since higher rates will reduce bond prices. I seem to recall Carney proposing to go the other way at one stage …. not that he scaled back the “support”

    Bailey has also been claiming today that without bond purchasing, aka printing money, the govt would have found it “impossible” to sell enough debt to cover the deficit recently. Well, it would not have an issue if it offered a real return – but that just shows how much trouble we are in to support fake house and share prices.

    • Hi Dave

      The previous Bank of England plan to reverse some of its QE or what he now call QT seemed designed to lose money on its holdings, Raise interest-rates to reduce the value of what you are about to sell is none too bright, but it had been policy for quite some time.

      I am not clear that Andrew Bailey knows what he is talking about on this subject. I have rarely heard him talk about monetary policy so perhaps he is not that well versed in it.

  7. I see no joy in environments where I am constantly reminded of the risks of disease. I for one will be another (to add to Forbin’s friends) who will be abstaining what are supposed to be joyous activities – pubs, restaurants, holidays abroad etc.

    Picnics great. Walks, cycling, great. Beach great. As long as no face masks are there to remind me of danger. I think a lot of people have discovered the joys of the simple picnic out with friends and family at parks etc. Some things will take some time to get back to ‘normal’.

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