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 )

 

 

 

 

UK Retail Sales and Public-Sector Borrowing Surge

We were supposed to be receiving some grand news from the Bank of England this morning. But in fact we find ourselves simply noting a rather botched public relations spinning effort.

You spin me right round, baby
Right round like a record, baby
Right round round round ( Dead or Alive)

The main movement was in the value of the UK Pound £ which fell by around 1% so we saw using the old rule of thumb monetary easing equivalent to a 0.25% Bank Rate cut. How much of that was due to the PR shambles?

Anyway there was some good news in an implied better trajectory for the UK economy and that has been backed by the data this morning.

The monthly growth rate in May 2020 is strong because of a combination of recent increasingly rapid growth in non-store retailing and a pick-up for non-food stores from the lowest levels ever experienced.

Also let me give the Office for National Statistics credit for this.

Weights to total retail are calculated from the amount of money typically spent in each retail sector and used as a proportion to calculate growth contributions. For example, around 38.1 pence of every pound is typically spent in food stores, providing us with a weight of 38.1 to total retail. In May 2020, these proportions were recalculated to reflect the changes in spending during the pandemic. The amount of money spent in food stores increased to 51.4%,

In what are volatile and uncertain times one needs to keep on our toes and this example should be spread to the inflation numbers. The data should reflect as best we can what is happening not a world “far,far,away”. As you can see,doing so makes quite a difference. The number below gives a hint of how the inflation data would be affected and in my opinion it is a great shame that the Bank of England Minutes ignored this factor yesterday.

Fuel sales usually has a weight of just over 10.4% to total retail, but was at around 5.5% in May 2020, resulting in a positive contribution of 2.3 and 2.7 percentage points for value and volume sales respectively.

Actually the release even hints at this.

Fuel prices also continued to fall in May 2020………When compared with the same month a year earlier, fuel prices fell by 14.9%

However whilst the monthly improvement was very welcome and you might like to note was another example of the “expert” forecasters missing the dartboard as they were expecting more like 6% growth as opposed to 12% or so, we need a deeper perspective.

While we see some partial bounce back on the monthly growth rate in May 2020 at 12.0%, levels of sales do not recover from the strong falls seen in March and April 2020 and are still down by 13.1% on February 2020 before the impact of the corona virus pandemic.

Putting this another way the volume index was 93.7 in May if we set 2016 as the base level of 100. Previously the numbers were bouncing around 108.

I doubt any of you will be surprised by the shift to online retailing.

Online sales as a proportion of all retailing reached a record high of 33.4% in May 2020, exceeding the original record reported last month of 30.7%.

There was a larger uptake of online spending for food, which reached record proportions, from 9.3% in April to 11.3% in May.

Should consumers continue with this trend this is more bad news for the high street. Although as a counterpoint the mobs that descended on the shops which opened recently suggests there is some hope, although the health message sent from that was rather different.

Public Finances

Let me start with an apology as I was asked about this and thought it would probably take place in June.

Debt (public sector net debt excluding public sector banks, PSND ex) at the end of May 2020 was 100.9% of gross domestic product (GDP), the first time that debt as a percentage of GDP has exceeded 100% since the financial year ending March 1963.

There are a couple of factors in my defence however and one of them we have just been noting. That is a further hint that the economy is doing better than the consensus expectations. Oh and my first rule of OBR Club is likely to help me out.

 the current estimate of GDP used to calculate this ratio uses forecasts based on expectations published in the Office for Budget Responsibility’s (OBR’s) Coronavirus Reference Scenario.

They look well on their way to being wrong again. Also there is the large £13.9 billion revision to borrowing for April and we learn quite a bit from it. Take a look at this for example.

Central government tax receipts and National Insurance contributions for April 2020 have been increased by £5.4 billion and £2.4 billion respectively compared with those published in our previous bulletin (published 22 May 2020). Within tax receipts, Pay As You Earn income tax has been increased by £3.0 billion and Value Added Tax has been increased by £2.8 billion, both because of updated data.

As you can see there is another hint from the numbers that the economy was doing better than so far reported in April as we see upwards revisions to both income and expenditure taxes.Indeed the numbers have quite a conceptual problem as we mull whether imputation is like a pandemic?

In other words, we attempt to record receipts at the point where the liability arose, rather than when the tax is actually paid.

Oh and you can’t say I have not regularly warned you about the OBR!

On 4 June 2020, the OBR published an update to its Corona Virus analysis in which it reduced previous estimates of CJRS expenditure.

Perspective

We can start with May.

Over this period, the public sector borrowed £55.2 billion, £49.6 billion more than it borrowed in May 2019.

But via the revisions noted above we have already seen how unreliable a single month is so we do a little better looking at this.

In the current financial year-to-date (April to May 2020), the public sector borrowed £103.7 billion, £87.0 billion more than in the same period last year.

Although we need to note that we will be lucky if it is accurate to the nearest £10 billion. Within the receipts numbers there are some points of note. The Retail Sales numbers with monthly rises of 30%,61% and now 3,6% for the category with includes alcohol sales meets alcohol duty receipts which have fallen from £2.1 billion to £1.6 billion. Perhaps a health kick has been going on as tobacco receipts fall by £400 million to £1 billion. Also a slowing in the housing market is kicking in as Stamp Duty receipts fall from £2 billion to £1.1 billion.

Switching to the national debt there is this.

Debt (PSND ex) at the end of May 2020 was £1,950.1 billion, an increase of £173.2 billion (or 20.5 percentage points) compared with May 2019, the largest year-on-year increase in debt as a percentage of GDP on record (monthly records began in March 1993).

Comment

We have some welcome news today on the economy but context is needed as we have still experienced quite a drop, simply one which is smaller than reported so far. There is an irony in the two numbers released as we see this being reported which gives a worse impression.

Just in: UK government debt exceeded the size of the country’s economy in May for the first time in more than 50 years, official data published on Friday showed, as borrowing surged to pay for coronavirus response measures ( Financial Times)

Having awarded myself a slice of humble pie let me move onto an issue that the more clickbaity reports have ignored.

If we were to remove the temporary debt impact of APF and TFS, public sector net debt (excluding public sector banks) at the end of May 2020 would reduce by £195.5 billion (or 10.1% percentage points of GDP) to £1,754.6 billion (or 90.8% of GDP).

That is the role of the Bank of England in raising the reported level of the national debt and frankly this bit below is one of the silliest inclusions.

As a result of these gilt holdings, the impact of the APF on public sector net debt stands at £95.7 billion, the difference between the nominal value of its gilt holdings and the market value it paid at the time of purchase. Note that the final debt impact of the APF depends on the disposal of the gilts at the end of the scheme.

Oh well. Let me end by bringing yesterday’s extra QE bond purchases and the borrowing together with these two numbers.

At the end of May 2020, the gilt holdings of the APF have increased by £46.7 billion (at nominal value) compared with the end of April 2020, to £475.1 billion in total. This increase is of a similar order of magnitude to the new issuance by the DMO in May 2020, which means that gilt holdings by units other than the APF have changed very little since April 2020.

As I have pointed out before if we take a broad brush the Bank of England is implicitly financing the government spending. That is why we can borrow so cheaply with some gilt yields negative and the fifty-year a mere 0.55%.

 

 

The UK is being paid to borrow just as it borrows record amounts

Sometimes even when you expect something it still creates something of a shockwave. We knew that UK public spending was on speed and that tax receipts were going to be like one of those cartoon characters running off the edge of a cliff. But even so this had an impact.

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in April 2020 is estimated to have been £62.1 billion, £51.1 billion more than in April 2019; the highest borrowing in any month on record (records began in January 1993).

Boom Boom Pow as the Black Eyed Peas would say. As we break it down we see it is a central government game as it also is pouring money into local authorities as we noted last time.

In April 2020, central government borrowed £66.2 billion, while local government was in surplus by £7.3 billion. This local government surplus partially reflects the increase in current transfers from central government to fund its COVID-19 measures.

If we look at spending we see this.

In April 2020, central government spent £109.3 billion, an increase of 38.3% on April 2019.

There was an increase of £1.6 billion in social benefits which ordinarily would be a big deal but this time gets swamped as the “other” category rises by £36.1 billion. We can start to break that down.

This month we have recorded the expenditure associated with the Coronavirus Job Retention Scheme (CJRS) for the first time. CJRS is a temporary scheme designed to help employers pay wages and salaries to those employees who would otherwise be made redundant……..In April 2020, central government subsidy expenditure was £16.3 billion, of which £14.0 billion were CJRS payments.

A fair bit of the amount below would have gone on the NHS.

Departmental expenditure on goods and services in April 2020 increased by £7.1 billion compared with April 2019, including a £1.2 billion increase in expenditure on staff costs and a £5.7 billion increase in the purchase of goods and services.

Also I did say they were pouring money into local government.

Central government grants to local authorities in April 2020 increased by £14.2 billion compared with April 2019, mainly to fund additional support because of the COVID-19 pandemic.

The only gain was from lower inflation

Interest payments on the government’s outstanding debt in April 2020 were £5.0 billion, a £1.2 billion decrease compared with April 2019. Changes in debt interest are largely a result of movements in the Retail Prices Index (RPI) to which index-linked bonds are pegged.

Tax Receipts

This is an awkward category as it relies on past patterns and well you can guess the rest. But they have tried to come up with some suggestions.

In April 2020, central government receipts fell by £16.4 billion compared with April 2019 to £45.6 billion, including £29.6 billion in tax revenue.

They have tried to allow for the lower level of activity although sadly the numbers they have used have come from the Office for Budget Responsibility or OBR. For newer readers the first rule of OBR Club is that it is always wrong.

We do get some further clues from the Retail Sales numbers also released earlier.

The volume of retail sales in April 2020 fell by a record 18.1%, following the strong monthly fall of 5.2% in March 2020.

As you can see VAT receipts will be hit as will income tax payments from many shop workers. Also we got evidence that there was a lot of panic buying of food when the pandemic hit.

The fall of 4.1% for food stores was mainly due to a fall back from the strong growth of 10.1% in March 2020. Retailers provided feedback of panic buying in March, which caused a sales spike.

Also I hope that you are all sober when you are reading this.

In April, 13.6% of alcohol and tobacco stores reported having zero turnover, however, the volume of sales for these stores increased by 2.3%; a further rise from the strong growth of 23.9% in March.

As you can imagine a trend we have been noting for some years got another boost.

Online sales as a proportion of all retailing reached a record high of 30.7% in April 2020, exceeding the original record reported last month of 22.4%. All sectors reached their highest-recorded proportions except non-store retailing, which reached record proportions in February and March 2020, both at 83.2%.

As well as being sober I hope you are dressed reading this.

The sharp decline in April 2020 has resulted in the lowest levels seen in the volume of textile, clothing and footwear sales since the beginning of the series, when March 1988 was at a similar level.

Last Month

The uncertainty about the amount of tax receipts is highlighted by what has just happened to the March data.

Borrowing in March 2020 was revised up by £11.7 billion to £14.7 billion, largely due to a reduction in the previous estimate of tax receipts and National Insurance contributions and the recording of expenditure associated with the Coronavirus Job Retention scheme.

The main player here was this.

Additionally, the subsidies paid by central government in March 2020 have been increased by £7.0 billion to reflect the additional CJRS payments not previously recorded.

National Debt

This comes with some caveats but the ONS has tried to allow for an expected lower level of economic activity here so fair play.

The Bank of England’s contribution to debt is largely a result of its quantitative easing activities via the Bank of England Asset Purchase Facility Fund and Term Funding Schemes.

If we were to remove these temporary effects, debt at the end of April 2020 would reduce by £184.5 billion (or 9.6% percentage points of GDP) to £1,703.1 billion (or 88.1% of GDP).

Of course we know about the word “temporary” as regards Bank of England activities! However I have always thought it odd ( and frankly a bad design) where the Term Funding Scheme ended up inflating the national debt. Losses on it should be counted but there is collateral held so any net impact should be far lower than the gross.

The only flaw here is the use of an OBR scenario as I have explained above, but it is a worthy attempt none the less.

Comment

I thought I would now spin things around a little because if this was a film there would be no demand for any with titles like “Revenge of the Bond Vigilante’s”. Over the past week or two the UK has in fact increasingly been paid to borrow, so in fact we now inhabit a sort of anti matter driven Bond Vigilante universe. I have been noting for a while that the two-year UK Gilt yield has been on the edge and it has been slip-sliding away this week to -0.07%. It has been joined by the five-year which is now -0.02%.

Now let me shift to the causes of this as at first the Bond Vigilantes will be revving up on the start line.

In April 2020, the Debt Management Office (DMO) issued £51.7 billion in gilts at nominal value, raising £58.5 billion in cash. This represents an unprecedented increase in gilts issuance (at nominal value) compared with March 2020.

But the Bank of England has stepped in with its QE purchases.

At the end of April 2020, the gilt holdings of the APF have increased by £43.7 billion (at nominal value) compared with the end of March 2020,

As you can see this effectively neuters a lot of it and let me bring you right up to date. This week the UK debt management office has been working hard and issued some £16.5 billion of UK Gilts but if it was a race the Bank of England has only been a few paces back as it bought some £13.5 billion. Also the Bank of England has been driving us into negative yields by for the first time buying them as it has done on at least 4 occasions this week.

So we borrow enormously and can do so at record low yields. So for now we are “lucky” according to the definition provided by Napoleon. On the pattern so far we may see our benchmark ten-year yield go negative as well ( currently 0.14%). One consequence of this is I expect cheaper fixed-rate mortgage deals as the five-year yield is my proxy for that and it has gone negative. If the banks are as “resilient” as we keep being told they will be slashing rates. Meanwhile back in the real world we may see some mortgage rates being trimmed.

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