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.
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.
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.”
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 )