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 )

 

 

 

 

Is the UK in recession or not?

Today sees or if you read this later has seen the announcement of a new UK Prime Minister. Most likely Boris Johnson but possibly Jeremy Hunt faced some unwelcome news from the National Institute for Economic and Social Research or NIESR yesterday.

Economic growth has stalled and there is around a one-in-four chance that the economy is already in a technical recession.

The opening part of the statement is true as the 0.5% GDP growth in the first quarter will not be repeated and the Bank of England has reduced its forecast from 0.2% to 0%. What they did not say is that as we look at our peers this is a pretty common phenomenon. For example both Germany and Italy fear a contraction in the quarter just gone as this from the latest Bank of Italy economic review points out.

In the second quarter, economic activity in Italy may have remained unchanged or decreased slightly; it was affected by the weak industrial cycle, common to Germany too, caused by persisting trade tensions.

Actually more disturbingly the Bank of Italy thinks things may then get even worse.

The Bank of Italy’s surveys show that firms expect a slowdown in demand over the next few months and indicate a very modest growth in planned investment for the current year.

France seems to have a little growth but not much so the general picture is weak.

Then we get to the phrase “technical recession” . Sadly they do not define this as some describe this as the formal version which is two quarters of economic contraction. If they mean a monthly fall because of course we have monthly GDP data then they are in a bit of a mess because we got this in December.

 However, monthly growth contracted by 0.4% in December 2018 ( UK ONS )

Then it grew by 0.5% in January so quite what that tells us I am not sure about from the monthly date being very volatile.

What is the current position?

Here the monthly GDP review from the NIESR.

The UK economy is on course to contract by 0.1% in the second quarter of 2019. Two quarters of contraction would mean that the economy is in a technical recession, but the initial outlook for the third quarter of 2019 is for growth of 0.2% . If correct, that would still imply that the economy has lost significant moment since the first quarter.

Okay so we learn that recession would have done. I guess they thought it would attract the media more if they used technical recession. Anyway they do not think we will have a formal recession and as it happened the Office for National Statistics suggested we seem to have moved away from a quarterly contraction. Here are its new faster indicators of economic activity. These are not national statistics but then one of its best measures ( RPI) is not either.

The all-industry quarter-on-quarter turnover diffusion index was 0.02 in Quarter 2 2019, slightly above its 2008 to 2018 average; the level of 0.02 means there were very slightly more firms reporting an increase in turnover between Quarter 1 (Jan to Mar) 2019 and Quarter 2 2019 than the number of firms reporting a decrease in turnover between the two periods……..The quarter-on-quarter turnover diffusion index for the services industry was 0.03 in Quarter 2 2019, substantially above its historical average.

Care is needed as for example to get a real number from turnover you need an inflation measure or deflator. But the services number seem hopeful as it is by far the main player in the UK economy.

The Value Added Tax (VAT) indicators show a mostly positive picture for Quarter 2 (Apr to June) 2019.

Moving on the road traffic data for lorries was slightly weaker in May which may well be welcomed in a general sense but less so for the economy. Shipping traffic however went the other way.

The number of ships visiting important UK ports increased in May 2019 to its highest level since comparable data became available in October 2018. The number of ships was 9% higher in May 2019 than April 2019, although these data are non-seasonally adjusted.

Of course in July we have become rather obsessed with the number of UK ships in Iranian ports! Actually the link between that ship and the UK seems a bit tenuous but there you have it. Also I wonder what an unimportant port is?

Brexit

I agree with the “very murky” bit.

The outlook beyond October, when the United Kingdom is due to leave the European Union, is very murky indeed with the possibility of a severe downturn in the event of a disorderly no-deal Brexit.

For a start we may not leave in the same manner that we did not leave at the end of March. Also the NIESR has reined back its rhetoric in this area.

On the assumption that a no-deal Brexit is avoided, the economy is forecast to grow at around 1 per cent in 2019 and 2020 as uncertainty continues to hold back investment and productivity growth remains weak.

This continues here.

In our main-case forecast scenario, economic conditions are set to continue roughly as they are, with high levels of employment and capacity utilisation but slow growth as businesses refrain from investment in view of continuing high uncertainty about future trading relations. CPI inflation would continue to be close to target.

That is a change from back in the day when we were told this.

In the longer run, our analysis suggests that it would lower GDP by between 1.5 per cent and 7.8 per cent in 2030, also compared with a world in which the UK voted to remain.

Of course we might be lower than otherwise in 2030 but in most scenarios we would have very little idea how true it was. They think a no-deal scenario would hammer 2020.

 In an alternative orderly no-deal scenario, we would expect GDP growth to fall to zero in 2020 and CPI inflation to rise above 4 per cent in response to a lower exchange rate and accommodative monetary policy.

This next bit I found interesting because we keep being told we need more fiscal policy, whereas in this report it does not have much impact.

Fiscal policy measures may be required to help smooth the adjustment to a no-deal Brexit though, as shown in Box C, they would be unlikely to have a large macroeconomic effect.

Comment

So we see that for all the column inches devoted to it there was in fact much less to the NIESR report than you might think. One of the signals I report on regularly has been flashing a warning for some time. This is the issue of UK Gilt (bond) yields. Both the two-year and five-year yields are below 0.5% suggesting yet another interest-rate cut is on the cards. So the general consensus is for weak growth at best. Also that view seems to be spreading as this from a Markit survey suggested yesterday.

There were some noteworthy developments in
interest rate expectations in July, as the proportion
of UK households predicting the next move by the
Bank of England to be a cut rose to its highest in
over two-and-a-half years.

Tucked away in the report was a hopeful signal which correlates with the recent strong retail sales growth.

UK households continued to signal decent growth
of incomes from employment, which corroborates
what recent ONS data have shown and is a positive
indication for consumer spending this summer.

If we remind ourselves of my view that the UK economy has been growing at around 0.3% per quarter for a while then after 0.5% in the first quarter we would literally expect ~0.1% in the second. With the inaccuracies in the data and the problems around the world signalled by the trade data in the Pacific we looked at yesterday we could see a negative quarterly number for growth. However we would be very unlikely to be alone….

 

 

What does UK tax revenue tell us about economic growth and GDP?

One of the ways of measuring the economic output of an economy is to look at the tax revenue it raises. We do this because of the fact that there are a litany of weaknesses with the economic growth or GDP (Gross Domestic Product) numbers we receive. Only on Wednesday they received a critique from the labour market update where the employment situation was markedly different to the economic growth numbers. In the quarter just gone the extra hours worked (1.7%) far exceeded the economic growth of 0.5% which after the construction and industrial production updates is in danger of becoming 0.4%. So tax revenue received gives us a check on the state of play. If we look wider afield we see that one of the signs of the “lost decade” in Japan has been its inability to raise its tax revenue as the problems created by the latest Consumption Tax increase have shown.

Why this month?

January is the month in the UK when the self assessment forms have to be sent in by and income related  taxes paid. There will be some overflow to February for it all to be accounted for but we get a look at a sector which the official average wages figure ignore. They have a threshold of 20 employees and so miss smaller businesses and the growing number of self-employed which means that they are exactly what a data series should not be which is skewed and biased.

The pattern for Income Tax

If we look back we see that the employed or Pay As You Earn (PAYE) version of this generated receipts of £130.9 billion in 2008 tax year. If we compare like for like we see that it fell and  then bounced in 2011 but was then stable until 2014 when it rose to £138.3 billion and £145.1 billion in 2015. So we see some backing for the economic improvement from 2013 onwards although of course we have the issue that inflation has eroded this but pulling the other way has been the rise in the personal (tax-free) allowance albeit one offset somewhat but the failure to raise higher-rate thresholds. So the picture here is murky and hard to determine.

If we move to today’s numbers then again we get some backing for the UK economic improvement as the £12.33 billion of this January was a 5.4% rise on the £11.7 billion of the same month in 2015.

What about self-assessment?

Care is needed here as some of the money is recorded in February but today’s numbers did come with some disappointment.

Self-assessed income tax receipts increased by £0.2 billion to £12.4 billion in January 2016 compared with January 2015.

That is only a 1.6% rise and it is hard not to think of the increasing numbers of self-employed as I type this. After all on Wednesday we were told this.

self-employed people increased by 154,000 to 4.66 million

Care is needed as we are not comparing like for like as we do not have the January numbers here and it is not only the self-employed who are self-assessed. But a 1.6% rise seems a bit thin as we note an increase of 3% in their numbers. Have their wages fallen and if so what does that tell us?

So we have an odd picture here where the employed income tax numbers look excellent whilst – with caveat s- the self-employed ones are worrying and may show a decline.

Value Added Tax

This was suggested as an indicator in the comments section and the rationale behind this is simply that it gives us an idea of how much is being sold in the economy and thereby taxed.If we look back the picture is muddied by the changes in its rate but 2007 saw receipts of £92.02 billion to give you a sighter but for the reasons explained 2011’s £111.5 billion is more of a benchmark. We have seen a genuine pick-up here as 2013’s £118.2 billion was replaced by 2014’s £124.2 billion and 2015’s £128.4 billion. Perhaps the numbers are better than they look if we allow for a higher rates of avoidance and evasion in response to the rise to a 20% rate of VAT.

If we bring this up to date we see that VAT revenue is performing.

VAT receipts increased by £3.8 billion, or 3.7%, to £108.2 billion ( in the tax year to January).

This should not be a surprise as at the same time we received another excellent set of retail sales figures in the UK.

Year-on-year estimates of the quantity bought in the retail industry showed growth for the 33rd consecutive month in January 2016, increasing by 5.2% compared with January 2015.

The driver behind this has been the fall in retail prices which as I pointed out on the 29th of January last year has been an economic benefit.

Today I wish to challenge a piece of economic orthodoxy which is that lower prices are bad for us.

The 2.6% fall in prices over the year to January has been accompanied by the strong volume increase shown above. Also the 2.4% increase in spending (rounding means this doesn’t quite add-up) has fed into better VAT numbers helping the Exchequer. So far this tax year we have collected some £108.2 billion of VAT.

Stamp Duty on houses

Regular readers will be aware that it is my opinion that the Bank of England lit a fire under the UK housing market with its Funding for Lending Scheme in the summer of 2012. Thus we should see quite a pick-up in Stamp Duty receipts if the theory hold water. Well how does £6.7 billion in 2012 followed by £8.7 billion in 2013 and £11.1 billion in 2014 grab you? There was a slight fading in 2015 to £10.77 billion but it was still some 61% up on 2012.

I am not sure it could be much clearer and if other taxes had done the same we would be home and dry!

Comment

We find that the UK revenue numbers do provide a guide to what has been going on in the UK economy. We can see that whilst the medium-term picture is murky due to all the changes we see to be getting a solid increase now in both income tax (4.7%) and national insurance (3.5%) in the year so far. However whilst we only have a partial picture it looks as though the employed have been doing much better than the self-employed.

The VAT figures are more bullish in that they have a clearer rising pattern with the economic improvement and as they reflect the surge in retail sales seen in 2015 and so far 2016. It will not be too long before we find that reflected in the balance of payments numbers I suspect but enough of that for now. The clearest surge has come from Stamp Duty on houses! As Turkish pointed out in the film Snatch “Who da thunk it”

My musical summary comes from the delightful Sheryl Crow.

Everyday is a winding road
I get a little bit closer
Everyday is a faded sign
I get a little bit closer to feeling fine

Oh and as to the January Public Finances they appear to be a little better but it is hard to be clear as you see the expenditure figures have confused the concepts of up and down.

Number Crunching

We are regularly told that there is no inflation. Today I got news that my gym and track membership at (the public) Battersea Park Millenium Arena is rising from £28 to £30 per month or 7%. Whilst the Guardian reports quite a surge in Probate Fees.

The flat £215 fee will be replaced with a new system of tiered charges that would result in some paying as much as £20,000 for estates worth more than £2m.

For estates worth between £500,000 and £1m the new fee will be £4,000, rising to £8,000 for those worth between £1m and £1.6m, and £12,000 for those valued at between £1.6m and £2m.