Opinion: Clegg half-way there on tax cuts

The Liberal Democrats made a significant step forward at their Conference last week when we passed the Make It Happen policy paper.

The main issue of the debate revolved around Nick Clegg’s pledge to cut billions of pounds from the income tax of low and middle income families. The party has broadly welcomed this, though many have accepted it only as long as it is accompanied by a promise that the overall tax-take will remain the same, and that richer people should shoulder more of the tax burden.

This redistributionist error was sadly reinforced by Clegg himself in an otherwise excellent interview with The Times, in which he said:

Economically it makes no sense when you are heading into recession to give tax cuts to the better off because they will just save them. You have to give them to people on lower incomes who will transfer them into consumption on food and fuel.”

In this he is half-right. Wealthy people do save additional income, whereas poor people spend it. Right now, who wouldn’t love to squirrel away spare money into an ISA so that they have something in reserve? But when your children are growing out of their shoes, or you haven’t had a holiday in three years, you are more likely to spend a few hundred quid in tax relief than save it. On this point, at least, Nick is correct.

Unfortunately though, there is no long term prosperity as a consequence of such a policy. Rather, it is based on one of the most fundamental economic fallacies: one of which the leaders of all three political parties – and even (dare I say it?) Vince Cable – are guilty. This is the assumption that consumption drives growth.

This is utter folly. Consumption is important to a healthy economy, but growth can only be achieved through investment, and investment is a euphemism for saving. And it is growth, not redistribution, that is the real root to prosperity.

Growth averaging just 3% per annum will double household incomes within a generation. By comparison, there is no level of redistribution that could double the household incomes of the majority of the population.

To put it another way, the only way that real wages can rise is if the productivity of workers rises. This requires investment in new plant machinery, new IT solutions and training for employees. This can only come from companies and investors. In addition, this productivity rise makes consumer goods cheaper (which is the equivalent of making consumers richer) and creates new jobs (as productivity overtakes wage costs) so that unemployment is reduced.

So while Nick is right to say that “the better off … will just save [tax cuts whereas]… people on lower incomes … will transfer them into consumption” he is utterly wrong to say that “Economically it makes no sense”. Economically, it is vital.

Politically, however, tax cuts for businesses and entrepreneurs are unpalatable. Our party, much like the other two, often suffers from the reactionary instinct of “something must be done”; yet while noble sentiments lead Liberal Democrats to want to tackle poverty urgently, we should consider how these goals are best served through overall increases in prosperity. The long term interests of everyone in society – and of the poorest most of all – are best served by tax cuts that will ensure that our children are twice as prosperous – that their lives are twice as easy – as ours. Temporary relief is no substitution for such prosperity.

Scepticism over such tax cuts at least recognises the political realities of the 21st century. No matter how correct the economics, it would be impossible to implement tax cuts solely for businessmen and companies, because the vast majority of voters would understandably ask why their taxes are not being cut while those of £billion businesses and rich oligarchs are.

What is needed, therefore, is a sort of liberal realism that recognises that lowly paid workers, who form the bulk of the electorate, will want to see some of the short-term gain that their richer peers will enjoy as they wait for the longer term growth-benefits to kick in. One might suggest that a little honey today keeps us sweet until tomorrow’s jam arrives.

So Nick Clegg and Vince Cable are half-right to advocate tax cuts for those on low and middle incomes. These are indeed vital, not primarily as poverty-reduction tools but as symbols of the fairness that the party holds so dear. These in turn will buy support for the tax cuts that will make a real difference to the prosperity and so the lives of every person in this country (and to the poorest most of all): tax cuts for businesses, investors and entrepreneurs.

The great lesson of liberalism is that it is not only from one’s own wealth or prosperity that one can benefit, but also from that of others. To put it another way, it is not from benevolence that we expect our dinner, but from others’ regard to their own interest.

The Lib Dems were right to cut taxes for the poor. Now, for the benefit of the poor most of all, it is time to cut taxes for the rich as well.

* Tom Papworth blogs at Liberal Polemic, where (he tells us) “you can read a more in-depth explanation of the relationship between tax cuts, investment and prosperity for all”.

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34 Comments

  • Sorry but saving and the type of investments you talk about are two different things

  • I wouldn’t claim any kind of expertise, but I think the bald assertion of plainly contentious economic theory as though it is factual makes this barely worth reading.

    You can’t get away with saying the Clegg position is ‘half right’. It’s just a dishonest way of assigning your own totally different view credibility that it doesn’t do anything to deserve.

    Clegg couldn’t be clearer that he thinks (along with a lot of people) that ‘trickle down’ economics is fundamentally flawed. There don’t seem to be any shortage of politicians out there who disagree with him about that, but none that I’m aware of in our party.

    You seem to be trying to argue – pretty disingenuously – that economic growth and fairer distribution of wealth (or indeed fairer distribution of the burden of taxation) are mutually exlusive. Why?

    The observation that:

    “there is no level of redistribution that could double the household incomes of the majority of the population”

    is a pretty unremarkable statement. Have you ever seen anyone argue the contrary?

  • Rather than tax cuts for the rich, you could, of course, give tax cuts to the poor and then provide additional incentives for them to save more. Or you could boost growth by spending more on Britain’s crumbling infrastructure…

  • I suggest reading up on the paradox of thrift. The increased proportion of saving leads to a reduced level of aggregate demand, with the resultant consequence of reduced employment and growth. Total savings equals total investment at equilibrium, it is true, but aggregate income has fallen and planned investment has remained constant or even declined slightly due to lowered aggregate income so the greater proportion of saving at the now lower income and output levels at best doesn’t make any difference to the overall level of savings or investment in the economy and may actually be lower. However, employment and aggregate income has fallen aggravating the effects of a recession.

    JM Keynes is part of our Liberal heritage. Be proud of it!

  • Summary in five words plz

  • Laurence Boyce: “go further by matching the Tory inheritance tax cut”

    Never!
    Isn’t inheritance tax rather an important symbol of a commitment to social mobility?

  • Iain Coleman 25th Sep '08 - 12:50am

    The majority of the rich may well have worked jolly hard, but a lot of poor people work jolly hard too. And the rich can afford to pay a little bit more because they have more money.

  • julian astle 25th Sep '08 - 10:58am

    if anyone wants to read a knock-down argument as to why the Tories (and to a lesser extent the government) are wrong to prioritise IHT cuts, they should read this by Irwin Stelzer.

    http://www.spectator.co.uk/the-magazine/features/269796/listen-to-adam-smith-inheritance-tax-is-good.thtml

  • Iain Coleman 25th Sep '08 - 3:44pm

    Taking money from people who have it is clearly a much better strategy than taking it from people who don’t.

    And if we’re concerned about distributing the tax burden fairly, then the diminishing marginal utility of money is a key concept.

  • David Heigham 25th Sep '08 - 4:03pm

    The priorities for tax policy in the UK now are:

    1. Sorting out the mess at the bottom of the income tax scales where tax credits, benefit withdrawals and a number of other G. Brown meddlings like variable personal allowances, create a lot of marginal dis-incentives to behaving productively and sensibly, and millions of errors in claims and payments. The best way to do this is cut income tax at the bottom.

    2. Transferring to local authorities and to devoved governments clear responsibility for raising the taxes to fund their expenditure. We won’t effectively decentralise British government until we do it.

    3. Removing tax on saving, which is not the same as cutting tax on the rich; even though they will benefit from it. This matters for sorting out pensions as well as for future prosperity. Quite a bit of progress has already been made on this; but it is messed up because it has all been done in bits, many of which intract with baffling Brownian complexity.

    It is a good liberal principle that money fructifies in the pockets of the people (and a good liberal and democratic principle that people should be able to choose and pay for the quality of public services they want), but Tom Papworth seems to have the wrong end of that stick for the here and now.

  • Clegg's Candid Friend 26th Sep '08 - 1:32am

    Never mind all this political stuff! This online encyclopaedia that anyone can edit has got badly out of control and obviously needs help with the accuracy of its article on Nick Clegg:
    http://uncyclopedia.org/wiki/Nick_Clegg

  • Clegg's Candid Friend 27th Sep '08 - 12:14am

    Nick Clegg has suggested – and I promise this doesn’t come from Uncyclopedia – the establishment of a national minimum price for alcohol:
    http://www.politics.co.uk/news/opinion-former-index/health/clegg-calls-minimum-price-on-alcohol-$1242471.htm

  • I don’t think the argument is convincing,
    not least because the idea that rich people invest and poor people don’t is at the very least, not universal.

    Do we suggest the micro-investment in thrid world countries is less life improving than giving billions to dictators?

    How is conspicuous consumption and waste by the rich better than investment by the poor?

    The logic of the article is that the more money I give to Richard Branson, the better off I will be, ad infinitum.

    One of the reasons poor people remain poor is not because they rush out to spend on their money on beer fags and flat screen TV’s, it is because they do not have capital to invest.

    The rich don’t pay far more tax – they pay less as a proportion of their income.

    I can’t agree that some people need a £2 million inheritance allowance when some people won’t be inheriting anything. In anycase, the idea that inheritance Tax hits anyone with a bit of money and a house is not backed by the evidence.
    The reality is that people who inherit £2 million from their parents will find it slightly easier to buy a house, pay tuition fees and start their own business (buy to let properties?) than the person who’s mum is on benefits.

    David Lloyd George got it right years ago when he said wealth was like water, too much and it forms stagnant pools, too like and you get deserts (think sink estates)what wealth needs is irrigation in the form of redistribution.

  • Clegg's Candid Friend 27th Sep '08 - 9:30am

    Joe

    I know the BBC isn’t always 100% reliable, but this report says “And as the Liberal Democrat leader and city MP Nick Clegg called for a minimum price to be set for alcohol …”, which seems clear enough:
    http://news.bbc.co.uk/1/hi/england/south_yorkshire/7638589.stm

    This Sky report says the same, and says “He also cited the Canadian province of Ontario as an example of the policy’s successful implementation”. As far as I can see, Ontario does stipulate a minimum price for the sale of alcohol. The Sky report also has this direct quotation from Clegg:
    “As a rule, I don’t believe governments should set prices, but when retailers are deliberately distorting the market we need to take action.”
    http://news.sky.com/skynews/Home/Politics/Nick-Clegg-Liberal-Democrat-Leader-Calls-For-Minimum-Alcohol-Price-To-Prevent-Binge-Drinking/Article/200809415107895?lpos=Politics_News_Your_Way_Region_9&lid=ARTICLE_15107895_Nick_Clegg_Liberal_Democrat_Leader_Calls_For_Minimum_Alcohol_Price_To_Prevent_Binge_Drinking

  • Alex Sabine 28th Sep '08 - 3:01am

    I agree with much of Tom’s logic here and also with his conclusion that we should be looking to reduce overall taxation rather than simply redistributing the burden between different groups. But I don’t agree with his contention that (in principle if not in practice) we should prioritise tax cuts for the wealthy over those for low and middle income earners.

    First a few points of rebuttal:

    1. Tom says of the Make It Happen tax policy: “the party has broadly welcomed this, though many have accepted it only as long as it is accompanied by a promise that the overall tax-take will remain the same, and that richer people should shoulder more of the tax burden.”

    This is only half-right. Yes, the redistributive aspects of the tax policy were emphasised by its proponents, and no doubt this helped to ensure that it received broad support from party members of differing ideological stripes.

    But the redistributive element – funding a 4p cut in the basic rate of income tax partly through increased taxes on the better off – was already party policy.

    What was new about the motion passed at conference was that we endorsed a reduction in the overall tax burden (albeit by an unspecified, and probably quite small, amount), to be financed by lower government spending.

    So while there was indeed a promise that richer people should shoulder more of the burden, we have expressly NOT promised that the overall tax take should remain the same; rather, we’re saying it should be lower. (How much and by what means is another matter, but my point is that a shift has taken place compared to our previous position.)

    2. GavinS accuses Tom of stating the obvious or setting up a straw man when he claims that “there is no level of redistribution that could double the household incomes of the majority of the population”.

    The problem is that the discourse on taxation within soi-disant progressive parties (as on ‘competitiveness’ within the Tory party and business lobby groups) often seems to assume that economic activity is a zero-sum game, and that one group of people (or one nation) can only get richer at the expense of another.

    Whereas in reality, prosperity is not in most respects contested; all citizens and all nations can become richer at the same time. The main reason why the poor today are incomparably richer than 150 years ago is economic growth, not redistribution through tax and benefit systems.

    The salience of this point to the debate about tax is that high tax rates can clearly affect incentives, location/investment decisions etc. It’s not much use pursuing an aggressively redistributive policy if it reduces economic growth, unless of course the aim of the policy is symbolic (a self-righteous warm fuzzy feeling) rather than the substantive goal of alleviating poverty.

    I think Tom’s point is that even if redistributive taxation can help to reduce poverty, history has shown it to be a less powerful means of doing so than economic growth. Policies which ostensibly help the poor but inhibit growth are counter-productive and we should reject them.

    3. Nick Clegg’s rejection of ‘trickle-down’ economics is, I think, based on (at least) two arguments, both of which are valid but do not refute Tom’s case about encouraging investment and thereby productivity growth.

    The first is a matter of equity: Justice demands that tax cuts are ‘for the many, not the few’, particularly when in the UK the bottom 20% of the income distribution currently pay a larger proportion of their income in total taxes than the top 20%.

    His second argument is a macroeconomic one: that cutting taxes at low and middle income levels is more likely to boost consumer demand at a time when the faltering economy may need a demand-side stimulus.

    You can debate whether or not discretionary fiscal policy is effective, but the claim that low earners are more likely than higher earners to spend the money handed back to them in tax cuts and therefore to stimulate demand is pretty uncontroversial even among economists.

    I don’t think that by advocating this Nick and Vince are necessarily saying that consumer spending is the basis for improving the trend rate of GDP growth; merely that it could play a useful role in cushioning the downturn.

    (In fact, this isn’t really a classic Keynesian counter-cyclical policy in any case because that would involve the tax cuts to be financed by borrowing rather than by a combination of tax increases elsewhere and spending cuts; but because lower earners have a greater propensity to consume, it could still have the effect of stimulating demand.)

  • Alex Sabine 28th Sep '08 - 3:08am

    A couple of other substantive points:

    1. The thrust of Tom’s argument is that policies that superficially benefit one group of people (say, lower corporate taxes) can in the long run wind up benefiting another group (say, low and average wage earners).

    As he writes on his blog, “capitalists invest in improving the efficiency of production so that they can enhance their profits, but in the process they make the goods we buy cheaper and make our labour more productive, so increasing real wages”.

    This is easily caricatured as ‘trickle-down’ economics but in fact it simply recognises the crucial role of capital accumulation in economic growth.

    The key reason why we are richer than two centuries ago is that we have accumulated machines (in the widest sense of the word) that do things for us, and those machines carry with them the benefit of accumulated know-how.

    This has required investment – devoting resources in past years not to that year’s consumption but to accumulating productive capital for future use.

    To this extent it is investment, rather than consumption, that drives long-term economic growth. And in a capitalist economy this involves businesses investing from post-tax profits.

    (Of course, it’s not just the amount of investment that matters but also the quality; if only the quantity mattered the communist states would have been economic nirvanas. Increasing investment will tend to decrease marginal return, since few people’s love of future generations is so great that they will go on saving and investing until every positive-return project has been exhausted.)

    2. Laurence is right to point out that rich people already pay a lot of tax in the UK today. In fact, the richest 1% pay 23% of total income tax receipts and the richest 10% pay more than 50%.

    So they pay a lot more in absolute terms, which is important because without that money the government would have a whole lot less money to fund hospitals, schools, defence, police etc. They also pay a higher marginal rate (40%, versus 20% for the majority of taxpayers – although Gordon Brown has used fiscal drag to bring many more people into the top tax bracket) and therefore a higher proportion of their income.

    So the good news is that the current income tax system is in fact highly progressive. The problem is that when we look at the tax system as a whole, we find that the poorest 20% actually hand a higher proportion of their income to the taxman than the richest 20%.

    They do so because many other taxes – National Insurance, VAT, council tax, tobacco duty and some green taxes, for example – are borne disproportionately by the less well-off.

    Overall, therefore, the tax system is regressive and actually worsens income inequality. This is the case not just because of specific iniquities that we must rightly address, but because the state is too large, requiring low/middle earners to be heavily taxed.

    Of course, you might argue that the public spending funded by these taxes that ensures a fairer society. But, as Denis Healey – not exactly a right-wing firebrand – pointed out in his autobiography two decades ago, a social-democratic-sized state requires heavy taxation of the average man and woman, since there aren’t enough rich people to pay for it and they won’t stay in the country if tax rates become punitive.

    In fact, it’s worth noting that in the tax year 1978-79, when the top rate of income tax in the UK was 83%, the richest 1% contributed 11% of total income tax receipts; as the rate was lowered (to 60% by Geoffrey Howe in 1979 and then to 40% by Nigel Lawson in 1988, where it has remained), the richest 1% contributed a steadily rising share of total receipts, to the point where they account for 23% today.

    In the spirit of Tom’s broader point, we might ask who was more progressive: Denis Healey or Nigel Lawson?

    So while it may be tempting to believe that tough choices on spending can be avoided and all our policy whims realised by higher taxes at the top, it is largely a chimera.

    That’s not to say that we shouldn’t address specific tax loopholes and anomalies, but we should base policy on something more sophisticated than a populist and unattractive impulse to fleece “the rich”, and we should recognise the limited revenue it is likely to yield.

    If people want to support a state on the current scale, fine; but don’t be surprised that the tax system that finances it is regressive.

    Personally, I would prefer a smaller state financed by a more progressive tax system in which low and middle earners pay substantially less than they do now.

    How to achieve that is a debate in itself, but we could start by tackling the fiscal “churn” in Brown’s labyrinthine tax credit system, allowing low-paid people to keep more of their own money; phasing out the industrial and agricultural subsidies that distort competition and enrich producers (the few) at the expense of consumers (the many); and axing the corporatist Regional Development Agencies and numerous other quangos that suck autonomy away from both the public and private sectors.

    Apologies for the marathon posts, but since taxation is currently a hot topic in both the party and the country, I thought it was worth tackling seriously and in detail.

  • A different take –

    I would suggest a few simple principles for a tax system – they may not be deliverable but I think they are worth considering.

    1) The tax system is current not progressive. The reason the Lib Dems were right to drop the 50% income tax on high earners is because most of them don’t currently pay the 40% rate.

    That is why the Party has switched the focus onto closing tax loopholes, tax avoidance and tax allowances for the better off.

    2) We agree that punative tax rates act as a disincentive to enterprise, investment and hard work. But this applies to everyone, not just a select few.

    Therefore over the life time of two parliaments, the Lib Dems will seek to eliminate marginal tax rates of above 50%. It is not right for example that someone should be worse off if they work overtime or get a payrise.

    So along with fairness, we would seek to restore aspiration to our tax system.

    Obviously commentators might see this a a blatant pitch for both ex-Labour voters (fairness) and likley conservative voters (aspiration and rewarding hard work). It might also be seen a blatent pitch for the ‘common sense’ vote, people who can’t understand why someone struggling to get off benefits migt pay tax at over 100%.

    Apparently, the richest 10% of taxpayers pay more than 50% of income tax. So you can see how much more income they have than most other people. So why is it the pensions incentives offer 40% tax relief to these people, 20% to people on average income and leaves those least able to save with no tax relief?

    Lib Dems want to unleash the ability of the British people. As over time, our policy reduces the cost of beaucrcay, benefits and watse talent – we will free up money to reduce the overall tax burden.

    To vote Conservative will be ground hog day – Blair all over again.

    It is not society which is broken, it is our politics which is broken. A 19th century system in the 21st century.

    If the car is broken, it’s no good changing the driver. If you want to fix the car, you don’t go back to the garage that failed to fix it last time. So if you want real reform not just a change of faces, now is the time to support the Lib Dems.

    Don’t vote for the parties that got us into this mess. Vote for the party that will get us out of this mess.

  • > how much of a difference would it make if regressive taxes such as VAT (and the vast duties on cigarettes and alcohol) were reduced (as well as quasi-taxes like the “TV licence”)?

    I don’t know, but if you are on minimum wage and paying 20% income tax, 11% National Insurance and then have to pay 17% Vat on something, then the overll tax take on that £1 of your income is high.

  • David Allen 29th Sep '08 - 7:25pm

    Thanks Tom, for comprehensively blowing the gaff on “Make It Happen”. Clegg is, as you say, halfway along a well-worn course, from liberal to conservative, that far too many people follow as they get older.

    David Owen followed a similar trajectory. When he defeated Jenkins for the SDP leadership, he claimed to be the more “radical” of the two candidates. He likewise presented his new-found free-market enthusiasm as being balanced by a fervent commitment to redistribution (and even “socialism”). Once elected, Owen’s redistributionist claims could be allowed to gradually wither away.

    We know the consequences. Years of chaos, a Party that lost its course, and a messy division and eventual renewal. Owen, meanwhile, eventually ended up endorsing John Major.

    I fear that it will all happen again. Nick, can you prove me wrong?

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