Finance and economics: what we have learned, and what still needs to be done – part 3

This week Liberal Democrat Voice is running a series of articles from Tim Leunig about the economy – how we got here and what we should do next. So far the series has covered bank bailouts and bank lending.

Fiscal policy

Much has been written about the need for a fiscal boost. The debate has been poor, with politicians and the media muddling up underfunded tax cuts, tax cuts funded by spending cuts, and tax cuts funded by rises in other taxes. The last two have no impact in this context, and will not be considered.

Underfunded tax cuts, or unfunded spending rises, are not what Britain needs at the moment, for three reasons. First, the British government has spent the last 10 years spending as though there were no tomorrow. Tomorrow has now arrived and the kitty is bare. We have one of the world’s highest structural deficits. There is talk of the deficit rising by more than £200 billion over the next couple of years. You would have to more than double income-tax to pay that off. Even if you wanted to pay it off over 10 years it would require a huge rise in taxes. Or we could never pay it off, and pay £10bn+ a year in extra interest payments, for ever. But £10bn is not trivial – if we had done the same in the last downturn, which £10bn of recent public expenditure would you be happy to see disappear to pay higher interest payments? Or do you prefer £10bn in extra taxes? If we were Australia or Canada, who have big surpluses, then we could think about a fiscal stimulus. But thanks to the least prudent chancellor since Anthony Barber, we do not have that option.

Second, a fiscal boost may not be needed. Interest rates have already fallen dramatically, putting a lot of money into the pockets of people with mortgages. Someone with a £200,000 tracker or variable rate mortgage is currently £4000 a year better off. At least some of that money will be spent, keeping the economy afloat. In addition, the pound has fallen dramatically helping every firm that exports, or which competes with imports. Foreign students applications to British universities have increased noticeably this autumn. Lower interest rates and a lower value of sterling will both helped refloat the economy and may be sufficient of themselves.

Third, a fiscal boost may actually be harmful. The Bank of England have been explicit that underfunded tax cuts without a credible repayment plan are inflationary, and make it less likely that they will cut interest rates in the future. Underfunded tax cuts mean higher interest rates.

Of course, automatic stabilisers (lower tax revenues as the economy declines, and higher spending on items such as welfare payments) should be allowed.

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This entry was posted in Op-eds.


  • Liberal Eye 26th Nov '08 - 5:13pm


    I certainly agree we can’t afford Brown’s mad bad plan. I also agree that lower interest axchange rates will make a substantial difference.

    But this does not necessarily mean that there’s nothing to be done.

  • Andrew Duffield 26th Nov '08 - 7:28pm

    Mark’s (W)right! Now is precisely the time to be talking up tax switching rather than tax “cuts” per se. In the (alleged) absence of bank lending to SMEs, firms’ cashflow problems could be eased and, more importantly, jobs saved with a significant reduction in (or better still, scrapping of) employers’ NI contributions.

    The “quid” pro quo tax switch would be on the future revenues from resource rents – especially from bank created credit, from recovering land prices and from other various and vast areas of privately appropriated public wealth.

    Duty on share transactions could potentially be doubled to discourage short term speculation, with little if any effect on real investment. Other forms of financial speculation – currency futures etc – could also be taxed.

    And we should give fair warning now that, as the recovery kicks in, interest payments will no longer be allowed as a “business expense”, so firms would be discouraged from re-gearing with debt.

  • The stock of debt is low, the rate at which we are and have been adding to it for some years now is high. (Economists have got a lot wrong this year, but we have been saying that for some time)

    There is very little evidence that £1bn of VAT has any significantly different effect than £1bn off any other tax in terms of its overall macro effect (clearly it can have an effect on individual sectors – £1bn off wine taxes would increase wine sales at the expense of other items).

  • PS Daniel Davies was the person who said I had confused GVA and GVA per head in my earlier work on regional policy. He was wrong then, and he is wrong now. His article is just silly.

    If it were not silly, and borrowing did not matter, the govt should simply borrow £1m for every person and sent it to us, and then everyone would be a millionaire.

    Guess what? That wouldn’t work: borrowing has a cost. Sometimes it is worth it, sometimes it is not, but his article is not worth the £85 that CiF may have paid him to write it.

  • Tim,

    I think you have missed one key point where tax tax cuts funded by other tax increases can act as a stimulus. The key effect of Tax cuts funded by other tax increases as a fiscal stimulus lies in two factors a) the marginal propensity to spend of those who gain against those who lose and b) the proportion of that spending that will stay within the domestic economy (i.e. not spent on imports), where the multiplier effect comes in.

    Other than that, I recon you are close to spot on, other than I am worried if there was a real run on the pound. this could stoke up inflation as most of our essentials are now largely imported.


  • DD said that we had used GVA per town, not GVA per head to assess success or failure, and therefore our finding that regen towns were falling behind on GVA was just a reflection of their decline in population. He was wrong: we used GVA per head, for all the reasons that he said that we should have. I emailed him about it, but he never wrote back.

    Borrowing always matters, in that it always has to be paid back, or inflated away, which is costly for someone.

    As David says, the issue is the marginal propensity to spend and to import. There is no evidence that this varies my any significant margin with income.

    I don’t think inflation is the greatest of our worries at the moment!

  • I ignored your email because you didn’t address the actual point, which was that GVA per head in Liverpool and Sunderland grew faster than the national average over the time period of your study. One way in which you could have made this mistake would have been to have used gross GVA rather than per capita. Another way (which I also suggested) would be to have only looked at the aggregate data for your cherry-picked “development funding towns” peer group. Another way to have made this mistake, of course, would have been to have done it on purpose. Since it’s not really my job to diagnose mistakes in other people’s thinktank documents, I didn’t want to get involved in a debate with you; my experience with thinktank people is that they are always trying to get away with misleading and partial statements like the one you just made to Sam.

    I will happily apologise for suggesting you made the mistake about GVA/capita, but only if you admit that you did in fact make a mistake and that GVA per capita in Sunderland, Liverpool and East Merseyside grew faster between 1997 and 2005 than the national average.

    Meanwhile, your discovery that there is “no evidence” that marginal propensity to spend “varies my[sic] any significant margin [sic] with income” puts you pretty far outside the mainstream, you know?

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