Finance and economics: what we have learned, and what still needs to be done – part 5

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, bank lending, fiscal policy and interest rates.

Tax policy

The rapid deterioration in the fiscal position should worry us all. The British tax system is much more pro-cyclical than people previously thought, so that tax revenues fall dramatically even when the downturn is relatively small. (Remember, the economy has only just started to decline, so the fall in tax revenue so far is massively disproportionate to the decline in the real economy).

The government’s previous fiscal rules did not work, and we need to develop some better ones. The first thing to do would be to look at the cyclicality of the tax system, piece by piece. It does not ultimately matter how cyclical the tax system is, so long as we know how cyclical it is. The more cyclical the tax system, the more important it is to run a (massive) fiscal surplus in boom years that can then be used when the economy turns down. In general, there seems to be some correlation between the most progressive elements of the taxation system and the extent to which the tax system is procyclical. Those of us who believe strongly in progressive taxation should therefore be calling for much greater fiscal surpluses in good years.

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2 Comments

  • David Evans 28th Nov '08 - 6:26pm

    I wholeheartedly agree. The only point I would add, is that Brown’s various fiscal rules, were never meant to work, other than in the sense that they persuaded the credulous that Gordon was married to Prudence. Hence whenever the rules gave evidence of a break up, the rules were re-defined.

  • Andrew Duffield 28th Nov '08 - 10:22pm

    The answer is to minimise the cycle of course. Economic (and therefore fiscal) cycles are directly and evidentially linked to the c.18 year global cycle in land prices. To smooth – and potentially eradicate – all of them, we only need to:

    a) recognise this fact;

    b) stabilise land price through the equitable, efficient and sustainable capture and recycling of all forms of economic rent (including the unearned return to banks from their creation of debt-based deposits!); and

    c) phase out and replace all taxes on productive, value-adding, wealth-creating endeavour accordingly.

    The biggest worry at the moment and for the next few years is undoubtedly unemployment. The starting point in terms of our response to its rising scourge must be to scrap employers’ NICs, cutting business overheads, saving jobs and reducing the need for firms to seek short-term cashflow alleviation by borrowing from banks that are still utterly (and understandably) risk averse.

    The Tories and Labour have nothing to say or offer on jobs – yet this is critical to minimising the effects of the depression. We should commit to cutting business costs now and start planning for the fiscal switch that will help the UK return – first and fastest – to growth, this time sustainably.

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