A Charter for Tax Cuts

The contest for the leadership of the Conservative Party has been focusing on the issue of tax cuts.  The case for these cuts has been made by economist Julian Jessop, in a pamphlet for Conservative Way Forward.   (The format of the online version makes it exceedingly difficult to read, but the author has sent me a clean copy I can work from, for which thanks are due.)

The first step is to consider whether or not we need to take measures, at this point, to stimulate the economy through an injection of resources.  I was uncertain about this a year ago.  We’ve moved on from then. We were facing a clear threat of an economic recession at that time, which argues for some kind of stimulus, but now we also have the immediate prospect of rampant inflation.  Injecting money into the economy would fuel inflation – simply put, too much money chasing too few goods. This paper talks about a ‘dash for growth’.  That would be risky, and previous experience argues against it.  The ‘Barber Boom’ (1971-73) destabilised the economy and left us in a parlous position when further problems arose.  The Conservative government of the time had believed that the obstacles to sudden growth were self-imposed, and that if they rushed at the barriers hard enough, the economy would break through those barriers. The conventional economic analysis of the time suggested, on the contrary, that the effect would lead to ‘overheating’ – generating a demand that couldn’t be satisfied, fuelling inflation and forcing money abroad because the domestic economy couldn’t meet the demand.  That is exactly what happened.  By the end of 1973, we had the three-day week; and then there were the deflationary terms dictated by the IMF, which made a bad situation worse.  The problems of the 1970s weren’t caused by the unions, who only responded to the situation, or even by the oil crisis, which only took hold when we we already facing a slump.  They were created by economic mismanagement. There’s every reason to think that pumping money into the economy will have the same effects as it did in the 1970s: fuelling inflation and diverting money abroad.

The second part is the question of what tax cuts will do.  The idea that a modest tax cut of one or two pence from income tax will shield people from rising prices in any meaningful sense is, frankly, preposterous.  There’s a good argument for reforming much that goes on in our tax system – it’s too complex, and there are too many anomalies, and in so far as it creates perverse incentives, the most destructive is the incentive to load companies with debt (because that is tax-deductible) rather than building  viable structures for the long term.  Fiddling with corporation tax or VAT won’t address these problems; both measures are indiscriminate.

Third, there’s the question of values.  The demand for tax cuts is linked here with a set of familiar claims:  that the frontiers of the state should be rolled back, that people should keep more of their ‘own money’,  and that the ‘formula for success’ is (in a short appreciation by Lord Frost) ‘free markets, low taxes and personal freedom’.   The idea that people’s income before tax is ‘their own money’ is spurious (salaries and wages are largely  based on social conventions, including tax rates) and there is no evidence to support the contention that low taxes promote more successful economies.

There are points in the argument which I’d agree with.  The tax system is too complex, there’s been far too much of an obsession with debt, and we should be looking for ways to support effective demand.  However, if we are talking about government using national resources differently, tax cuts are just about the worst possible choice -ill-directed and primarily beneficial only to those who don’t need it.  If we really wanted to inject money into the economy, we should do it at the other end of the income distribution. Let’s get the money to people who can’t afford food or heat.

Further thoughts, 31st July

Since this initial blog, the arguments have been gathering pace.  Some of them seem to me, frankly, half-witted.  One really stupid argument is based on the ‘Laffer Curve’, which claims to demonstrate (as a matter of theory, not practice) that there are circumstances in which lowering the rate of tax will increase the amount of revenue a government receives from tax.  There are two problems with that.  One is saying that there are circumstances where this could happen is not the same as saying that it happens in every case: clearly, it doesn’t.  The other relates specifically to its application to Corporation Tax.  It seems abundantly clear that offering people the option to pay one kind of tax rather than another will lead to those people, especially if they have a competent tax advisor, to choose to pay the lower rate of tax available to them.  That is done, of course, at the expense of revenue from the higher tax.  Corporation Tax is already set at a rate which is lower than the upper rates of income tax, and accordingly those who have a choice will put the money through the Corporation’s books rather than their personal income.  That is not evidence of getting higher revenue – the opposite is the case.

The other daft argument is that tax cuts don’t alter the money supply, and so aren’t inflationary.  That is daft partly because tax cuts (as opposed to cancelling proposed changes in taxation) clearly would inject money into the economy – unless they are paid for by reduced government spending, which would be disastrous for millions of people – and partly because it’s a misunderstanding of inflation.  Inflation depends not just on how much money is going round, but on what that money can buy – it’s a matter of balance.  In current conditions of high inflation, which are already leading to higher production costs and higher wage demands, that balance is at best precarious.  I see no good reason for the current optimism that inflation will fall of its own accord.

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