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21 March 2015

It’s the economy, stupid

Tag(s): Politics & Economics
In the 1992 US Presidential election one of then Governor of Arkansas Bill Clinton’s aides hung a board in his campaign office with the words “It’s the economy, stupid” It was intended for internal consumption but came to be the main message of Clinton’s argument to the American voters as to why President George Bush should be removed from office. It has come to be a truism that in every election voters vote with their wallets. In this fifth of my pre-election blogs I want to examine if that’s the case in the British General Election taking place on 7th May.

The coalition government has taken as its central purpose the reduction of the deficit. The deficit is the gap between what the government spends and what it raises in income. It is entirely a matter of the current account. Much of the debate in this very long election campaign lies around this single issue. The Conservatives say they have reduced the deficit and would continue to do so in the next parliament finally eliminating it by the end of that parliament. Exactly how they will do this is not clear but it seems to rest on a greater degree of cuts in public expenditure. The Liberal Democrats also claim credit for reducing the deficit as coalition partners but say that if they are in power in the next parliament they would not reduce the deficit quite as fast, would not cut expenditure as much and would increase taxes on the rich by means of a ‘mansion tax’. Labour say they would reduce the deficit but not as much and would not cut public expenditure but would increase taxes on the rich. I will deal with the other parties later.

This analysis is horribly wrong and misguided. It fails to deal with two massive issues. Firstly the debt has never been so high. The UK national debt exceeds £1.5 trillion and grows at a rate of £5000 per second. Secondly if we factor in all unfunded liabilities including state and public sector pensions and public finance initiatives it is closer to £4.8 trillion, some £78,000 for every person in the UK.[i] Only by a complete overhaul of public finances can this be dealt with. Interest payments on the government’s debts now exceed £1 billion per week, more than is spent on defence.

Labour have picked up on the Conservatives desire to reduce public spending by saying it would take us back to the levels of government spending in the 1930s. This again is crass nonsense. They are simply comparing the percentage of GDP but the UK economy is substantially larger today so if the same percentage is spent but of a much larger number then it follows that much more is being spent. In general governments have raised between 30% and 37% of GDP in tax. Any more than this is self-defeating as there seems to be a natural limit. Government makes up the rest by borrowing and that borrowing is from the private sector, both home and abroad. During the Thatcher and Major years public spending was held below 40% of GDP. But by the end of the last Labour government Gordon Brown had pushed it back above 47% with a massive increase in borrowing.

What would a complete overhaul of public finance look like? Countries such as Canada have in the recent past done full reviews of every single part of the state’s spending, with every programme having to justify itself or be junked. Between 1995 and 1997 Canada cut federal spending by 10%, slashing defence, business subsidies and unemployment insurance, and shrinking total spending from 53% of GDP in 1992 to just 39% by the mid-1990s. The result was a 15-year boom.  We probably need to establish a cross party Commission into Public Spending to do the same in the UK. It could look at abolishing or merging entire departments; means testing all benefits; privatising motorways; dumping all the regulations that make both prices and compensatory welfare payments high; axing layers of pointless management and doubling up of services; introducing user fees for services and using properly competitive processes of public procurement. It won’t be easy but if we don’t try we will never get the UK back on a stable financial footing and the consequences of that would be dire.[ii]

If we don’t resolve the issue of unfunded liabilities the demographics will overwhelm us. The taxes needed to pay for these would have to go up by a staggering and indefinite 14% of GDP- equivalent to hiking consumption taxes by over 21 percentage points. Tax rises on this scale would kill growth. The alternative is to halve all health and social protection spending for now and forever.[iii] The idea that the rich can pay for all this is also pie in the sky. The highest paid 3000 people in the UK pay more income tax than the bottom nine million according to HMRC figures released on a Freedom of Information Act request. The very highest earners, those 3000 people, will contribute 4.2% of total government revenue from income tax in the current financial year. The richest are shouldering a greater share of the tax burden than any time in history, and that happened after the top rate of income tax was reduced from 50p to 45p.

But the debate about the top rate of income tax is also misleading.  At £100,000 pa the personal allowance tapers off.  My accountant explains as follows: Your marginal rate including National Insurance (NI) could be higher than 62%, depending on the mix of income:
  • Income tax on its own has a marginal rate of 60%, because of the tapering out of the personal allowance (PA)
  • there is no Class 1 NI on pension income, only on salary, this is charged at varying rates, as follows:
    • up to £149 per week is nil
    • between £149.01 & £797.00 is 12%
    • over £797.00 is 2%
    • just to make life more complicated the above rates are per employment, so if, for example, you have 5 employments at £7,748pa (so £149 per week) you wouldn’t pay any NI, even though your total employment income would seem to put you in the 12% band
    • in addition, no Class 1 NI is payable once you reach pensionable age of 65   
  • Class 4 NI on self-employed income is charged at the rate of 9% if your self-employed profit (so after expenses) is more than £7,755 in the current tax year, this ceases to be due at the end of the tax year in which you reach pensionable age, rather than when you reach pensionable age.
Of course, the politicians, and most of the general public, don’t care about people who earn £100,000 do they? Well they should because they include not only the wealth creators but also head teachers (who are in short supply), doctors (who according to letters to the papers I've seen are refusing work rather than go over that marginal tax rate of 60% plus NI) and so on.

The top 0.1% of earners – about 30,000 people with a declared income above £670,000 - collect 5 per cent of the nation’s income but pay 11.3% of income tax. That contribution of about £18.8 billion covers the cost of the Home Office and the Ministry of Justice combined. In a democracy the politicians try to win power by making promises they can’t afford to keep. The only way they can keep them is to defer the cost to future generations. 

The other way politicians can pay for their largesse is to generate growth in the economy and increase the tax collection that way by taxing growing profits and incomes. The coalition is boasting that its policies have led to growth rates better than any other G7 country or indeed any other European state. In the last two years this is true but we are only getting back to the levels of 2008 before the crash. In the last ten years the population has grown by 5 million owing to a combination of increased birth rates, longer lives and very high net immigration. GDP per head remains around 1% lower than before the Lehman collapse.[iv] Productivity has not improved, wages have fallen in real terms and many businesses have failed.

The coalition also claims very healthy job growth with private sector jobs more than compensating for public sector cuts. But how do they know? I can see how they can count the number of people claiming benefits for being out of work. But how do they know the rest? HMRC would have the information for all tax payers but do they collate it? It would be a massive task. In the past ten years I have deliberately followed a policy of not looking for full time work but rather doing a number of part-time roles, both as a retained non-executive director and as a consultant. The only public place this information is partly collected is in my tax return and even there it is incomplete as it includes both self-employed and employed income but does not specify hours or days worked. I only ask.

And what about the fringe parties and their economic ‘policies’?  We have not seen any manifestos yet but I have learnt the following:

UKIP wants to drop inheritance tax, increase personal allowances to £13,500 and all the thresholds above that, tax large corporations on turnover and stop giving overseas aid.[v]

The Scottish Separatists would not make any cuts in government expenditure as far as I can see though how they would pay for the present levels is unclear.[vi]

The Green Party would nationalise the banks and restrict credit thus destroying large parts of the economy. They would introduce a Citizen’s Income to which everyone would be entitled. How this will be paid for is unclear. There is very little difference between their economic policy as laid out at length [vii] and early manifestos of the Communist party.

I have not bothered to study the economic policies of the Welsh separatists or the Northern Irish parties but all of these could have a factor if the newly constituted House of Commons is as fragmented as looks possible. One of the two major parties, in order to get its own budget accepted, may do a deal with one of the crackpot minor parties so that a party that may have a limited share of the national vote may have undue power and influence and a crackpot policy somehow becomes reality.

I once had the pleasure of meeting the great economist Sir Alec Cairncross. In 1962, when he was the government’s chief economic adviser, he told Selwyn Lloyd, then Chancellor, who was desperate for  a formula to raise the rate of growth: “In economic affairs there is always room for differences of opinion…the things we really know as beyond dispute are often outweighed by the things we can only guess at. So any economic adviser is a bit of a charlatan half the time.” In retirement, in 1972, Cairncross said: “We do not know for sure how the economy works and …it certainly does not work in the same way for long.” Other social scientists of less integrity, eager to retain the confidence of ministers, have claimed knowledge that they did not have – and told ministers what they wanted to hear.[viii]

In essence the economy is not as important in this election as it should be. The politicians talk about the wrong parts of the economy in the wrong way. George Osborne gave a spirited upbeat performance this week in delivering his sixth budget speech. It had a few lollipops as expected and one or two good jokes at the expense of Ed Miliband but it showed no understanding of what is really happening in the economy. We already know that the ‘two Eded beast’ of the Labour party has no understanding of economics. Every Labour government there has ever been has wrecked the economy or devalued the pound or both. The two Eds were acolytes to the biggest wrecker of all in Gordon Brown so if it was about the economy noone would vote Labour.

No it’s about politics, not the economy. Politics has trumped economics. I will try to address the politics, and in particular the politics of leadership, in my final election blog next month. Oh and please note. After each of the last five general elections taxes have been immediately raised.

[ii] ‘Slay Leviathan’ Merryn Somerset Webb, editor in chief Money Week, 12 December, 2014
[iii] Ryan Bourne, head of the Institute of Economic Affairs. 17th March 2014
[iv]Recovery? The feel-good factor feels elusive’. Liam Halligan. Sunday Telegraph. 16th November 2014
[viii] Governing Post-War Britain: The Paradoxes of Progress, 1951-1973 Glen O’Hara Palgrave Macmillan 2012.

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