Yesterday's blog which discussed the problems of the Greek economy reminded me that I was talking to the students in my macroeconomics lecture last week about the role of fiscal policy in a recession. I mentioned the view of the Korean born Cambridge economist Ha-Joonn Chang (the author of the excellent book "23 things they don't tell you about capitalism"). A recent Guardian piece just after the budget quoted him as saying "Anyone who is reasonable, which actually excludes most people in the current government, would agree that it makes sense to run more debt in the short-run to recover faster. You cannot get out of this kind of massive debt crisis without growing." (Guardian, 23rd March 2013).
It is as if Keynes had never debunked the old Treasury View that public spending will always crowd out private spending - or to turn it the other way around that a reduction in public spending will somehow automatically stimulate private spending.Lots of ordinary people, and politicians,just don't seem to get it that when you cut back the income of households they will cut back their spending leading to a downward multiplier effect. And in a liquidity trap monetary policy doesn't work. As we have seen the banks are just holding on to the extra money they have been allowed to have because they don't have the confidence to lend to businesses in the face of what looks like it will be a triple dip recession. As Paul Krugman has said - there is no confidence fairy. What is it about austerity economics that people find so compelling? I suppose it is a kind of masochistic need to punish ourselves.
And if you look more carefully at what the Chancellor is doing the picture isn't quite what it seems to be. Despite the increase in the personal tax allowance and the cut in the top rate of tax, the overall tax take for the economy is going up, as it has to in order to finance the growing debt. This is mainly due to an increase in indirect taxation, and what economists call fiscal drag. As the threshold at which people enter the top rate of tax is going to be allowed to rise by only 1% anyone right up on the threshold who has an increase in income above 1% will get sucked into the higher tax band. This is an example of what some commentators call a "stealth tax". The politics of being Chancellor of the Exchequer revolves around keeping these things out of the public gaze.
I asked my students how much tax they were paying. Why, nothing, they said. We don't have incomes high enough to have to pay any tax. "Oh" I said "so you don't buy beer, petrol or energy - or football shirts" I added as my gaze settled on a student in the front row wearing a brand new Arsenal shirt. I pointed out that as well as VAT there was an insurance premium tax (assuming that students who drive are actually properly insured!) and lots of other special indirect taxes and duties. I asked them what proportion of the total tax take they thought came from indirect taxes of this type. Most thought around 20%. But according to an estimate prepared by Grant Thornton reported in a piece in the Sunday Times by James Charles, it stands at around 42% (Sunday Times, Money section, 24th March 2013). And the Institute for Fiscal Studies has calculated that in order to service the increasing debt payments the government will need to raise taxes by the equivalent of 2p on the basic income tax rate. Of course it won't raise the money this way. Instead it will be done via a mix of fiscal drag and various increases in indirect taxes. With the economy only predicted by the Office for Budget Responsibility to grow by only 0.6% this year and 1,8% in 2014 additional tax revenue won't come out of households' increased incomes so it will have to come from these less obvious sources.
At the end of the lecture I asked the students to keep a diary of their spending over the next week and to see if they could calculate how much indirect taxes they were contributing to the exchequer. It will be interesting to get the results.
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