Monday, November 24, 2008

Some initial thoughts about the budget

My main impression was that this was a budget to shore up business. Let's deal immediately with the temporary cut in VAT from 17.5% to 15%, which will cost circa £12bn. Tories are saying "this won't make any difference". They sincerely believe that releasing £12bn into the economy will have no effect and this reflects their lack of understanding of how business works (possibly because their leadership comes from the aristocracy rather than the commercial community).

Here's why it will make a difference. In the current tough retail climate, retailers are slashing prices - for example the M&S 20% discount sale. When retailers slash prices, they are in effect slashing their margins. But there is a limit as to how low they can slash. If the price the consumer is demanding is below the break-even price for the retailer, the retailer has only a few options. They can try to cut costs such as heads of staff - which will increase unemployment, and which has the effect of scaring other consumers, fearful for their own jobs, into spending less. They can try to cut the price below break-even to grab market share and force their weaker competitors to try to match them and take losses in the hopes of forcing them out of business (job losses again), which then opens up room to raise prices again. Or they can try to hold prices at break-even and hope that their competitors who are discounting cannot sustain the discounts for long, and either go bust (job losses) or raise prices to above break-even again.

Therefore doing nothing leads to job losses. VAT represents a cost to business. So the 2.5% cut means that they should be able to maintain small margins even while discounting, and hence forstall the need to cut costs through letting employees go. That's why the retail industry has welcomed todays move. The main point about this is to help businesses maintain trading and thus safeguard employment.

The Tory opposition to the £12bn cut is also incoherant - if we had raised VAT by £12bn they would have made no end of fuss. But if it makes no difference one way it should make no difference the other way!

The govt has also deferred the small business corporation tax increase, and let struggling businesses spread the amount they owe the Inland Revenue, which should make a huge difference to cashflow. As any small business knows, the Inland Revenue is the scariest of creditors and it is usually not being able to pay the Revenue that precipitates firms going into bankruptcy. The additional help to small business will be worth £7bn.

What about boosts to the consumer, I hear you ask. This will come from monetary policy. The 1.5% cut in the base rate has been passed on by most lenders (apart from HSBC), and will hit people on the standard variable rate or trackers in Dec. It's worth about £100 a month. The BoE will undoubtedly cut rates again in Dec, and going forward.

So you see a two-pronged attack - putting money into pockets via monetary policy and shoring business up (and hence employment) via fiscal policy.

With regard to the tax rise for those earning over £150k - the cover for doing this comes from the election of President Obama. I wrote the following on 5th November:

Obama has stated that he thinks a person on an income of $250k is rich (this is about £158k). He intends to raise the top federal tax rates to to 36% and 39.6% (from the current 33% and 35%). Remember that Americans pay state income tax in addition to federal income tax. The American state that mirrors Britain's economy most is New York State. There, the state income tax if your income range is between $100,001 and $500,000, is 7.375%. If your income range is $500,001 and over, your tax rate is 7.7%. People living in New York City pay city income tax too of between 2.9% and 3.6%.

That means that the top marginal rate of tax for high earners in New York City (London's great rival) will go up from the current 46.3% to 50.9% under Obama. Compare that to the 41% levied in the UK.

The tax rise comes into effect in 2011, when Obama will have implemented his tax rise. This means that those in the City inclined to complain won't find it viable to up roots and go to New York. They are still better off in London. The 0.5% increase in N.I. will mainly affect those who earn over £20k (due to moving of the thresholds).

The other point to make is that the tax rises will come after the general election, so the country has a chance to vote on it.

Regarding borrowing - the point needs to be made that doing nothing and letting a deep sustained recession take place will kill tax revenue, and force government borrowing up even further. Only the economically illiterate do not understand this. As for public spending, the next round will have an increase of just 1.2%, which is very tight. In order for the Tories to do better than that they will need to actually close schools and hospitals.

So now the battle for the next election is set. People in 2010 will be voting to either increase tax on those over £150k to 45%, or to vote Tory and keep the top rate as it is, to increase the inheritance tax threshold to £2 million from the current circa £600k, and to pay for it by physically closing hospitals.


Anonymous said...

National debt the highest since the war and will hit £1 trillion with a back to the past Callaghan socialist budget,says it all.

Clearly New Labour know they are finished electoraly and now just want to trash everything.

snowflake5 said...

Sorry broncodelsey, national debt isn't the highest since the war.

National debt was 232% of GDP on the eve of the 1945 election, and was 101% of GDP on the eve of Harold Wilson's election in 1964. Wilson brought the debt down, but it took the Calaghan government of the 70's to reduce debt. Debt was 58% of GDP in 1972, and 46% of GDP in 1979. Tories raised debt again so that when they left office in 1997, it was 53% of GDP.

It's now currently 41% of GDP and that includes Northern Rock.

See here for the stats.

If we Did Nothing, as the Tories advised, we would have such a prolonged recession that tax revenue would completely collapse and debt would really climb to worrying levels of the war. Only Tory cretins don't realise that. Most Brits do.

I note that all small businesses are cheering the Labour budget and are worried that the Tories aree not supporting the VAT cut. I suppose they have more to worry about if the Tories actually get in and hurt thyem with a VAT rise to 22% to pay to raise Osborne's inheritance tax threshold.

Anonymous said...

Including Norther Rock GDP is now 42.9%, at the start of the recession borrowing. That is less than 1.5% different for the peak after the last recession (44.2% in 1997) (source ONS). The Chancellor now predicts it will peak at 57% of GBP.
That is why you shouldn't run deficits the in good times, so you start recessions from a low base. Labour stopped paying down net debt in Feb 2002. when it dropped to 29.1%. If that had been our starting point now the predictions for the recession would take our debt to 44%, exactly where the Tories left it.

Anonymous said...


As a Labour supporter - do you honestly think that the VAT cut was the best use of the money ?

Surely a lifting of taxable allowances for normal rate tax payers only would have been a better and more equitable way of putting the money into the economy.

The real beneficiaries of the VAT cut are rich people buying Bentley's and house extentions.


snowflake5 said...

Devonchap - we didn't run deficits in the good times. The good times were the 1990's before the bust. And it was the Tories who ran deficits in that time - debt was accelerating in the lead up to 1997, despite tghe economy growing strongly.

Labour saved from 1997-2002. Then came the crash. We spend to save the economy going into recession, but things were sluggish from then on (in the USA, they only survived by slahing interest rates to 1%, keeping them there for a couple of years and stoking their sub-prime crisis (esp when Greenpan advised Americans to abandon their traditional 30-year fixed rate mortgages and to go for adjustable rate mortgages).

Essentially, we are still dealing with the fall-out of the bust and it's aftermath. You simply don't realise it, because you've been cocooned in Labour Britain and protected from it. This is our first downturn in 11.5 years, but for the Americans, it's only 7 years since their last downturn, and for the Germans and Jaoanese only 5 years since the last downturn.

Big Jock Knew - yes, the VAT cut was the right thing economically (though maybe not politically). If you cut income tax, people simply hoard the money in a downturn. The cut in VAT will support business - without business there is no employment.

Anonymous said...

Fact,national debt,(excluding Brown's 630 or so major PFI's estimated at £ 110 billion)and the bank bail-out debt will hit 57% of GDP in 09.

You really need to get out more,with the stores offering discounts of 10,20 & 30%,do you really believe that a piddling 2.1% cut in VAT is going to be noticed or make any difference?

The one thing everyone including the idiots in government know is that their borrowing forecasts are always miles out and they end up borrowing more.This combined with their wildly optimistic growth forecasts means more public spending cuts in mid 09,as usual we are only being told half the truth.

Anonymous said...

Snowflake, the US dotcom recession only lasted till 2002. So the fall out of a non-recession (for the UK) costs as much and lasts nearly as long as the fall out of an actual recession? And that at a time when the world economy was growing very strongly.
Now if that were true why isn't Gordon Brown making that case to show was a wise statesman he is, saving us before? The answer is because its rubbish, or if true, suggest that the UK economy was far weaker than he claimed, needing a hidden stimulus package even when in growth. You are clutching at straws.
Now it is true that we are dealing with the aftermath of the dotcom bubble in the fact that the US used cheap money to re-inflate the economy and that pumped up house prices and other assets here and the US, and fuelled a rise in personal debt. However, this government did nothing to protect the UK from that, rather it pushed debt at every opportunity. We are suffering from that now and that is why the OECD brackets us with Hungary and Iceland.

snowflake5 said...

Devonchap: "Snowflake, the US dotcom recession only lasted till 2002. So the fall out of a non-recession (for the UK) costs as much and lasts nearly as long as the fall out of an actual recession? And that at a time when the world economy was growing very strongly."

And yet the USA kept interest rates at 1% till 2004. Their economy was on drip-feed in emergency theatre. If they had really been "strong" they would have removed the interest rate stimulus in 2002. As it was they CUT rates in 2002. And Bush pushed through the mother of all fiscal stimuluses at the same time.

I'm sorry, but there is a lot of revisionist thinking out there from the opposition. The world economy was very strong from 1994-2001. After that it was only kept going by extraordinary measures.

In the UK we handled things better than the Americans IMO. Most of our spending went on infrastructure - rail-links, new schools with students no longer having to study in leaky huts, and so on. We are in better shape as a result. The Tories left the UK in a third-world state of disrepair with everything crumbling and shanty-towns of homeless people in cardboard boxes everywhere. Yes, Labour from 2002 spent money to correct this. Uncivilised people like yourself moan about teh spending because they LIKE to see everything falling down around them. Actually Britain is a better place because we did fix the infrastructure. It was money worth spending.

Anonymous said...

"Uncivilised people like yourself” When you lose the argument resort to personal insults. You are displaying typical leftie arrogance. "I'm a better person than you because I support Labour", let’s forget the fact everyone finds you smug and condescending.

How come NOBODY (but you) makes that case you do that the UK budget deficits from 2003-2007 were anti-recessionary? It is because it isn't true.

You can not run deficits forever, eventually you have to cut spending back to what you can afford or restrain spending till economic growth catches up. You have posted before on what a clever girl you are personally not to have large debts, well it is the same for countries. You can’t spend more than you earn for ever.

If the economic fundamentals don't support growth of 2-3% then government spending to create that level of growth will inflate a bubble that eventually must crash down. So by your argument the government is even more culpable since it knowingly created a false boom and encouraged businesses and individuals to over-extend themselves, rather than support a sustainable rate of growth. The effects of will have terrible consequences on individuals and families in the recession. Labour claims to care about people but they have created the conditions which will hurt millions more than otherwise would have happened.

All those shiny new schools will soon leak because necessary budget cuts will mean there isn’t money to fix their roofs. This government is planning GBP 37 billion in budget cuts already, and that is on Darling’s overly optimistic projections. We are looking at a boom and bust in government spending. Not the sustainable long term gradual increase we could have afforded. And I and children will be paying for this folly for years to come.

Danivon said...

bronco, that's not a 'fact' it's an estimate.

Snowflake is right - the dotcom bubble bursting did affect the US economy, ultimately leading to the current problems there now.

That we now have new infrastructure means that it won't need to be renewed for a couple of decades, which will result in long term stability.

Still, I don't know what the alternative courses of action are at the moment. The Tories don't seem to have any.

Anonymous said...

Is Angela Merkel "economically illiterate" ?

snowflake5 said...

Devonchap - you are the only person arguing that the USA going into recession in 2001, and Germany and Japan going into recession in 2003 meant that the global economy was "strong". LOL. The UK is an extremely open economy, and the only way to offset cold global winds is by govt action. We survived the 2001-2003 period because of Labour government action.

Big Jock Knew - Frau Merkel has not covered herself in glory in this crisis. She criticised the Irish for guaranteeing their banks, and the very next day announced a guarantee of her own banks. She and her ministers were insisting that this was an "Anglo-Saxon prolem" and then had to recapitalise large German banks.

Germany has already entered recession (it's second recession in five years). I accept that Merkel's hands are tied by the high level of German government debt (currently 65% of GDP), but if she does nothing, their debt will get worse as tax revenues fall off a cliff. She should look at Germany's own recent history for a guide - their government debt is higher than a decade ago precisely because they continue to allow their economy to be hit by recessions and make a virtue of "Doing Nothing". Doing Nothing turns out to be more expensive than Doing Something

Anonymous said...

Nice way to avoid answering any of my points. I wasn't taliking about 2001-2003 but the years after it. I'll chalk that up as a win for me.

snowflake5 said...

Devon-chap - if you were really talking about the years after 2003 you would know that the UK growth slowed sharply in 2005, as the housing market underwent one of it's government induced cooling phases (in particular punters were responding to warnings about a housing crash). If we'd cut spending then, the economy would have gone into recession.

As usual your "growth was extremely strong at all times by magic" mantra is false, and you are making things up as you go along. I'll chalk that up as a win for me.

Anonymous said...

The growth of the last few years may not have been by magic, but it was an illusion, created on cheap money, which has crashed about our ears.

Also Snowflake, the figures don’t seem to bear out your assertion growth was weak from 2005 onwards.

Going to Eurostat for nice year on year figures we get the following growth rates for the UK

Year GDP increase %
1999 3.5
2000 3.9
2001 2.5
2002 2.1
2003 2.8
2004 2.8
2005 2.1
2006 2.8
2007 3.0

I don’t see any sharp slowing post 2005. The ONS website shows a similar steady growth after 2005

So unless they all got it wrong it looks like your argument is taking on alot of water.

A sensible governemnt, seeing that the economy was built on cheap money would have been saving like made over the last few years, ready for the eventual correction. Of course we know that isn't what happened. Honours still with me.

snowflake5 said...

Growth slowed post 2003, as stated in my previous post (I never ever claimed it slowed post 2005, merely that IN 2005 growth was slow). Trend growth in our economy is 2.5%, anything slower than that means we arn't really keeping up with population growth.

Take a look at this chart from the ONS. Note the very low growth in Q3 2004, it rebounds in Q4 (because of Christmas) and then slows again. That slowdown was deliberate. The government was trying to slow the housing market with speeches and interest rate rises and scare borrowers into not overextending themselves, but conscious at the same time that a reining in of that sector meant a slowdown of growth, so they supported things with public spending. I suppose they could have simply ignored household borrowing, and let it rip away further, and cut public spending. Would we be better off as a result? Don't think so - households would be in a far worse position now if that temporary slowdown in housing hadn't happened then. And the level of government borrowing doesn't really affect things, especially in the present situation where you are the only borrower around and savers are anxious to lend to you (cause no one else is borrowing). We got things the right way round - it was more important to try to rein in households.

snowflake5 said...

P.S. You ahve a tendency to look at the end result and assume it would have happened ANYWAY, when in reality the end result happened because of government action. Eg the only reason we had positive growth at all in the 2001-2003 period was because the government offset the world recession by spending. The only reason there was positive growth in 2005 at all was because the government offset an intentional slowdown in the housing market with public spending. Nothing happens "all by itself like magic" the way Tories assume.

snowflake5 said...

P.P.S That slowdown in Q3 2004 followed Mervyn King's famous speech about the dangers of house prices, and it did have an effect immediately. What's more interest rates were raised and the Treasury made speeches applauding and backing the BoE in it's attempts to rein in housing, and all this in the lead up to a general election. Something no Tory government would have had the guts to do.

Tories pretend that no attempt was made to slow the housing market, when actually serious attempts were made, and they also assume that you can simultaneously rein in household spending and government spending at the same time with no effect on the economy (magical thinking again). In reality it's not like that, it's a very difficult balancing act - and the Labour government succeeded in keeping the economy going for 11 solid years (something no Tory government has ever achieved, and on the basis of their confused thinking, never will). It ended when externals we couldn't control intervened (the oil price, the US sub-prime crisis and resulting crunch and Lehman Brothers going bust).

Anonymous said...

Now this is the thing Snowflake, if anything good happens, it is because of the leadership of the Labour Government, if anything bad happens it is because of the world economy. Stop trying to fit the evidence to what you want to have happened

Britain as I think you’ll agree is an open trading country, so what happens in our major trading partners affects us. Our two biggest trading partners are the EU and the US. In 2001 the US slowed sharply but the Euro area growth remained at 1.9%. In 2005 Germany only grew at 0.8% but the Euro area as a whole grew and the US grew at 2.9%

Euro All UK United
area EU States
2001 1.9 2.0 2.5 0.8
2002 0.9 1.2 2.1 1.6
2003 0.8 1.3 2.8 2.5
2004 2.1 2.5 2.8 3.6
2005 1.7 2.0 2.1 2.9
2006 2.9 3.1 2.8 2.8
2007 2.6 2.9 3.0 2.0

So in 2005 we slowed down at the same rate as the US and slightly faster than the Euro area. That doesn’t leave much credit for the government. You can attribute the housing slow down to the general slowing of the economy. Chicken and egg I guess.

My beef is the increase in borrowing this government took on

General government consolidated gross debt as a percentage of GDP
Euro All United
area EU Kingdom
2001 61.0 68.4 37.7
2002 60.3 68.2 37.5
2003 61.8 69.3 38.7
2004 62.2 69.7 40.6
2005 62.7 70.3 42.3
2006 61.3 68.6 43.4
2007 58.7 66.6 44.2

The UK increased its debt much faster than the EU, but since 2004 hasn’t massively outpaced Europe in growth (Eurostat only have US figures to 2004). This is symptomatic of a massive increase in the size of government spending which can only be paid for in the long term by higher taxes, or equally massive cuts to the government spending. The global downturn focuses attention on credit worthiness and someone who is already spending more than they earn in the good times is a less good credit risk than a more prudent individual. Same goes for countries so we risk having to pay more to service our debt.

When people like Martin Wolf think we are flirting with disaster then I worry about the future

We are never going to agree about the government’s handling of the economy. I have been right to say insolvencies were going to rise massively, I was right about the fall in the pound (GBP1 = USD 1:47, EUR 1:15) (do you still think it is all down to the carry trade?). Time will tell who is right. I fear I will be. I’d hope your rosy view is right but instead I think government wishful thinking will hurt millions of people.

snowflake5 said...

Devonchap :"Now this is the thing Snowflake, if anything good happens, it is because of the leadership of the Labour Government, if anything bad happens it is because of the world economy."

?? I said that the slowdown in the UK in 2005 was down to the Labour government, not the world! It was certainly not down to Germany (we don't export much to Germany, they have had chronically low domestic demand for years and rely on the UK and France to buy their goods and effectively carry their economy).

We've discussed previously how the Labour government tried to slow the housing market - well, what is not recognised is that these attempts always have a cost. You cannot slow the housing market without slowing the economy, and the government sensibly balanced the slowdown with public sector spending.

As for debt, you are cherry picking as usual. From 1997-2002, our debt as a % of GDP fell much faster than that of the eurozone (with the exception of Ireland). After 2002, we increased debt faster, but that was because we had done the ground work in the previous six years and were able to. Germany for instance wasn't able to do this, because they'd spent the 1997-2002 era Doing Nothing, and their debt increased during this period. Lots of foolish Tories are praising Merkel's Do Nothing stance, but she's in that position because Germany's debt position now is a lot worse than in 1997 and she's scared. Germany is an example of a decade of doing nothing, and the UK is an example of a decade of Doing Something. The UK is in better shape!

Anonymous said...

Hey, we are back to the "we did pay off some debt, 6 years ago (but then we borrowed it all back again)" argument. It’s like a marriage when the husband says, 'I know I've been having lots of affairs recently, but I was faithful 6 years ago!' That doesn't cut much mustard. Like the errant husband promising to give up the mistresses each year, but continually going back to them, the government has promised each year for the last 5 years to reduce the levels of debt, and each time the debt keeps growing.

Now if your argument that Labour increased spending to deal with global problems in 2001-2002, and a housing correction in 2005 then why didn't the government rein it back in 2004, or 2006? I know you can't stop and start spending but we have had a consistent increase year on year since 2001. That goes against your Keynesian economic management view. The government may have laid the grow work so they could borrow, but just because you can doesn't mean you should.

Germany has a near balance budget; we have a budget deficit near 3% GDP going into this recession. The Germans have an ingrained fear of inflation having suffered hyper inflation twice in the last century and large stimulus spending undermines sound money. Don’t forget their Finance Minister said they have tried stimulus packages before and they didn’t work. They just ran up debt. The monetary easing that is being talked about as the next step after interest rate cuts sound to the Germans like the printing of money the Weimer government carried out after the Great War to cover Germany’s war debts that sparked the first bout of hyper inflation.

Not having a crystal ball I can't say for definite but at the end of this recession we will be able to compare the GDP lost in Germany with that lost in the UK. Then we can see who was better placed. Until then this dialogue of the deaf will carry on.

snowflake5 said...

Devonchap, Germany may have a budget near balance, due to strong performance in the first quarter, but how long do you think it will last? Industrial orders are falling fast there, as are orders for cars. Their budget situation will deteriorate quickly. Because the Germans have been told by their government that no bailout is available, Germans have increased their savings rates from circa 10% last year to over 11% this year. Which means another drop in domestic demand, which comes at the same time their government is reluctant to spend and their trading partners are reluctant to buy their goods. Which means their economy is looking at a sharper collapse than ours, which will do horrible things to their tax revenues and budget situation.

Sometimes government action is actually the CAUTIOUS thing to do.