Pay­ing for the pan­demic

This is no time to start putting up taxes

The Daily Telegraph - Business - - Front Page - Roger Boo­tle

As the nights have been draw­ing in, so the fis­cal pic­ture has started to darken. Trea­sury of­fi­cials, re­cently joined by the Chan­cel­lor, have been warn­ing us about im­pend­ing tax rises. You will all know the back­drop. Gov­ern­ment bor­row­ing has soared to lev­els un­known in peace­time. Ac­cord­ingly, the stock of gov­ern­ment debt has risen alarm­ingly and is still ris­ing. Sup­pos­edly, some­how or other, we need to take ac­tion to “pay for the virus”. But do we re­ally need to raise taxes?

The eco­nomic dam­age from the virus – or rather from the lock­down im­posed to con­tain it – con­sists of the fall in out­put, con­sump­tion and in­vest­ment. In that sense, we have al­ready largely “paid for it”.

Once the econ­omy has fully re­cov­ered, we will still have suf­fered that loss, which is largely ir­recov­er­able.

And we will be left with the fi­nan­cial con­se­quences, in­clud­ing the Gov­ern­ment’s huge deficit.

In this con­text, you can see why higher taxes strike some peo­ple as in­evitable.

Yet higher taxes would dam­age eco­nomic per­for­mance.

They blunt in­cen­tives and cause dis­tor­tions, thereby re­duc­ing pro­duc­tive po­ten­tial.

More­over, they re­duce ag­gre­gate de­mand as they with­draw pur­chas­ing power from the econ­omy. They may even re­duce tax rev­enue.

An al­ter­na­tive would be to re­duce the deficit by cut­ting gov­ern­ment spend­ing in­stead. Here also, though, there are po­ten­tial prob­lems.

It all de­pends on what sort of spend­ing you cut. Cut­ting pro­duc­tive in­vest­ment dam­ages growth po­ten­tial. Mean­while, all gov­ern­ment spend­ing – even the waste­ful sort – con­trib­utes to ag­gre­gate de­mand.

One ex­cep­tion is spend­ing on for­eign aid. Not only does this not de­liver any boost to UK pro­duc­tive po­ten­tial but it doesn’t boost UK de­mand ei­ther since the money is spent abroad.

In our cur­rent strait­ened cir­cum­stances, if any part of gov­ern­ment ex­pen­di­ture de­serves to be trimmed, it is surely this.

And then there is the Brexit fac­tor. Even Brex­i­teers like my­self have recog­nised that there is a po­ten­tial down­side to the econ­omy in the im­me­di­ate af­ter­math of Brexit as busi­nesses and in­di­vid­u­als are con­fronted by rad­i­cal change and feel uncertain about the fu­ture. The way to counter this is to bol­ster their con­fi­dence and to take mea­sures that high­light the fu­ture po­ten­tial of this econ­omy and the peo­ple mak­ing their liv­ing within it.

This is not what higher per­sonal and cor­po­rate taxes would do. They would risk an ex­o­dus of both tal­ented peo­ple and suc­cess­ful busi­nesses.

‘Higher taxes can blunt in­cen­tives and cause dis­tor­tions, re­duc­ing pro­duc­tive po­ten­tial’

In­deed, there is a case for cut­ting taxes on both in­di­vid­u­als and busi­nesses in or­der to en­sure that we get the best Brexit lift-off.

Of course, the deficit needs to come down and like­wise the ra­tio of gov­ern­ment debt to GDP. The is­sue is largely about timing.

As Bri­tain fought for its life dur­ing the Sec­ond World War, can you imag­ine be­ing ob­sessed by the level of gov­ern­ment debt?

In prac­tice, we let the debt ra­tio rise to a peak of about 250pc of GDP (com­pared to to­day’s 100pc) and only sought to bring it down once the war was won. More­over, we sought to do this grad­u­ally. This should be the ap­proach now.

Mind you, wher­ever we can, we should try to fi­nesse the dif­fi­cul­ties of our cur­rent fi­nan­cial po­si­tion. At the mo­ment, the huge level of gov­ern­ment debt is caus­ing few prob­lems be­cause in­ter­est rates are low and the Bank of Eng­land is hoover­ing up the new debt is­sued. But things will not stay this way for­ever.

The Trea­sury’s night­mare is that in­ter­est rates will rise at a time when the gov­ern­ment debt ra­tio is still enor­mous. Then we could face a se­ri­ous fi­nan­cial cri­sis.

Peter Oppenheime­r, the Ox­ford econ­o­mist, has sug­gested a way of avoid­ing this dan­ger.

If the real threat in the cur­rent sit­u­a­tion con­cerns re­fi­nanc­ing risk, then why not post­pone the re­fi­nanc­ing, or even erad­i­cate it al­to­gether?

The lat­ter would be achieved by the is­sue of per­pet­ual bonds, that is to say bonds that have no re­demp­tion date.

This may sound like pie in the sky but in fact it is very far from it. In the past, we have is­sued many per­pet­ual bonds, start­ing in the 18th cen­tury.

In­deed, there were some per­pet­u­als – also known as “ir­re­deemables” – still in is­sue un­til re­cently.

The most fa­mous of them was War Loan, is­sued in 1917 to help fi­nance gov­ern­ment spend­ing in the First World War.

The Gov­ern­ment had no obli­ga­tion to re­deem War Loan at any par­tic­u­lar date. In the end, it was re­deemed (at the orig­i­nal is­sue price) in 2015.

A less ex­treme ver­sion of this would be to rely more on long-term debt, where the re­demp­tion date is far into the fu­ture.

The long­est gilt-edged se­cu­rity is cur­rently about 50 years. We could eas­ily is­sue more of such gilts – or even some with a ma­tu­rity date fur­ther off. How­ever, even this would carry costs.

At the mo­ment, the in­ter­est rate on these ul­tra-long gilts is about 0.8pc per an­num, which is ex­tremely low by all his­tor­i­cal stan­dards.

But the Gov­ern­ment can bor­row on short ma­tu­ri­ties at neg­a­tive in­ter­est rates and, on the stock that is held by the Bank of Eng­land – of what­ever ma­tu­rity – the cost to the Ex­che­quer is just 0.1pc per an­num.

So it is a mat­ter of bal­anc­ing the se­cu­rity of know­ing that the in­ter­est rate will not go up for a very long time – or even, with per­pet­u­als, ever – against pay­ing a higher rate of in­ter­est now. That is a dif­fi­cult judg­ment call.

Which brings us back to broad strat­egy. As­sum­ing that the Gov­ern­ment doesn’t splurge more money on “de­serv­ing causes”, the deficit is go­ing to fall sharply any­way as spe­cial sup­port mea­sures are wound down and tax rev­enues rise in line with the re­cov­er­ing econ­omy.

It is not yet clear that we need to bring it down faster. If we do, we should trim inessen­tial cur­rent spend­ing and dump duff in­vest­ment projects.

Mean­while, bring­ing down the debt to GDP ra­tio can wait.

An im­me­di­ate hike in taxes is un­nec­es­sary. And it would be deeply dam­ag­ing.

Now is not the time for Rishi Su­nak, the Chan­cel­lor, and Prime Min­is­ter Boris John­son to con­sider tax in­creases

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