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Tax cuts now, tax rises later
Topic Started: Nov 24 2008, 05:29 PM (174 Views)
ds9074
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Admiral
Quote:
 
In the UK we have had a significant set of announcements today from the government on fiscal policy.

The main points are;

Cut in the rate of VAT from 17.5% to 15% for 1 year
£145 Income Tax reduction per taxpayer next year
Extra one off payments to pensioners and lower income parents
Cuts in business rates for small businesses
£3bn Government spending on capital projects brought forward

This will be offset in 2011 onwards (when the government hopes the economy will be growing again) by;

National Insurance (payroll tax) up 0.5% for employees and employers
VAT back to 17.5%, may rise higher
Corporation Tax up 1%
Increased tax on long haul flights
Increased tax on higher emission cars
New top rate of Income Tax for incomes over £150,000 of 45%
Public spending to grow by no more than 1.5% a year

After these tax and spending changes the Government will still be undertaking a massive amount of borrowing. Its being reported that the government plans to borrow, in cash terms, more in the next 5 years than the total sum borrowed from the Act of Union in 1707 to today.

The forecast deficit based on the economy recovering in 2011 are;

2008/09 £77bn (5.3% of GDP)
2009/10 £118bn (8% of GDP)
2010/11 £105bn (6.8% of GDP)
2011/12 £87bn (5.3% of GDP)
2012/13 £70bn (4.1% of GDP)

Total debt will rise from £526.8bn (36.3% of GDP) now to £1084bn (57.4% of GDP) by 2013.

Source of figures

To be perfectly honest this package of measures concerns me.

Yes it may give a short term boost to the economy and the spending as people take advantage of the lower rate of VAT and lower rate of income tax. Yet the cost in the vast amounts of extra borrowing and the long term damage of higher taxes may be great.

I do not like those borrowing figures at all. Its a big leap to go for debt to go from 36% to 57% of GDP in just five years.

Whats more this is based on the assumption that we will be out of the worst of the economic problems by 2011 and back to reasonable growth (I think the assumption is around 2%). That is by no means certain.

I wondered what anyone else, UK citizen or otherwise, thought of these planned measures. Do you think they are necessary or a bad idea.
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STC
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The question I ask when assessing these measures is, what happens if the alternative strategy is proposed, and government tries to 'balance the books', so to speak?

Confidence is shot to hell. The base rate is coming down but, crucially, the interbank lending rate (LIBOR) i.e. the one that matters, is not. So, I don't see monetary policy as being an effective instrument right now.

What else is left? Fiscal Policy.

Yes, it runs the risk of being ineffective, and building up a huge tax burden for the future.

The risk of doing nothing, leading to a long recession and falling tax revenues and deep structural damage to the economy, will of course result in a similar outcome. But, at least the aggressive fiscal option gives us some chance of limiting the damage. I would add this will only be effective if supported by our trading partners. With an integrated global economy, a unilateral fiscal stimulus by any nation will be leaked, with minimal benefits for the initiator. For this to really work, we all need to do it together.
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ds9074
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^^^
I think there is a difference between trying to balance the books during the downturn, which I agree would be ill advised, and opposition to the plan that has been set out.

Personally I think in the medium term they are going to have to address the underlying issue which is that spending is too high on these tax rates and potentially too high for the post-financial crisis economy to support. I think we are going to have to cut public spending, not just limit increases to 1.5%. They can start with some big ticket saving like ID cards and the NHS computer database, they can try to make savings in terms of waste but ultimately it will come down to cuts to services. We cannot go on living beyond our means as a nation.
Edited by ds9074, Nov 24 2008, 07:22 PM.
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STC
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^^^

While from a political perspective I share your views on cutting spending on the NHS database, and ID cards (which btw I totally oppose), I don't agree with the general proposition of cutting or curtailing public spending.

In a recession, people don't spend because they don't have the confidence to do so. Aggregate Demand falls and may keep falling without a stimulus from another party, namely goverment spending. If that happens, we'll have prolonged negative GDP growth and run the risk of a much worse PSNCR in the long term.

I know the alternative is tax cuts but, if people are worried about the future, will they spend the gains from those tax cuts? I'm not sure they will.

As for living beyond our means, have we really been doing so? I don't think our debt/GDP ratio is any worse than our competitors, nor is it historically high.

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ds9074
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^^^
We were running a deficit during years when the economy was supposed to be growing strongly.

I also think the picture has changed. Financial services may not recover for a long time and it hopefully wont recover to the way it was before because that got us into this mess. It might however mean that the tax revenue gained from things like large bonuses does not come back.

I am not talking about cutting spending now, you are right you could create a downward spiral, but as growth start to appear again then the public finances will need to be put back to balance. I would favour doing that by cutting public spending rather than large increases in taxation. I think the last thing the economy will need as it starts to grow and we start to work our way out of this mess is big tax rises.
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RTW
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Nov 24 2008, 06:55 PM
The risk of doing nothing, leading to a long recession and falling tax revenues and deep structural damage to the economy, will of course result in a similar outcome.
Don't you mean, doing nothing leading to a long recession, versus, doing something leading to a longer recession?
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ds9074
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RTW
Nov 24 2008, 11:21 PM
STC
Nov 24 2008, 06:55 PM
The risk of doing nothing, leading to a long recession and falling tax revenues and deep structural damage to the economy, will of course result in a similar outcome.
Don't you mean, doing nothing leading to a long recession, versus, doing something leading to a longer recession?
If they had done nothing and kept things exactly as they were its very likely the budget deficit would have ballooned to over £100bn anyway. They government by its actions had added about £20bn to that figure, in the hope of boosting economic output. I dont think that £20bn is going to have a particularly impressive effect on growth, I think there could have been better ways to provide the stimulus but neither do I think its going to do much more harm than if we had done nothing.

What would cause harm is to try to balance the budget immediately. You would have to either cut public spending so hard or raise taxes so much that it would very likely result in a longer and more painful recession.

What I question is the way the government proposes to restore the public finances once the economy starts to recover. It wants to go on spending, in fact it wants to increase spending over the levels seen in recent years, and is going to try and bring the books into balance by raising taxes.
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