Now consider UK taxation. Already under this current UK
government tax, and stealth taxation in particular, has become the
soft default option. By the mid-2000s the top marginal rate of tax
including all imposts, whether on wages or consumption, had
reached 60%, the average tax rate was 40% and the marginal tax
rate on the average person 43%.
Now that the explicit top rate of income tax has gone over 50%,
the top rate has gone up to around 67%. So far for the average
worker not much has changed since the mid-2000s. However,
further rises in tax rates from these levels are not an option and
indeed they must be cut, for two reasons.
The first reason concerns the ‘Laffer Curve’; which computes the
extra revenue raised for every rise in the marginal tax rate.
This curve reaches a peak at some fairly moderate marginal tax
rate because of the effect on effort and tax evasion.
All informed observers, including the Institute of Fiscal Studies
which is generally in favour of higher taxes and redistribution,
agree that the 50% new top tax rate will not increase revenue and
will probably lower it for this reason.
The second reason concerns growth. Growth comes from the
innovative activities of entrepreneurs, who are extremely sensitive
to marginal tax rates because their activities are risky and any
gains uncertain; the more these are taxed the less the expected
return and if this drops below some threshold they will not bother
at all.
The UK needs both to make the fiscal
adjustment on the spending side by reviving
old-style Treasury control and then quickly
bring their tax system back into the land of
reasonable incentives, following that up with
reforms ‘flattening’ the marginal tax rates
across the economy and income groups.
Estimates of the effects on growth of marginal tax rates are for
obvious reasons uncertain; but the sort of effect that comes out of
empirical studies is an elasticity of one third, i.e. for every 10%
reduction in tax growth would rise by 3% (e.g. a reduction of the
marginal tax rate from 40% to 36% would raise growth from 2.5%
to 2.58%).
This effect seems small but it accumulates into something large.
So in short the UK needs both to make the fiscal adjustment on the
spending side by reviving old-style Treasury control and then
quickly bring their tax system back into the land of reasonable
incentives, following that up with reforms ‘flattening’ the marginal
tax rates across the economy and income groups.
The supporting role of monetary policy
This fiscal adjustment, however gradually brought about, is going
to be a fairly grim process and it will dampen growth further.
It will require the efforts of the monetary authorities to support
the economy through it, without pushing inflation over the target.
At present the bank credit is not expanding, whereas a growing
economy requires bank credit growth usually of twice or more
times the GDP growth rate.
The Bank of England is keeping interest rates low but has suspended
the printing of money (‘quantitative easing’), even though bank
credit growth has not responded.
But it may well need to restart it. This is something the UK will
need to watch and if, as seems likely, inflation falls back to well
below the target and the economy falters under fiscal retrenchment,
the Bank of England will need to take steps to get the broad money
supply growing again.
As we have noted before, other channels for money appear to be
working in substitution … UK equity and corporate bonds issues
have been substantial recently. So liquidity may turn out adequate
even without credit growth revival.
Our forecast for the UK
Though the UK Budget was predictably vacuous, being a pre-election
affair, our forecast assumes that action pretty much along the
above lines will be taken after the election by whatever government
is in power … hung Parliament or not.
The reason is that there is little room for manoeuvre and privately
in fact the parties do not materially disagree, except to some degree
on what modest room there could be for tax rises instead of spending
cuts.
So in short we think there will be fiscal retrenchment, monetary
policy will provide support, and so the UK recovery will slowly
continue.
No comments:
Post a Comment