The TaxPayers' Alliance - Economics 101

Public spending dominates the economy outside of the 'Greater South East'

In 2007-08, 41.1% of the UK's Gross Domestic Product (GDP) was public spending.  There had been a significant rise since spending bottomed out in 1999.  But, that is nothing compared to what is projected to happen over the next few years.

The Centre for Economics and Business Research have used Treasury figures to show (PDF) that spending is set to hit 50% of the economy in 2010-11.  That is a shocking increase in just a few years.  The picture is even starker, though, when you look at individual regions.  While London, the South East and the East of England continue to have relatively small states - at 40.9%, 40% and 43.7% respectively - many other regional economies are dominated by state spending.

In Wales and Northern Ireland spending is over 69% of regional GDP.  In the North East, that figure is over 63%.   The make up of these regional economies therefore bears a greater resemblance to Cuba, where public spending is around 79% of GDP, than the South of England.

At that level, state spending is likely to be having severe negative effects on the economy, even if it is paid for by revenues elsewhere in the country.  David B Smith, in a paper (PDF) for the Economics Research Council, set out one possible reason:

"One possible political-economy explanation is that being in receipt of transfers is positively harmful to a region’s economic dynamism, because it encourages people to look towards political activism and state dependency, rather than their own efforts in the marketplace. This explanation is entirely consistent with the traditional concept of the rational economic person, who tries to maximise his or her rewards while putting in minimum effort. It may be easier to lobby for a handout than to work a ten-hour shift in a steel mill, for example. There is also the interesting phenomenon that high government spending regions, such as Scotland, Wales and the North-East, seem to produce large numbers of political entrepreneurs, who live off and lobby for a large state, but few of the traditional wealth creating kind these days – compare and contrast the careers of James Watt and Gordon Brown, or George Stephenson and Alan Milburn, for example. Again this is entirely consistent with the predictions of the rational economic behaviour approach, which states that enterprise will be channelled to where it attracts the highest rewards."

As well as entrepreneurs, the best workers are also likely to be creamed off by the state, which can out bid the private sector with higher wages thanks to the subsidy from the South.

Britain's oversized government is paid for by the South of England but it may have its most pernicious effects in the North, Scotland, Wales and Northern Ireland by trapping the most talented and the most unfortunate into dependency on subsidies.

HMRC get it right

At the TaxPayers' Alliance, we often have to criticise HMRC.  Whether they're harassing law abiding taxpayers, pushing for new powers to take money straight out of people's bank accounts without approval from a court or losing people's personal data - they often need to be criticised.  However, today they've really got it right.

HMRC has made it very clear that paying for accountants to fill out their tax returns can't legitimately be claimed as an expense by MPs.  On this point, at least, politicians have to live by the same rules as the rest of us.  Hopefully, HMRC's position will make it harder for the politicians to excuse their behaviour and make it more likely they will be held to account for this abuse of taxpayers' money.

There is a wider importance to this case.  Politicians have massively increased the complexity of the tax system in recent years.  We recently overtook India to have the longest tax code in the world.  That imposes massive costs on ordinary taxpayers and businesses who have to pay a fortune for accountants or risk getting in trouble if they get their return wrong.  If politicians can avoid these costs, by claiming them on expenses, then they won't really appreciate the burden being placed on ordinary people.  They won't grasp the urgent need for a move towards lower, simpler tax rates.

It is vital that politicians have to play be the same rules the rest of us.  If they don't, taxpayers will rightly be furious.

Joined-up hypocrisy on pensions: don't even do as I say

In one of the more mean-minded moves in his Budget, Alistair Darling has decided to claw back tax relief on pension contributions for higher-earners (those with an income over £150,000 pa) from 2011.  But the measure really comes into force from Budget Day, because the Government plans to implement regulations to penalise anyone who, in advance of April 2011, “change their normal ongoing regular pension savings” i.e. saves more into their pension.  If you now decide to save more than £20,000 per year, and you haven’t been doing so already, Alistair will slap an extra tax charge on you.

The logic behind this is pretty obvious.  Darling plans to introduce a new tax band for anyone with an income over £150,000 – originally at 45% from 2011, and now to be at 50% from 2010.  Until now, pension contributions have been eligible for tax relief at the individual’s marginal tax rate – so any one earning more than £150,000 who was worried about the higher rate could simply have paid the surplus income into their pension fund, or agreed to waive that surplus and have their employer pay the amount into the pension instead.  Both of these planning methods will be caught by the transitional tax charge.

In his Budget speech Alistair Darling claimed that “It is difficult to justify how a quarter of all the money the country spends on pensions tax relief goes, as now, to the top 1 ½ per cent of pension savers.”  But that’s what happens when you have a system of tax relief for pension contributions, Alistair: the rich receive more in tax relief because they save more, and they save more because they earn more.  The poor don’t save because they haven’t got any bloody money in the first place.

If salary sacrifice schemes are “unfair” and help only the rich, why does the HM Revenue & Customs website provide detailed advice on how to carry out a salary sacrifice in order to boost your pension contributions?  See here and here.

If Alistair Darling believes people who start to save more are nasty and have to be punished, what does he think of these irresponsible quotes from an evil financier:

“We want to build the savings culture.  That is good for individuals.  It is good for businesses and is therefore good for the country as a whole.  But of course the Government has also to foster the right economic climate to enable businesses and individuals to plan for the long term.” (Alistair Darling, Chief Secretary to the Treasury, 3 December 1997)

“We want to make sure that people on moderate and higher incomes who can save for their retirement, do so….The message that we want to get across to people is that if you can save for your retirement, then you should be saving for your retirement, because it always pays to do so.” (Alistair Darling, Secretary of State for Social Security, 6 April 2001)

“We want to encourage more people to save for their retirement” (Alistair Darling, Secretary of State for Work & Pensions, 30 July 2001)

Darling's dodgy accounting: the hidden £135 billion

Government ministers have led the pack in condemning banks for failing to come clean about the true value of the toxic assets on their balance sheets.  But is the Government any better itself?

Alistair darling has claimed to be “transparent” in confessing that the banking bailout will cost us 3.5% of GDP – but it is not obvious where or when this cost is actually recognised in his Budget projections.  Perhaps it is buried away in the forecast of the borrowing requirements?

One thing is certainly buried away in the small print: how Darling is massaging the national debt.  The headline borrowing figures are frightening enough but they actually obscure the true liabilities taken on by taxpayers through Alistair’s generous “financial sector interventions”.  At the back of the red book are a set of admissions that the Budget projections ignore both the potential final cost of the interventions and the liabilities of the nationalised banks (FSBR para C.99).

Why?  Well, apparently, although the Government and the Office for National Statistics now agree that RBS and Lloyds have been nationalised, “ONS have not yet been able to calculate the impact of these banks’ balance sheets on Public Sector Net Debt and have said that this may take some time to complete” (FSBR para C.104).  Really?  Six months not long enough to add a few numbers together?  The poor lambs must be really busy.

What does this mean?  It means that the bank bailout is excluded from the headline national debt.  So, if for example, the Government borrowed £1 billion to buy bank shares costing £1 billion, Alistair Darling has decided that the value of the shares somehow cancels out the borrowing and he can claim that the borrowing has not happened.  True debt is therefore much higher than the Government admits, and the real position is:

  
Source: FSBR, Table C14

Furthermore, as everyone knows, the share prices of the banks have fallen massively since the “interventions” first began.  RBS has dropped from over 100p per share to about 30p (having touched 10p) and Lloyds has fallen from over 200p per share to about 100p (having briefly gone below 50p).  But the Government is claiming that its shares are still worth what it paid for them back in the autumn.

So, Alistair Darling is:

• Hiding the true level of Government liabilities by using accounting conventions about when he can recognise costs and losses.

• Refusing to mark down the value of toxic assets to reflect their true market value.

Which, of course, is what the dodgy banks are supposed to have been doing wrong.

The cost of the bank bailout

Despite earlier government assurances, taxpayer losses on bank bailouts are going to be huge. Yesterday, the IMF said that UK taxpayers can expect to lose £200bn, or 13.4% of our GDP.

Needless to say, the government's version is rather different. Indeed, they were so embarrassed by the IMF's figure that they actually forced them to withdraw it. And today's budget gave us the government's own authorised figure - 3.5% of GDP, or about £50bn.

That is an extraordinarily optimistic estimate. It's just a quarter of the original IMF figure, and even well under half the IMF's "corrected" figure of £130bn, reported in the Times.

But even more striking is the way Darling describes his estimate. In paragraph 2.28 of Budget 2009, he says:

"Reflecting the principle of transparency, the fiscal forecasts include a provisional estimate for the high end of a range for the net impact of unrealised losses on financial sector interventions, equal to 3½ per cent of GDP."

Well, it may be the high end of his range, but it transparently isn't even at the low end of anyone else's.

The £15 billion cut in public spending

Darling's budget projections are based on some wholly implausible assumptions about public spending.
 
Post the next election he forecasts that current spending growth will fall to 0.7% pa in real terms (2011-12 onwards). That's a virtual halving from the 1.2% pa he incorporated in November's Pre-Budget Report. Yet while real public spending restraint is always difficult, Darling claims to be making this cut painlessly.
 
How?
 
By having another round of the magic Gershon efficiency programme, that's how.
 
Gershon was launched in 2004 by Gordon Brown, with the aim of getting better value for money in Whitehall and across our public services. The government claims it has already "saved" £26.5bn pa.
 
Yet when the National Audit Office did a detailed study of these claims, it found that only one one-quarter of them were dependable - in other words, the rest merely comprised the usual Whitehall deckchair rearrangement, or cuts in service standards. There was no magic. Indeed, the NAO found that some of the Gershon "savings" had actually resulted in knock-on cost increases elsewhere. A classic example was the surge in emergency hospital readmissions caused by sick people being discharged early from hospital in a Gershon drive to make "more efficient" use of scarce beds.
 
Darling is now claiming he can save a further £15bn pa from more of the same (including £5bn he announced in the PBR). Yet the detail of how he will do this includes several of the measures we know to have failed already, such as another £500m pa from those self-same counterproductive early hospital discharges.
 
There is no doubt that the dire state of our public finances demands some substantial cuts in future spending, and an attempt to produce £15 billion of savings is a good start. However, £15 billion is the tip of the iceberg, and these savings are not guaranteed to actually materialise as promised.

Brown Bombshell bigger than debts from the Napoleonic Wars, First World War and Second World War combined

Frightening statistics from today's budget for 2009 reveal the extent of Brown's debt mountain.  The revised borrowing figures for the public sector between the years 2008-09 to 2013-014 exceed the combined real terms (RPI-adjusted) borrowing required to defeat Napoleon (1793-1815), the Kaiser (1914-1918) and Hitler (1939-1945).  The TPA understands that although these three foes are now dead, it is not yet clear that we will beat the recession.

  

Historical debt statistics taken from British Historical Statistics by BR Mitchell, up rated from 1816, 1919 and 1946 to end of 2008 prices using http://www.measuringworth.com/ppoweruk/ and ONS RPI statistics (most recent available).  Public sector net borrowing statistics taken from the Budget Report 2009, Table C4.

Historic data is uprated using RPI figures because this provides historical consistency in comparing the real cost of debt.    RPI is the measure of inflation the public understands best and is the only statistic available for the entire period in question.  Governments spend and borrow in pounds sterling, not percentage points of GDP.

New green jobs might mean 480,000 fewer jobs in total

In his Budget speech, Alistair Darling announced a number of policies that he hopes will support growth in green industries.  The key measure is "£1bn to help us combat climate change, by supporting low carbon industries and green collar jobs."

Those industries already get massive subsidies through policies such as the Renewables Obligation and the European Union Emissions Trading Scheme.  Our green calculator highlights the amount this is pushing up electricity bills, 14% of the average household electrity bill is now the result of climate change policies.

The burden on business is even larger.  21% of the average industrial electricity bill is now the result of climate change policies.  That burden on business destroys jobs by making it harder for them to compete with other firms abroad.

Paying for the new subsidies will also impose a new burden on business and families, reducing investment and the amount consumers have to spend.  That will mean more jobs lost in the rest of the economy.

The question is, does the number of green collar jobs created outweigh the number of blue and white collar jobs destroyed?

Bloomberg reports a study by King Juan Carlos University in Spain, which suggests that more jobs might be lost than created:

"March 27 (Bloomberg) -- Subsidizing renewable energy in the U.S. may destroy two jobs for every one created if Spain’s experience with windmills and solar farms is any guide.

For every new position that depends on energy price supports, at least 2.2 jobs in other industries will disappear, according to a study from King Juan Carlos University in Madrid."

The Budget report, on page 135, claims that the number of green collar jobs will rise by 400,000 by 2015.  The effect on jobs here will be highly contingent on the kind of policies used to support green industries and other economic conditions.  However, if we get a similar ratio of jobs destroyed to jobs created here as they found in Spain, that could mean 880,000 jobs lost in other industries for a net loss of 480,000 jobs.  That might be the reality of a "green recovery".

The growth forecasts in the Budget

There should be a health warning on the Chancellor’s forecast; “Do not believe.”  Fair enough, the fall in UK GDP of 3.5 per cent for 2009 looks reasonable but, for the economy to achieve growth of 1.75 per cent in 2010 it would require an extraordinarily vigorous bounce back, which is simply not credible.  Why?  Because the reasons for much of the growth leading up to the financial crisis, buoyant public spending and a rapid increase in consumer indebtedness, cannot be replicated.

Moreover, growth rates of 3.25 per cent in 2011 through to 2013 should not be regarded as realistic forecasts, they should be regarded as illustrative assumptions- nothing more and nothing less.

Given these over-optimistic GDP figures, the implications for the public finances are serious.  The current projections are bad enough, the actuality will be far worse, unless a scalpel is taken to public spending.  But the Chancellor knows he will not be the man to do it.

The Chancellor has fudged the issues, kicked them into the long grass and left the nasty work to his successors.

John Redwood on the Budget

John Redwood makes a powerful case that the Chancellor needs to force the public sector to live within its means:

"Finally, the Chancellor should say that he intends to start getting the UK public sector to live within its means. He will not delay this until after the next election, and not treat reducing public spending as some kind of imaginary game or political challenge to the Tories. He will instead this year make large reductions in undesirable, wasteful and not strictly essential expenditure. Schools and hospitals, nurses and teachers will be safe. ID cards, centralised computer systems, unelected regional government, more subsidies to banks and other large companies, increases in regulation and public adminsitration will all go. He will require all MPs to cut their costs and the costs of Parliament by 10% to show a lead."