Tax Breaks for Britain's Masses: Will Trickle Up Economics Work?

According to press reports in the UK this weekend, the government is about to launch an aggressive fiscal stimulus package designed to enable the UK economy to spend its way back to prosperity.

It appears from leaks to the Sunday press that Value Added Tax, the most conspicuous form of indirect taxation, will be the main vehicle to be adjusted and perhaps, a five percent temporary reduction will encourage the punters to get out in the stores this Christmas season and do their duty as good consumers. But this approach is looking increasingly desperate especially as there are also suggestions by the current UK Chancellor that, in order to show his credentials for prudence to the global capital markets, who still might decide to dump sterling and UK Treasury paper in response to the moves, that in the longer term the working stiffs should expect tax rises in order to pay for these short term emergency measures.

In the long run is this really the solution to the UK's economic problems? The question is especially acute for the UK economy which has a zero savings rate and some of the highest levels of personal indebtedness in the world. Why are UK policy makers continuing to focus on trying to enhance the marginal propensity to consume when it would be so much better, for the structural economy, in the longer term, to be looking at ways of decreasing the marginal propensity to take on more debt?

The suggestion outlined below is that permanent tax cuts for the less well advantaged in the UK economy, removing many of the working stiffs directly from the taxation system altogether, would see a more sustainable basis for dealing with the fundamental problem that requires a solution, i.e. how to find a bottom sooner rather than later in the housing market. Housing has to become more affordable at the margin again and the approach suggested is a Trickle Up Income Tax Stimulus.

But before laying this simple argument out let's look at the context of the current crisis in relation to UK fiscal policy in particular.

Gordon Brown's proposed new mini-budget, along with a host of other recent posturing and antics, puts a new focus on the real meaning behind the Clinton saying "It's the Economy Stupid". Failure by any politician to be visibly concerned about the plight of the common man, to be seen to be very busy and doing something active and positive during dire economic times, is a recipe for electoral defeat and like Clinton before him, Gordon Brown knows this only too well. Much better to be seen rushing to world summits and convening G20 meetings, encouraging the central bank to make emergency rate cuts and having countless initiatives that ultimately tap into public monies to get the economy "moving" again. And alas the UK punters are gullible and would rather a government that appears to be addressing their concerns than providing a sound basis over the longer haul for a more rational economy.

The combination of widespread financial illiteracy and the tendency of the public to engage in a form of massive self deception when it comes to economic crises is what has allowed the former Chancellor of more than ten years to be seen, as evidenced by a resurgence in his standing in opinion polls, as the right man to navigate the UK economy through the current financial crisis. Yet in many ways he is precisely the individual who is the cause of indigenous problems that have given rise to IMF expectations of a sharper downside for the UK than most other major economies.

During the last eleven years, the UK government has stealthily maintained a light touch approach to financial regulation, promoted a tax system which is inordinately favorable to the very rich who effectively enjoy all of the benefits of living in London and running their businesses in that city and yet pay virtually no tax. Not only is the UK the world's favorite onshore tax haven, but it is also one of the best places in the world for those that want to hide their affairs from fiscal authorities and to avoid/evade taxation. There are more experts in London that will be able to assist companies and wealthy individuals from having to pay what most working stiffs would consider to be their fair share of direct taxation than anywhere else in the world.

UK governments for years, including the current one, try their best to keep quiet about this egregious situation and, on the occasions when they have been challenged about this from within the domestic political system, have concocted all kinds of arguments to rationalize the fact that this form of inequity should not be challenged as it will scare the rich away from London. The argument goes along the lines that if you make life more uncomfortable for rich hedge fund managers or Russian oligarchs, then they will simply move to Monaco or Switzerland, taking all of their money with them.

So despite the fact that the UK Revenue barely gets a look in on these earnings of the super wealthy, the argument is that the crumbs that fall off their tables are good for the UK economy. This is trickle down economics taken to an absurd extreme.

But we may be at an important cross roads where all of this can and should be challenged and the spurious nature of the argument be properly exposed. The "hot money" crowd (many of whom enjoy that particularly British tax status of "non-domiciles") are now having their fair share of problems, large international hedge funds based in Mayfair are failing, whole buildings in Canary Wharf lie unoccupied and foreign investment bankers are returning to their home jurisdictions, many of which do not allow for all of the "offshore" shenanigans, and accordingly the good fortune of those enjoying privileged status from HMRC (i.e. the UK Tax authorities) can no longer be taken for granted as being a "good thing" for the UK economy.

Being nice to the super rich with a nod here and a wink there and an implicit assurance that UK Chancellors will never really upset the tax haven status for the international elite still hasn't prevented the partial collapse of London as a global capital hub. Other forces at work have ensured that that is now unfolding and financial services, a vital part of the UK economy, are now in rapid decline. So perhaps we should be even nicer to the fat cats? But that completely misunderstands the origins of the current financial crisis. Many of the super rich are floundering precisely because the light touch regulatory framework encouraged by Gordon Brown, as well as the US Administration, allowed the financial engineering community which was largely based in London to set in motion the financial meltdown which is still unraveling.

The real problem facing the central bankers and policy makers in the US and the UK is a critical mismatch between median home prices and median income levels. It is simply an affordability issue. Either median residential property prices have to come down a lot in value or median incomes have to rise a lot. The first of those two options is well under way with real estate correcting particularly viciously in the UK.

But how could the second option be addressed? One way to do this would be a permanent and significant reduction in the rate of direct taxation levied in the UK for those that are currently below the median income. How could this be paid for on a longer term basis? How can we break out of the tax con of "Oh you lucky people, here's a short term tax break so you can get out and spend for England before we have to put taxes back up again? Why doesn't the UK embark on a serious and long term program of increases in the marginal tax rates for those above the median income? By shifting the tax burden away from those with lower incomes, and thereby putting greater permanent purchasing power into the hands of those with the highest marginal propensity to consume, there could be a cushion under the real estate market much sooner than tampering with even more incentives to encourage the rich to remain in London.

Comments

[jack kreg:]

The UK's move to use Reagan's genius of tax cuts, simply puts the socialists into a frenzy.
Imagine, if Brown's tax cut plan went global, with coordinated cuts on worker and corporate income tax, yes, his plan would set the bottom in the current economic downturn and the global economy could begin to recover.
Why not let workers keep more of their own money, they might even make the house payment or rent payment, put a little aside for retirement (as clearly gov funded retirements in the future will be slim to none), or even buy some gas or food. Let the workers keep more of their own money.
Why keep on giving the same gov more taxes, when they are the ones who lead us to this economic crisis.
Maybe cutting taxes on those who employ us would be a good idea, conversely, raising taxes (did I say windfall taxes) would surely not result in more jobs.
Brown's tax cuts should be taken global, free the workers and their employers to fix what the gov's have broken.

2008 Nov 24 11:53 AM