In March, the UK went through parallel political universes. When budgeted, the government’s social response to the coronavirus stood at just over elimination of the three-day waiting period for sickness benefits. Fast forward a few days, and the Chancellor had committed to two wage subsidy schemes who would continue to pay the salaries of almost a third of all UK workers.
The month of July should mark a return to political reality with the “chancellor”summer economic update“next week. With his rhetorical flourishes, the Prime Minister has sought to evoke the comparison with Franklin D Roosevelt’s New Deal, but the background tells a very different story. Even if it was all new money – rather than a modest reshaping of existing spending – the Â£ 5bn infrastructure package is seven times smaller than the increase in annual public investment after the 2008 recession, and 200 times smaller than the original 1930s New Deal.
There are several reasons believe that the UK economy is not about to “rebound” on its own. Travel restrictions and social distancing will disrupt services such as hospitality and tourism for months to come. Meanwhile, a large chunk of the savings accumulated during the lockdown is concentrated among those least likely to rush up spending. This includes those who accumulated large savings before the crisis, or those who are past an age where there may be continued nervousness about shopping or traveling for leisure, or both.
Perhaps more so than in previous economic recoveries, additional support must now be strongly targeted at specific sectors, low wages and additional job creation. But to say that the announced tax cuts correspond poorly to these objectives would be an understatement.
Since lowest-paying jobs already attract few or no NICs (employee or employer), indiscriminate rate cuts simply transfer public funds to almost every sector of the economy, except where they are needed most. Further cuts would create what economists call big “deadweight lossÂ», With few redemptive assets.
The reduction in VAT is arguably even worse. Many of the basic essentials most in demand by families in difficulty are already Zero-rated VAT, and many retailers are either willing to offer deep discounts or currently have such tight margins that they will not be able to pass on a lower price at all. Following an ineffective VAT cut in advance also risks the worst of all worlds: Consumers hold back spending today in anticipation of lower prices tomorrow, with the turn that tomorrow either disappoints or never comes.
Direct public investment in job creation, and targeted rent vacancies for struggling households and businesses, are likely to yield much greater benefits and at a much lower economic cost. Reforming the job retention program into more targeted and sectoral support, while rebuilding the rest of the UK’s safety net to provide a genuine ‘guaranteed minimum incomeWill also be vital.
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That doesn’t mean that tax cuts should be ignored altogether, but they need to be a lot smarter. The highest marginal tax rates are those on employment benefits. Even before earning the equivalent of Â£ 9,500 a year, which is needed to start paying for network cards, many employees on Universal Credit only keep 37p on every extra Â£ 1 they earn because benefits gained create a “marginal effective tax rateBy 63 percent. This figure rises to at least 75% after the entry into force of new taxes, compared to only 32 percent for those paying NICs and income tax on average incomes – or a maximum combined rate of only 47 percent for income over Â£ 150,000 per year.
Tackling the exorbitant tax rates encountered precisely where increased hours, income and expenses are needed most should be an indisputable goal that both left and right can endorse. Above all, there are already ways to achieve this quickly and efficiently.
The “typing” in Universal Credit sets the rate at which benefits are withdrawn for each additional Â£ 1 of work income, and the so-called “work allowances” give a threshold for earned income, above which the cone is applied. Simple changes to these rates and thresholds could significantly reduce effective tax rates for the poorest working people. Because these policies are extremely well targeted to those who need them most, the costs to government begin in the hundreds of millions, not the billions needed for significant changes to NICs and VAT.
For a chancellor ready to travel through political space-time as recently as March, ignoring calls for costly and ineffective tax cuts in favor of targeted support where it is most needed should be a task. simple. We’ll see soon.
Alfie Stirling is responsible for the economy at the Foundation of the new economy