Taxation

What was the problem with the 2012 budget? The problem was not so much what the Chancellor did but rather what he did not do. There was precious little in this budget to address the most pressing need of the British economy – and indeed the world economy – the need for growth.

 Tax Troubles: A lack of principles

Take the Big Media Story first. The Chancellor fed some red meat to the Tory heartland by reducing the top income tax rate from 50 per cent to 45 per cent but needed to sell this to his Lib Dem partners. This was done by a number of wheezes including the hopes-spring-eternal tightening of tax loopholes. But the main soak the rich policy was a new 7% rate of land stamp duty rate on houses worth over £2m. Her Majesty’s Treasury puts the cost of the 45p tax at only about £100m per year, but the stamp dutyrevenues at well over £200m per year. What could be better? More tax revenue and the only people complaining are the London prime real estate agents and the whinging Labour front bench!
Unfortunately, the Chancellor has missed a chance to make a real reform to the dumb tax of stamp duty. Basic public finance principles say that taxing an immobile factor like land is a good thing because it creates less distortions to behaviour – for example it cannot up sticks and leave the country. But Principle 2 says that we should tax property values rather than just the proceeds from selling a house. Someone who doesn’t sell a house has been sitting on a huge untaxed capital gain. Council taxes hardly touch this, not least because successive governments have backed away from properly revaluing the housing stock for fear of upsetting voters. But taxing transactions reduces the incentive to move, say for purposes of finding a job. Rather than reform the tax system to make it “fairer, more efficient and simpler”, this complicates it further.
Reducing taxes on the very rich such doesn’t seem fair in an age of austerity, but will the reduction in the top rate of tax make a big difference to incentives? The truth is, as my CEP colleague Alan Manning has written, no one really knows. The lower than expected tax take from the 50p tax could simply be because of changing wage patterns rather than the rich slacking off.
Reducing child benefit for the rich is a reasonable move, but it would have been better to integrate this properly into the existing system of child tax credits and benefits. Instead it is being bolted on to the whole system which is going to create more complexity and perverse incentives.
What this whole episode of tax at the top illustrates is the triumph of political manoeuvres over sound public policy principles.

The Big Picture: We need an alternative to Plan A

As expected there was no movement away from the Chancellor’s current austerity programme. In my view, the rate of fiscal consolidation is too fast and unnecessarily raising unemployment and slowing growth. Economic forecasting is a conservative profession but most regard austerity as directly knocking a third of a percent off growth last year and more this year. Unfortunately macro models do not fully factor in the way in which austerity damages the productive potential of the economy as unemployment begets more unemployment as scrapped workers lose their skills and motivation. Putting these in to their equations would result in an even larger depressing long-term effect of austerity on growth. And since in 2011 GDP growth was a pathetic 0.8 per cent, this is a big, big cost.
The Chancellor’s defence of his tight fiscal stance is that it is needed to calm the nerves of over-anxious bond traders. But I can see no reason why the markets would panic from a set of policies to boost government investment in shovel-ready projects like school buildings or road repair. Unfortunately these types of investments have been curtailed the most severely over the last few years. Nor do I see major costs to our fiscal credibility in offering temporary NI breaks to mitigate the scourge of young unemployment which is at record levels.
Putting aside the overall fiscal position though, there are two concerns over the Chancellors’ economic strategy.
But it’s not all bad news…  
There are many welcome aspects of the Budget – the increase in personal allowances, longer term government bonds, credit easing, and implementation of the Vickers proposals to reform banking. There are worthy consultations over local pay, integrating NI with income tax and controls over tax deductions. Of course we need to see whether consultation becomes action. But none of these welcome moves are enough to counter the deeper intellectual vacuum at the heart of the Budget and the government’s whole approach to economic growth.

Read more here.