The Great Debate UK

This budget will heighten income inequality

–Daniel Tarling-Hunter is an economist at Euromonitor International. The opinions expressed are his own.–

The 2012 Budget has highlighted the divide between the richest and the poorest. Two standout policies have come under scrutiny; a reduction in the top rate tax, and support for the lowest income groups by raising the personal allowance. Though these changes don’t shift the fiscal position of the government, Euromonitor International forecasts that the UK’s existing income inequality is set to widen further with more pressure on the poorest consumers.

Income inequality in the UK, measured through the Gini Index, has risen each year since the coalition government came into power in 2010. Euromonitor International expects the Gini Index to continue to rise to 34.3 by the next general election in 2015 from the 2010 figure of 33.0 (where 0 equals perfect equality and 100 equals perfect inequality). A combination of recession following the global economic downturn of 2008-2009 and subsequent fall-out from the eurozone debt crisis, and government austerity measures have all acted to squeeze the country’s lower and middle-income consumers since 2008. The latest budget will exacerbate income divides further.

The controversial 50p tax cut is a deeply ideological move. The claim that the five percentage point reduction to 45.0% will cost the government just £100 million in lost revenue is questionable given the estimates are based on a short period of data. Funding for the cut comes from closing loopholes for tax avoidance by the wealthy, an increase in stamp duty and higher effective taxes elsewhere.  However, the richest 10% of households in the UK had an average disposable income 10 times that of the poorest 10% of households in 2011.  Given the level of inequality already, many will question further tax relief affecting the richest in society.

As a result of the financial crisis, during this parliament (2010-2015) Euromonitor International expects the average household disposable income to decline by 2.6% in real terms, a £903 reduction. However, the decline is most pronounced in the lowest income decile 1 (the poorest 10% of households) where real household disposable incomes are expected to decline by 7.8%, while the highest income decile 10 (richest 10% of households) is expected to be the only group to see positive growth of 1.0%.

Given the fiscally neutral position of this budget, even a policy focussed on reducing inequality (such as the increase in the personal income tax allowance to £9,205 effective from April 2013) has been countered by raiding tax allowances elsewhere. Instead of a genuine redistribution of wealth from higher income groups to the lowest, it redistributes an estimated £3.6 billion, according to HMRC, between 2013 and 2016 from the elderly to provide for those of working age. Given weak economic conditions and an ageing population, an increasing number of over 65 year olds are staying in work; between 2007 and 2011 Euromonitor figures show a 34.7% increase in 65+ year olds working. It is important to note that in 2011 the average gross income of 65 year olds and above was already the lowest of all age groups above the age of 24.

Road privatisation can deliver huge benefits – if government gets out of the way

–Dr Richard Wellings is Director of the Transport Unit at the Institute of Economic Affairs. The opinions expressed are his own.–

The British government is finally recognising the strong link between transport infrastructure and economic growth. The Budget set out plans for a national road strategy while earlier this week the Prime Minister announced that motorways and trunk roads could be operated by the private sector.

The new proposals represent a significant shift in policy. Since the early 1990s public transport has been prioritised by successive governments. Huge subsidies have been given to buses, trams and trains. Expenditure on roads has focused on deterring car use through traffic calming, new controls and priority lanes for buses and bicycles. But despite these measures, private cars still carry 85% of passenger traffic. In most areas public transport carries a tiny minority of travellers (with the important exception of travel to and from central London).

In practice, public transport simply does not have the capability to move more than a small fraction of passengers and goods around the UK. Economic activity is too dispersed and buses and trains don’t offer the flexibility and convenience of cars and lorries. Moreover, public transport requires massive taxpayer subsidies – totalling over £10 billion per annum. It is inconceivable that a heavily indebted government could increase this burden much further.

Improvements to the road network offer far better value for money and need not cost the taxpayer a penny. Unlike many rail projects (High Speed 2 is a typical example), road schemes can be self-financing with construction and operating costs funded by tolls. This makes roads an ideal investment for the private sector. Without the need for government subsidies, the political risks are much smaller than with public transport. David Cameron is therefore right to see the huge potential for greater private sector involvement in the core road network.

The benefits of privatisation are potentially enormous. Private operators would depend on toll revenues for their profits and they would have very strong incentives to provide a good service to customers. Congestion – which currently costs the UK economy about £20 billion per year – could be eliminated by flexible pricing, with off-peak users offered bargain rates. Safety could be improved dramatically as operators sought to avoid costly delays from accidents. Perhaps most importantly, investment in new capacity would reflect consumer demand rather than political priorities. In marked contrast to the current system, new roads would be built where they were needed most.

Privatisation would also bring entrepreneurship and innovation to the road network. This is how really big efficiency gains become possible. For example, private operators could increase weight and size limits on goods vehicles. Imagine the productivity gains in the distribution sector if each lorry could carry say 50% more cargo. Speed limits could also be increased where safe to do so, leading to massive time savings and lower business costs. All manner of improvements would be possible as entrepreneurs sought to maximise the returns from their infrastructure.

Why have a budget?

–Tim Knox is Director of the Centre for Policy Studies. The opinions expressed are his own.–

Next year, the British government will spend £680 billion – or just under £2 billion a day, every day of the year. Remember that when considering all the noise – in both Parliament and the media – about yesterday’s Budget.

Take the five main areas of tax reform put forward yesterday:

• The reduction in the top rate of income tax from 50p to 45p. Cost to Treasury:  £50 million
• The increase in the personal allowance to £9,205 in 2013. Cost to Treasury: £3.32 billion
• The freezing of the personal allowance for pensioners. Tax raised: £360 million
• The further cut in Corporation Tax to 24p. Cost to Treasury: £730 million
• The increase in Stamp Duty on properties over £2 million to 7%. Tax raised £180 million

(Figures are for 2013/14. Source: Red Book. Table 2.1)

So these main tax changes account for £4.5 billion – the equivalent of a couple of days spending.

Then we had a list of fashionable giveaways: £100 million for new research facilities at universities, £60 million to establish a UK centre for aerodynamics, an additional £50 million for broadband, tax breaks for video games, animation and high end TV industries, £3 billion for oil and gas exploration, £1.2 billion of infrastructure investment in Manchester, £150 million for other northern cities, an increase in the Growing Places fund of £270 million, £15 million for improving the safety of cycling and so on. In the words of Rick Blaine in Casablanca, this surely “don’t amount to a hill of beans in this crazy world”.

The politics of today versus the economics of tomorrow

–Sheila Lawler is Director of Politeia. The opinions expressed are her own.–

The 2012 Budget seemed to have something for everyone. For low earners there are tax cuts; for business there are cuts in corporation tax; for well-off families fearing the loss of child benefit, a reprieve; and for all who recognise that the public finances and public spending must be brought under control, there is the comfort of a ‘fiscally neutral’ budget.

But the Chancellor, in seeing off some of the demands of today, may be stacking up difficulties for the future. For instance, the way in which ‘neutrality’ has been achieved will bring its own problems as the threshold for paying tax has gone up as well as down.

Pensioners on modest incomes will see personal allowances cut, and the threshold for higher rate tax at 40% has been lowered (kicking in at earnings of £41,450 and over, not £42,750 as now). These tax rises augur ill for a country which is now racing against time to make the changes needed for its economy to survive and succeed against stiff global competition.

If the UK is to compete and to sell its goods to the emerging markets of Brazil and Asia, on which the Chancellor has set his sights, it will need to change. People will have to work harder (not just longer) and earn more in a labour market which is flexible and open, not stifled by anachronistic regulation. They are not going to do that under current penal policies. Moreover, business will have to grow, not be driven elsewhere by the current tax and employment costs levied on business and employers. If Germany can cut corporation tax from 25% to 15%, so can we!

So instead of penalising people who work harder by juggling the thresholds at which income tax is applied, more ambitious plans are needed, short and long term, for cutting levels of public spending – the real problem for any Budget is not the politics of today, but the economics of tomorrow.

Levels of public spending proportionate to GDP must continue to fall. Efficiency savings are often mentioned here. They should not fall on frontline services – as is already the case, with the most able doctors and specialist research hospitals being squeezed out by Whitehall’s henchmen. Rather the squeeze should be on those very officials whose number and kind exploded in the decade to 2010.

The North – the more you put in…

–Graeme Henderson is a Research Fellow at IPPR North. The opinions expressed are his own.–

George Osborne made it clear today that infrastructure investment is a central part of the Coalition’s plans to help accelerate us out of the current economic downturn, but in the build up to this year’s budget, a multitude of infrastructure proposals have been vying for the Chancellor’s attention. Announcements today that there will be further investment in work on the so called Northern Hub is therefore very welcome – to be most effective, infrastructure investment has to be targeted where it is needed most, and where it will make the greatest impact.

The Northern Hub is a network of rail connections and central Manchester improvements that will increase capacity and substantially reduce travel times between all the major Northern cities, stimulating economic growth throughout the region. However given that, as acknowledged by the Chancellor, there has been decades of under-investment in Northern transport, today is a good start in addressing this deficit, but it does not go far enough.

IPPR North’s Northern Economic Futures Commission has highlighted further rail priorities. For a start, northern rolling stock is in a much worse state when compared to franchises in the rest of the country: 87% of Northern Rail’s rolling stock was manufactured in the 1980s or earlier, whereas 64% of Southern’s rolling stock and 53% of South Eastern’s was manufactured since 2000 (link).

Equally important, there needs to be a link between High Speed 2 and the Midland Mainline. This would extend the benefits of HS2 across the North as soon as Phase One (London to Birmingham) is completed, and long in advance of the completion of the full Y-shaped network. This is crucial to prevent “leaking-by-linking”, i.e. the North losing business from a better connected Midlands, while it waits for the sections to Manchester and Leeds to be completed. On top of this, the Transpennine electrification proposals should be extended to reach Middlesbrough, Scarborough and Hull, and improvements are needed at each of Leeds, Liverpool Lime Street and Sheffield stations, to solve long-standing capacity issues.  All of these initiatives would cost £800m – a lot of money to be sure, but only around 2% of the HS2 budget.

Such spending would help redress decades of under-investment in the North’s transport infrastructure, but not the process that caused it. The current transport appraisal process heavily skews investment decisions in favour of areas of high population density and high salaries. This is good for London and the Greater South-East, but not the North. Another crucial change which needs to be made to the appraisal process is to better account for a project’s wider economic benefits.

These additional rail improvements and changing the transport appraisal process have the potential to kick-start the Northern economy and ensure it fully plays its part in leading the UK’s economic recovery. Today is a start, but no more than that.

Good luck, Chancellor

–Matthew Oakley is Head of Economics and Social Policy at Policy Exchange. The opinions expressed are his own.–

As an economist and ex-Treasury civil servant, the Budget always delivers mixed emotions for me. The 2012 Budget was no different.

Positives on a national level include the government progressing with a consultation into radical tax simplification for small businesses, and a pilot later this year for a programme of enterprise loans to help young people set up and grow businesses. Policy Exchange made the case for both in our recent report, Financing Innovation.

On a regional level, tackling the current system of National Pay Bargaining in the public sector (Policy Exchange has previously laid out the large distortions in the labour market that this practice leads to) will improve public services, using the money saved in smarter ways has a real chance of boosting growth in areas currently dominated by an inefficient public sector, and it provides us with a vital opportunity to link public sector pay to performance. It was also a relief that, contrary to reports in the press over the weekend, there will be no knee-jerk reform in this area.

However, the decision to levy Stamp Duty Land Tax at 7% for properties bought for over £2 million continues to complicate a tax that is already distortionary. While the politics of this are understandable, the economic rationale is unclear: if there is a desire to tax property in a progressive fashion, there are better ways of doing so.

It is also frustrating to see more changes to the corporation tax system. While cuts to rates should (nearly) always be welcomed, Policy Exchange has argued strongly that the instability and uncertainty that constant changes bring are detrimental to business and growth. This is particularly true when they are, again, financed mainly through increased taxes on our banking sector.

Overall on growth, the Budget is likely to come out positive, but leaves the toughest political decisions on public sector pay to the future. The same is true on welfare, where the further £10 billion savings that George Osborne says will likely be needed by 2016 will be tough on top of £18 billion of savings already made since 2010.

Tit for tat – tax for tax

–Tony Dolphin is Senior Economist and Associate Director for Economic Policy at IPPR. The opinions expressed are his own.–

The Conservatives and Liberal Democrats agreed to co-own the first two budgets of this coalition government. The so-called ‘quad’ of David Cameron, George Osborne, Nick Clegg and Danny Alexander defended the measures in both budgets as if they had thought of them themselves.

That was not the case with today’s budget. It was clearly the result of horse-trading between the two parties of the coalition – largely conducted in public over the last few weeks. Nick Clegg has sought ownership of some measures; Conservative backbenchers have proposed others; and the Treasury has systematically leaked on behalf of both parties. The result is, for all George Osborne’s attempts to present it as a budget for growth that rewards work, a rather odd mixture.

So, for the Liberal Democrats, there is a bigger than previously announced increase in the personal tax allowance; for Conservative backbenchers, a cut in the top rate of tax from 50p to 45p in the pound. For Liberal Democrats, restrictions on the tax reliefs of the wealthy; for Conservative backbenchers, an accelerated cut in corporation tax. For Liberal Democrats, increases in stamp duty on houses valued at over £2 million; for Conservative backbenchers, relaxations in planning rules and employment law.

Just about the only measure that was not trailed in advance was George Osborne’s announcement that the age-related personal allowance is going to be phased out over the next few years. As this hits pensioners with an annual income between roughly £10,000 and £25,000, it is perhaps unsurprising that neither Liberal Democrats nor Conservatives were clambering for ownership of this particular policy.

Future budgets are likely to follow the same pattern as this one. The nearer we get to the next general election, the more both Liberal Democrats and Conservatives will want to differentiate themselves from their coalition partners.

Floating tax and spending policies in advance of the budget so that they can be discussed and examined is not necessarily a bad thing. Indeed, if poor policies are weeded out as a result, it would be a very good thing. But this is not what is happening. Policies are not judged on their merit, but rather on what they can be traded off against.

That was a budget for growth?

–Patrick Nolan is Chief Economist of Reform. The opinions expressed are his own.–

The UK’s public finances are not out of the danger zone. This can be illustrated with a quick comparison of today’s Budget with earlier ones: in June 2010 the target for public sector net debt was expected to be 69.4 per cent of GDP in 2014-15, now it is 75.0 per cent. All up public sector net debt is still expected to increase by £440 billion over the next 5 years.

On tax the Chancellor brought forward the increase in the personal allowance. This is expensive and does little for “fairness.” (Reform estimated that only £1 in £14 of an increase in the personal allowance to £10,000 goes to people below this level.) This poor targeting creates economic as well as fiscal costs – with this policy providing no incentive to work harder or grow the tax base. Indeed, by making tax avoidance more attractive to middle income families this policy may shrink the tax base.

There is a stronger case for cutting the 50p rate. Yet while the tax system would clearly be better without the 50p rate this was not the biggest challenge facing the tax system. It was probably not as damaging to entrepreneurship and enterprise as policies such as restricting visas for skilled migrants from outside the EU or clawing back personal allowances and pension tax relief. Further, by combining the cut to the 50p tax rate with the introduction of measures like a higher stamp duty land tax rate and a cap on overall tax reliefs, the overall tax system has become more hostile. A small problem has been replaced with a bigger one.

The Chancellor failed to properly address the earlier mistake in means-testing the Child Benefit. The Child Benefit is expensive and gives too much to wealthy families. Yet the policy of withdrawing the benefit from families with top rate taxpayers was never going to work. The approach in this Budget was little better and makes reform more complex. The better approach would have been to scrap the Child Benefit and to compensate low income families through the existing Child Tax Credit.

The Coalition’s numbers largely depend on achieving (as yet unspecified) further savings of £10 billion in the welfare bill by 2016. Achieving this additional spending restraint will be challenging and will require reform to middle class welfare (which Reform has estimated costs £31 billion a year) and pensioner benefits. Reform has argued that further savings could also come from having another look at the key ring-fenced departmental budgets, such as health and schools. It was these reforms, rather than tax giveaways, that we needed to see in this year’s Budget.

In his City AM editorial this morning, Allister Heath called on the Chancellor to reveal his economic philosophy. Perhaps today’s Budget did reveal a little of that. On spending, he wants to reform spending on welfare rather than on public services. On tax, he is not convinced by the arguments for broader bases and lower rates, for both income and consumption. For these reasons, his Budget is not as clearly a Budget for “growth” as he claimed.

Two very different inflation problems

-Kathleen Brooks is research director at forex.com. The opinions expressed are her own.-

There was more evidence in February that the world economy is re-flating; both China and the UK released inflation data that showed prices running above 4 percent. Authorities in these economies have a difficult few months ahead, if prices continue to rise at this clip then they may have an economic crisis on their hands.

Although the root causes of inflation in China and the UK are fairly similar – rising commodity prices combined with weak currencies – the treatment for both countries couldn’t be more dissimilar. China has to tackle its problem with rate increases and currency appreciation, whereas in the UK a rate rise could seriously hinder the economic recovery.

Taking a step back, inflation always had to rise in China if its economy was to shift to a domestic consumption model and the global economy was to stand any chance of effectively rebalancing. Thus, it could be argued that commodity price increases came at the right time for China’s economic growth story as it put pressure on employers to hike wages. The price of food and energy hit Chinese consumers  faster than they do consumers in the west because of the larger proportion of food in the Chinese basket of goods used to measure price changes (even though the food component was reduced in January, it was only reduced by 2 percent and remains high relative to western economies). Workers need prices to rise, and they need to rise at more than 5 percent a year to give the average Chinese enough money in their pocket to spend on discretionary items.

Pay packets have been increasing in China for the last 5 or 6 years, but they picked up extremely strongly in 2010 (just as commodity prices started to take off). According to some anecdotal data wages in the professional and financial services sectors are now rising at a 16 percent annual clip.

While that is extreme, the general trend towards higher wages is good news. Inflation is driving wage gains, which have been the missing ingredient from the Chinese growth mix. Wages need to rise in China to unleash a tsunami of domestic demand that, if all goes to plan, will help reduce China’s massive surplus and the US’s massive deficit and protect the future of the global economy.

But while some wage inflation is good, too much could cause employers to cut staff, pushing up unemployment and actually weakening consumption. In order to avoid this situation, action is required by the People’s Bank of China (PBOC) to stop an inflationary spiral getting out of control. Although the PBOC has raised interest rates 3 times since October, it needs to hike further to reduce the chances of the economy overheating.

A new paradigm for inflation

-Kathleen Brooks is research director at forex.com. The opinions expressed are her own.-

Looking through the minutes of the Bank of England’s policy meetings for the past year, there are a couple of patterns that you see emerge. Firstly, that rates are on hold, and secondly, that the UK’s elevated inflation rate is temporary. Now the European Central Bank has joined the chorus. ECB President Trichet recently sounded confident that prices will moderate, even though consumer prices rose above the ECB’s target rate of 2 per cent in December.

But how long will citizens of Europe and the UK accept rising prices and how long can central bankers continue to stand by while inflation smashes their target rates? To answer this we need to find out two things: firstly, is this rise in inflation really that bad? Secondly, why are central bankers willing to let inflation pass them by without exercising monetary control?

Inflation is a tricky thing to get right. A little is good since it helps growth, but not enough is bad as it can stunt an economy and leave it in a deflationary spiral. There is also another benefit to inflation: it helps to erode debt levels in real terms. When many developed economies are struggling with unsustainable debt loads, a little inflation helps to lower the size of the mountain.

But prices are rising at a 3.3 per cent annualised rate in the UK. While the Bank of England rightly points out that this is due to commodity prices, but its assertion that inflation will prove temporary has been incorrect for more than a year.

Commodity super-cycle:

We are in a super-cycle for commodities. Burgeoning demand for food and raw materials from the fast-growing emerging world is set to dominate demand for commodities for the next few years, possibly even for the next generation. This means that people in the west who were used to low prices for most of the last decade will have to get used to coughing up at the supermarket and at the petrol pump for a while yet.