As reported in the FT, UK Chancellor of the Exchequer Alistair Darling is planning to go all Robin-Hood by upping taxes on the rich to incentivise spending by the poor via tax cuts - and with that cure the ailments of the UK economy. The FT writes
Mr Darling will announce plans for a new 45p top tax rate to be set at about £150,000 a year, to be introduced after the next election. He accepts that a tight squeeze on public spending alone will not plug the hole in the government’s finances.
Although the new tax would only raise several billion pounds a year, it breaches a central “new Labour” tenet of not putting up income tax or penalising the wealthy. It also opens up potentially sharp dividing lines between Labour and the Tories at the next general election. David Cameron, Tory leader, now faces a difficult choice of whether or not to support the mooted tax rise.
As well as marking a clear u-turn in New Labour policy, the move is hardly going to ingratiate the financial services sector to the government - the very sector the UK ironically depends on the most as far as contribution to GDP goes.
Here’s the take on the move from one American investment writer. Dennis Gartman writes:
According to reports out of the UK this morning, Darling is going to propose a 45% marginal tax rate on incomes above £150,000 ($225,000 at the current sterling/dollar rate) that shall go into effect in 2010. Mr. Darling will say that his cut in the VAT from 17.5% to 15% will offset the tax increase upon the nation’s wealthy, but this is nonsense. England has relied upon financial services for economic growth for the past decade or so, and to tax that area of the economy at a time when it is already contracting materially is economic lunacy. Certainly this cannot be supportive of the British Pound Sterling, either in the long run, or the short run too.
Writing in today’s FT former chancellor Nigel Lawson goes one step further, suggesting the entire Keynesian-style fiscal stimulus idea is flawed in the first place. He writes:
It is understandable that, at a time of great economic difficulty, the government feels it has to do something; and with monetary policy quite rightly devolved to the Bank of England, that seems to point to fiscal policy. Nor is it unaware that both tax cuts and spending increases that apparently do not have to be paid for are likely to prove popular. Moreover, with other countries, for the same reason, singing the same tune, it would be strange to stand aside. And cheering us all up — or what is more pompously described as restoring confidence — is not to be despised.
But there is a trade-off. Mr Darling will be well-aware that any economic benefit secured now will be at the expense of increased problems in the not-too-distant future. And the trade-off is not an encouraging one, with the benefit likely to be trivial and the problems far from trivial — particularly since our structural budget deficit is worse than that of any other major economy. Indeed, were this not so, today’s stimulus would be very much larger than is likely to prove the case.
His proposition instead is to strengthen the banks via yet more recapitalisation efforts, specifically focused on the strongest institutions. He also suggests buying out the banks’ toxic debt at prices digestible to taxpayers, a la the original Paulson Tarp plan. He concludes:
The remark attributed to Keynes — “When the facts change, I change my mind. What do you do, sir?” — has been much quoted lately as justification of throwing fiscal prudence to the winds. It would be better applied to accepting that subsequent events have invalidated the empirical foundations of Keynesianism — rather than to throwing fiscal prudence to the winds, in spite of the undoubted short-term political attractions of doing so.
If that wasn’t enough, Monument Securities finds a flaw with Darling’s plan to cut the standard VAT rate, saying if the UK authorities were really worried about deflation they would not be considering such a move.
After all, a VAT rate cut would have a substantial impact on the consumer price index (CPI). There are strong indications that Mr Darling is planning to cut the VAT rate by 2.5 percentage points, from 17.5% to 15.0%, in his Pre-Budget Report (PBR), to be published later today. Such action might be expected to take up to 1.5 of a percentage point off the CPI, depending how much of the tax reduction suppliers passed on to end-consumers. The Bank of England’s latest inflation forecast saw the annual rate of increase in CPI, on market interest rate projections, most likely dropping to the region of 1.0% in the course of next year. The risk now, after a VAT cut, of a negative inflation rate being recorded at some time within the next twelve months might appear substantial. If falling prices exercise a potentially negative effect on consumer psychology, as is widely supposed, we might well have expected the Chancellor to avoid taking measures that reduce prices and thereby increase the risks of deflation.
Of course if those price-cuts are deemed by the public to be only temporary in nature, there is a chance the deflationary effect of people avoiding spending now on the expectation that prices will drop later could be avoided. But even that is unlikely to help those consumers who are hardest-pressed by debt and unemployment, say Monument Securities.
Full details of the pre-budget report will be out in all their glory at 15:30 GMT.
Related links:
Britain will pay for Brown’s fiscal boost - FT.com
Darling to raise taxes on wealthy - FT.com
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