Today Ed Balls followed the footsteps of Ronald Reagan in demanding a tax cut to stimulate the economy.
Yes, you read that correctly. Part of “Reaganomics” was the contention that cutting tax rates would stimulate the economy so that tax revenues would actually increase in the medium term, meaning that tax cuts could pay for themselves. While he simplified and cut taxes, Reagan increased federal spending (especially on defence). As the Washington Post recounts, the result was a surge in government debt:
The fiscal shift in the Reagan years was staggering. In January 1981, when Reagan declared the federal budget to be “out of control,” the deficit had reached almost $74 billion, the federal debt $930 billion. Within two years, the deficit was $208 billion. The debt by 1988 totaled $2.6 trillion. In those eight years, the United States moved from being the world’s largest international creditor to the largest debtor nation.
While this arguably stored up problems for the future, it was certainly successful in creating an economic boom during his presidency. (Margaret Thatcher’s fiscal policies were similar and had similar effects.) Cynical observers might notice striking similarities to the boom years under Gordon Brown’s chancellorship (after a few years of fiscal discipline, Mr Brown ran budget deficits every year from 2002), and indeed Mr Balls’ proposals for restoring Britain to growth.
Of course there is a difference. Reagan’s policy was justified by supply-side economics and the Laffer curve (the argument was that lower tax rates would encourage more economic activity which would then increase tax revenues).
Mr Balls on the other hand is a confirmed Keynesian and thus a demand-side economist. Supply-siders want to maximise production and argue that supply always creates its own demand; Keynesians argue that demand can be so depressed that the economy has unused production capacity. In those circumstances increasing productivity does nothing to help the economy.
Thus Mr Balls’ arguments for a temporary VAT cut in his speech revolve around stimulating consumer demand:
– By putting more money directly into people’s pockets, it would be a boost for consumers who are feeling the squeeze from rising prices and rising taxes – especially pensioners and those on low and fixed incomes;
– The inevitable increase in consumer confidence would help the struggling retail sector;
– It would help to push down inflation – and so reduce the risk of a recovery-choking interest rate rise later this year;
– And it would give the flat lining economy the jump-start it so urgently needs, boost jobs and help us get the deficit down for the long-term.
The question is not the cost to George Osborne of paying for this temporary emergency tax cut, but the price our country will pay if he carries on regardless.
You can quibble with some of his points. For example, why would a temporary VAT cut “inevitably” increase consumer confidence? After all, they know it’s temporary. And the inflation argument is a red herring for two reasons. First, the Bank of England knows that messing around with VAT messes up the Consumer Prices Index (CPI) measure of inflation so that it doesn’t reflect the underlying economic pressures in the economy, so they will look more at CPIY (which excludes indirect taxes). (Remember the Bank of England targets inflation in the interests of economic stability, not to limit the rise in pensioners’ weekly food bill.) Secondly, the Bank aims for getting inflation on target in two-three years’ time “because that’s what we can influence.” A temporary (one-year?) cut in VAT will not have any impact on that time horizon.
The most annoying thing Mr Balls said was his casual pooh-poohing of the question of whether a tax cut would be worth the extra debt. Americans, whose government debt is now mainly bought by China and by the Federal Reserve’s quantitative easing (printing money) programme, may not be so enamoured with debt-driven economics as they were under Reagan.
Update: Fraser Nelson has taken on the thankless task of Fisking the rest of Mr Balls’ speech in a blog post that’s well worth reading.