Tax and Fiscal Policy

The UK economy should be able to reboot itself, if markets are allowed to work properly again


This week the IEA and Civitas published a joint paper, Rebooting Britain, on the economics of the Covid-19 crisis, written by Len Shackleton and myself. Many commentators are arguing that the pandemic has demonstrated the need for permanent increases in government intervention and in public spending. We came to exactly the opposite conclusion.

These are exceptional times. The government has taken the extraordinary decision to shut down large parts of the market economy in an attempt to save many thousands of lives. This provided a rationale for exceptional policy responses to protect businesses and jobs, and thus prevent a temporary economic shock from becoming a prolonged depression.

Indeed, even fierce critics of the “nanny state” would agree that public health issues of this kind cannot be left entirely to markets. The risk of a great many deaths from coronavirus is a textbook example of a serious negative externality that can only be dealt with by collective action. This is also not a shock that most businesses could reasonably have been expected to insure against.

However, the need for unprecedented intervention over the past few months does not justify the state playing a much bigger part in normal times as well, let alone forever more. Indeed, this emergency has actually demonstrated many of the benefits of capitalism.

Only relatively wealthy and free economies have the resources to strengthen their safety nets in times of crisis. It is private businesses that are competing to come up with solutions to particular needs – from online delivery companies to those working on creating a vaccine. And it is the most flexible and decentralised healthcare systems, such as those in Germany, that appear to be coping the best.

Above all, we have seen numerous examples of how private businesses have been willing to work together and cooperate in the wider public interest. These examples demonstrate that free-market capitalism and the profit motive are perfectly compatible with socially responsible behaviour. And in many cases, the state hasn’t had to do anything – other than get out of the way.

Looking forward, the gradual easing of the official lockdown and the return of consumer and business confidence should be sufficient to kick-start the economy. Indeed, we could be pleasantly surprised at how quickly activity and employment bounce back, provided markets are allowed to work properly again.

We should also be wary of calls for even more increases in public spending and borrowing, or tax increases to fund them. It is reassuring that Treasury sources are said to be downplaying expectations of an emergency Budget in July. It does make sense to hold off from making any major fiscal decisions. There would be little point in trying to boost demand when the UK economy is still in partial lockdown. But it should also be clear by the autumn that a big stimulus package is not needed anyway.

In the meantime, plenty of policy proposals are being floated – some better than others. The best, of course, are those that won’t add to the mountain of public borrowing and instead would actually reduce state intervention.

Good examples include proposals to relax Sunday trading laws and fast-track the approval of outdoor eating and drinking areas for pubs and restaurants. In normal times, the main constraint on consumer spending is income, and neither longer opening hours nor bigger spaces would make much difference to demand. However, the requirements of social distancing and the need to make customers feel safer are game-changers here.

Even more encouragingly, there are reports of serious discussions at last about the liberalisation of planning rules which could help to accelerate housebuilding and the redevelopment of the High Street. But it remains to be seen whether the government will be confident enough to consider some of the more radical proposals summarised in an IEA briefing paper last year, including a more sensible approach to the “green belt”.

There also some things that the government could do to encourage people to bring forward spending that they might otherwise have delayed until next year. Ideas here include temporary cuts in taxes such as VAT or stamp duty on houses, or temporary subsidy schemes, such as contributions towards the cost of scrapping an old car and replacing it with a new one (‘cash for clunkers’).

Of these, cutting stamp duty would be my top pick. However, these sorts of measures usually involve large deadweight costs and mostly help better-off households which are more likely to be big spenders. In addition, if consumers are still worried about their health, or their jobs, or their future tax bills, a small price incentive could be less effective than usual in stimulating demand.

Better ideas might be a holiday for employer National Insurance Contributions, which is effectively a tax on jobs, and a rethink of the plans for large increases in statutory minimum wages. The surge in unemployment means that now should be the time to focus on lowering the burdens on employers, not adding to them.

However, the bigger decisions on tax and spending can wait. The economy should be able to reboot itself, without the need for the Chancellor to do much more. If anything, now is the time for the government to make the bold decision to do less.

 

Julian Jessop is an independent economist with over thirty years of experience gained in the public sector, City and consultancy, including senior positions at HM Treasury, HSBC, Standard Chartered Bank and Capital Economics. He was Chief Economist and Head of the Brexit Unit at the IEA until December 2018 and continues to support our work, especially schools outreach, on a pro bono basis.


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