Dec 02 2009
Falling living standards?
The two and a half main political parties have fought themselves to some agreement over the deficit. Gone are the government ’s words that we need to continue with Labour’s “investment” rather than Conservative cuts. They are all cutters now. The argument remains over the timing and target for the cuts, and the balance between cutting spending and raising taxes. So far so realistic.
The new battle is over growth. Both main parties recognise the need to offer some hope in an otherwise bleak landscape. Both want growth. The Conservatives recognise that the long term growth rate has likely been reduced and damaged by the last few years. Labour does not want to admit that, but does not vigorously deny it. The rhetoric of the next few weeks is likely to include exchanges over how you stimulate growth. That will allow some differentiation, with the Conservatives presumably favouring tax breaks and cuts in the burden of government on enterprise, and Labour favouring subsidies and public spending boosts. In a very competitive world, where there is too much capacity in most things, it is ever more important to offer a favourable backdrop for business to locate here and create jobs here. They do not have to come or stay.
The sad truth, however, remains that the Uk has in recent years lived well beyond its means. Its private sector borrowed too much in the run up to 2007. Its banks borrowed and lent far too much, and the regulator is now reining them back. Now its government is borrowing far too much. Whoever wins the election, action will be taken or forced upon the next government to move from its unsustainable current approach. The following things are unsustainable:
1. 0.5% Interest rates. These only apply to the public sector and to the minority who locked in to tracker rates some years ago. Interest rates will rise next year.
2. Money printing. They have created £200 billion of extra money. This programme is likely to end just before the election. Long term government interest rates are likely to rise, once the Bank’s buying stops.
3. Low inflation. Last month saw a large price rise, and more rises are likely, eroding the value of people’s savings and incomes.
4. A near £200 billion annual budget deficit. Spending cuts and /or tax rises are on the way.
5. Current levels of public sector employment and higher pay. There will need to be reductions through natural wastage, through pay restraint, from cuts in less desirable programmes and from efficiency improvements, whoever wins.
6. Public sector capital investment. This government has already planned susbtantial cuts for the post election period.
Higher interest rates, higher inflation at least in the short term, and a public sector squeeze, all point to lower living standards. If a government tried to ignore these huge problems for very long, it would lead to a 1970s type crisis. Then the deficit was too big to be easily financed. (It was half the current level relative to the size of the economy!) The pound fell sharply, fuelling price increases which cut people’s living standards. It forced up interest rates to try to sell the government’s debt, which undermined the living standards and cashflows of all people and companies who had borrowed.
This time round ignoring the deficit and borrowing some more is not a winning way but a risky option. It does not lead to faster growth and a better outcome, but to a deeper crisis when confidence finally snaps as Labour discovered in 1976. The private sector is well advanced with tackling its deficits, through credit card and mortgage repayments, curbing new debt, and the repayment of business borrowing.
So can we achieve growth when there are so many reasons why living standards are going to be squeezed? Can we get out of the massaged economy we live in without another nasty downwards dip? Yes we can. It will not be easy, and it does mean a lower rate of growth than the last debt soaked decade to 2007. It certainly means cutting spending to curb the deficit, not raising taxes. It means keeping taxes on income and enterprise down or reducing them to competitive levels. It means changing the approach to regulating the banks so they have more money to lend to the private sector.
Labour is hoping that a “Deficit Reduction” Bill will keep confidence up without requiring them to cut very much any time soon. The deficit reduction they have in mind will probably rely on recovery to raise revenues, when the recovery is not secured nor necessarily sustainable yet. A sustainable recovery requires tackling the structural deficit soon. They may lace it with some show taxes on the rich, which if implemented may make the problem worse. I agree we need to tax the rich more. The way to do that is to set competitive rates for people who save and create jobs, who build businesses and bring their wealth from elsewhere. If you set out to tax them hard they go away, or hire a better tax expert than the government or never come.
30 Responses to “Falling living standards?”
John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
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My hope is that whoever wins the next election will see that drastic action is needed – a complete U-turn from the policies of recent years. Although I was (just) too young to remember the 70’s I can remember the 80’s and Mrs Thatchers dismembering of the Trade Unions alongside the privatisation programme. I fear a similar policy will be required of the public sector. Tinkering at the edges simply won’t do.
Of course, I realise that no politician can come out and say such a thing in the run up to an election, especially in places like Scotland where I live and where the public sector and number of employees therein is breathtaking.
Now the main parties are largely in agreement, it is likely to impact further on the Conservative lead in the polls. Where is the “clear blue water” making the Tories different from the rest? I appreciate that the timing of Government action is as important as the action itself, but that’s too subtle for many of the electorate.
Regarding your points:
1. 0.5% Interest rates. Something similar to this applies to savers as well. My bet is that there are more savers inclined to vote Conservative than there are for Labour, so you could offer more for your core voters by treating personal savings favourably. We’re also doubly penalised by having to dip into capital to replace that which used to be earned from interest.
2. Money printing. Even though this has had no impact on the real (private) sector, the extra money has devalued our savings and made imports more expensive – just look at the value of Sterling against Dollar and Euro.
3. Low inflation. Inflation at a personal level has no relationship to the official Government figures – the rising prices of fuel and food have the largest effect on me, and that’s largely a function of Government stealth taxes combined with a weak currency.
4. A near £200 billion annual budget deficit. Yes, and the sooner this is addressed the better. We need a plan, although I appreciate it’s hard for the Conservative front bench to draw up proper plans until they can see the books after the election. Your colleagues need to be able to counter the MSM interviewers more effectively when challenged on this.
5. Current levels of public sector employment and higher pay. Reduce the Public sector to levels found in 1997. Is there a single new area that the Labour Government has intruded where the average man in the street thinks “I’d really miss that if it were gone”?
6. Public sector capital investment. We need more transparency over PFI to believe anything on this subject.
The electorate have lots of reasons not to vote for the Labour party, but many of us have yet to be convinced to vote for the Conservatives.
Much of falling living standards has little to do with tax and everything to do with falling wages and rising prices, wages have hardly kept pace. Prices for gas, electricity, water, and many other necessities are now set at the maximum the market can support and what the companies can get away with. Don’t blame the market or tax for this. As a rule of thumb prices have doubled. In this period of growth we have found that company effectiveness, efficiency and profits have little to do with wage levels for the average working person. Cheers Guv! Cough! Hack! Anything is good enough for the likes of us. Makes Unions and collective pay bargaining more relevant then ever. Lets face it they are not voluntarily giving anything except to themselves. My company. My ideas mentality. Even towards shareholders.
The country is being ran for the benefit of about five thousand bankers and the rest of the population can suffer.
Mike Stallard Reply:
December 2nd, 2009 at 5:00 pm
Erm…..
And one or two of the politicians?
And the EUocrats? (recent pay rise for all EU civil servants, after their benefits of excellent health and schooling, of 3.5%)
And the Quangocats?
And the Higher Echelons of the BBC?
And the Senior Social Workers after their miracle at Harringay…..
Standards of living have already fallen, for some, a very long way indeed as they have become unemployed. For people like my Family there has been a slow grinding reduction in our standard of living. I am a career for my disabled wife and a young family. The most obvious side effect of the credit crunch and rising prices is that we cannot afford an annual holiday and Christmas will be thin there year. Most of this is down to the rise in heating costs, as my wife is home 24/7 we have no choice but to heat our home all the time. We receive no additional money to help with the increasing bills. The other side effect is felt via our savings, where as a few years ago we would receive a couple of hundred pounds a year on our savings, we are hit twice, as we can longer save as much and what we save now only pays a very few pounds each years. Right now the prices in our local supermarkets are low, in the run up to Christmas. Even so I consider ourselves very lucky indeed, and know that for many life must be very difficult indeed. The only answer is to elect a government that is both friendly and which is willing to reform Welfare. I imagine that we will get slowly poorer over the next few years, and I may be left with little choice but to find work, hopefully that pays enough so that I can engage a part time helper for my wife.
I am in a stronger position than many, but even so at 52, it will be a struggle to make ends meet for a number of years to come, I believe.
Yes to all that. You might like to know what price our cartelised and nationalised banking sector is now trying to charge small businesses for loans and overdraft facilities. I have been quoted base plus 6% for an o/d facility and base plus 7.5% for a business loan. This is usery. Sorting out the banks is a priority, which must include breaking up the cartel. BTW I have a strong balance sheet and excellent regular cashflow based on service fees. These rates do not reflect ‘risk’. They reflect the intent of the banks to rebuild their balance sheets at the expense of ours. They need telling.
JimF Reply:
December 2nd, 2009 at 6:32 pm
Lola
This is truly appalling.
There should be a market opportunity here. We are getting squat diddly for our deposits with the behemoth LBG, and the same frankly for Euro and CHF deposits elsewhere right now. I’d be more than pleased with 5% if I had some collateral (as I am sure your Bank is also asking).
Lola Reply:
December 3rd, 2009 at 8:50 am
I come from a time when base plus 3% was a ‘fair’ price for a loan or facility. For a loan (not an o/d) to a good business I would expect base plus 2.5%.
And I am sure you know the old saw about 3 6 3 bank managers don’t you? Borrow at 3, lend at 6 and on the golf course by 3.
Mark Reply:
December 3rd, 2009 at 11:27 am
You have explained exactly why they don’t deserve to shovel any chunk of their margin into bonuses.
Lola Reply:
December 3rd, 2009 at 7:47 pm
Right. BUt how do we get this done NOW. Brown’s performance at PMQ’s yesterday (confirmed by his disgraceful leak of how many special forces we are fielding in Afganistan) shows that he has abandoned any attempt at actually doing what is right for us and the UK and that he is now purely focused on (a) cornering the Tories politically and (b) adopting a scorched earth policy. We cannot wait another 6 months to get something done. So how can he be winkled out PDQ? Hell’s Teeth I’d be at the polling booth on Christmas day if I could be sure that we could get a replacement government that would Do The Right Things now. The question therefore is, as the only chance we have is a Tory government, are Cameron / Osborne up to it? I have grave doubts.
What was it some Irish guy said, “… if you are going there, I wouldn’t start from here.”
There are odd things happening. Why are central banks around the planet buying gold? With all this quantitative easing, why is UK M4 growth so poor; are we all savers / de-leveragers now?
Do we actually know how much output capacity is left to produce growth; how quickly will the UK “output gap” get filled up and home grown inflation take off? See this link, that is, if it gets past JR’s pre-election editorial policy
Will rampant inflation be the tool of choice for this and the next government, to fix the UK sovereign debt problem?
Even next door’s dog knows that NuLabour Marxists – motto: State before Family – are overspending by £120 billion a year. As Norman said above, until someone with the testicular fortitude to dismember the public sector unions comes along, that problem will not get fixed. NuLabour are ideologically incapable of doing this. But, I have yet to be convinced that any other political entity can either.
BTW. You will hear a lot about smart meters today. There are projects around the planet that are way ahead of us. See this link.
Reply: I don’t have time to read all these links, so it would be helpful if bloggers could summarise the main point.
The first priority has to be to reduce business taxes to stimulate growth.
I do favour scrapping most “allowances” which try, but fail, to guide spending and instead having low basic rates. I also see no reason for small companies – who create more jobs – to have different tax rates from large ones.
A flat 10% rate of corporation tax with a £100,000 a year allowance for either re-investment in capital goods or distribution as dividend, seems sensible. Given corporation tax receipts are very low now, this cut would cost little, but attract a lot of investment ot drive increased tax receipts down the line.
Lola Reply:
December 3rd, 2009 at 8:59 am
And you also must cut taxes, especially income taxes, on individuals. They need to rebuild their own balance sheets before they will feel confident to spend.
To be controversial, you should only cut income taxes, or rather taxes on employment on employees in private business (that excludes employees of LloydsHbos and RBS). Why? Because employment/income taxes levied as a percentage of pay for state employees is really only a rebate to the rest of us in private business, and even if it was not, the whole amount deducted goes to fund their pension schemes which cost upwards of 30% of salary roll to fund.
Maybe what that previous paragraph reveals is the stupidity of payroll / income taxes. They just don’t work and destroy jobs. What about basic tax allowance set at £12,000 p.a. (roughly equivalent to the equally stupid minimum wage) and then flat income tax at 20% thereafter with an absolute commitment to reduce it to 10% and then zero within the life of the next parliament. Do you think any government would ever be able to reintroduce income tax once it had been removed? No, neither do I. Mind you the lefties would try to play the envy card and reintroduce it on people with ‘high’ incomes. Yeah. Right. That was the lie they told us last time.
Mark Reply:
December 3rd, 2009 at 11:34 am
It is important to consider the very different capital and balance sheet structures that occur in different kinds of business. Taxing investment in capital intensive industries (by not allowing tax relief) will have obvious consequences of hollowing out the economy into providing just services, while discouraging the building of the new power stations we need for example. It is important that those who design these policies actually have some wide understanding of different businesses.
John Moss Reply:
December 3rd, 2009 at 2:01 pm
I would certainly allow rent and/or debt interest and depreciation to be a cost on the profit and loss account, but the current Capital Allowances regime was developed in an era when people owned buildings and plant for years.
Now they rent and change them frequently, often holding plant on leases. Industry would not be particularly disadvantaged if they borrowed to invest in capital goods or buildings, unless they were holding lots of cash on their balance sheets. In that case, their shareholders might want to ask why it was not being used to buy things which made things which made a pforit.
Many of us have been experiencing falling living standards for some time already. We are looking for strong leadership which clearly demonstrates that there is a solution to this debt crisis and recession. Sadly, I don’t hear it from the frontbenches and have little confidence that they will effectively tackle it. Perhaps they really do want a hung parliament and a sovereign debt crisis leading to an external body telling them what to they have to do.
What we want is a Lawson type politician at the helm.
I was no fan of Lawson but in him there was a man supremely confident that he knew what he was doing and that all dissenters had it wrong.
We need to escape the timidity shown by the present Tory leadership and their deference to government policy in order to display confidence to the electorate.
This is no time to be showing how considerate the party is to government economic solutions but to show that the new Chancellor of the Exchequer knows exactly what he is doing, and that his policies are quite different to those of the Government.
Frankly if Cameron cannot see clearly the nonsense of QE and zero percent interest rates and is incapable of enunciating the argument then we are lost.
If there is one message that could be given to the Tory leadership before the next election it is that they should get a grip on themselves.
Mick Anderson Reply:
December 3rd, 2009 at 2:14 pm
“….a man supremely confident that he knew what he was doing and that all dissenters had it wrong.”
That sounds exactly like the way Mr Brown tries to come across, hence yesterdays PMQ pantomime.
I don’t mind a man being confident that he is doing the right thing, just as long as he is genuinely doing the right thing….
I do not believe that lo9ng term growth rates have been altered by the recession, though it has reduced the baseline we start from. For a decade the world managed AVERAGE growth rates of 5% & China & now India 10%. This is mainly because of the net & Moore’s Law, which now also appears to apply to nanotechnology & possibly space development. The reason for Britain’s lower growth rate is that we have bureaucratic regulation (elfin safety, housing, windmillery, the 5.5% of GNP destroyed by EU bureaucracy, the War against Fire) which destroys half our potential economy & government parasitism which eats half of what remains. Our entire economy is thus running on about 1/4 of its potential. All this potential can be released by firing the parasites which would get us a long term growth rate at least matching China’s.
Labour’s policy is to say they would like growth & that it will solve their deficit for them. The Conservative one is better in that they recognise that growth isn’t brought by the stork & wish to cut corporation tax. It is still a very long way from what it should be.
if we stopped funding the health care of foreign nationals from outside of Europe here on work visas that would be a start, i have to pay for my medical care in the states and India I see no reason why their nationals should get free care here
we could also stop paying for their kids to be educated free here, as above i have to pay for my kids education when in their countries
add this to scrapping the id card scheme etc
The message should go out loud and clear on every possible occasion: balance sheet problems are extremely difficult to deal with unless you raise the return on capital. If, on the other hand, you do raise return on capital, the magic of compound interest works in your favour, and your ability to trade out of the balance sheet problem is surprising.
So, in short, no rise in the UK’s ROC, no early or easy solution to the balance sheet problems inherited from Labour.
Therefore, the more that can be done to raise ROC, the quicker the recovery, the quicker the fiscal consolidation, the quicker we can start to think of something other than disaster.
So it’s surprising that DC et al have not yet started talking about the role of supply side reforms in dealing with our plight.
Supply-side reforms? Why not set up Special Economic Zones in unemployment blackspots, where businesses can benefit from lower tax rates, less burdensome planning, lighter labour and environmental regulation etc. Propose them, put them to a local vote in order to win the political battle. Jobs not Dole!
Why not get serious about busting up the monopolies which distort pricing in the UK? Banks, supermarkets, utilities etc. Lower prices to release extra income for savings/spending.
Why not argue for the abolition of much of the quango state as part of the supply-side reforms which can liberate the entrepreneurial spirits and talents of the country.
Why not encourage the re-start of local stock-exchanges to act as fund-raisers for local businesses?
I am convinced that Labour’s maladministration has at least this benefit – that it has bequeathed a plethora of targets and regulations which can be abolished without cost to the public good, and with benefit for the nation’s ROC.
The pity is, I sit here dreaming it all up, and know that JR has done work on this too, but from DC et al, we hear nothing.
Make the case for supply-side reforms. Then make it again. Then again. And again. . .
Living standards have some way to fall yet. The crash was because assets had become significantly out of synch with incomes, however the Govt policy has been to rescue these assets and push their values back to the 2007 level.
This means the cost is falling on others, notably the Taxpayer, savers & pensions (from low interest rates and printed money). Therefore living standards must fall….
Thank you for pointing out some unarguable ways to reduce the coming crisis of bankruptcy.
Allow me to repeat: we also need to send a team of reputable accountants into all the banks to see where the toxic debt has disappeared to.
Is anyone out there listening?
There are only two options for us:
1. Default on our debts. Probably too catastrophic to contemplate.
2. Devalue our debts. Inflation will be horrendous, but is the only real alternative to absolute chaos.
Then to revive enterprise:
a. Cut taxes drastically to less than 30% of GDP by slashing state interference in our lives and freedom of choice.
b. Simplify all taxation down to a single rate of VAT. Effectively we have that implicitly already in every consumer purchase. Take the taxman off the backs of business and employees.
c. Reintroduce sound money i.e. redeemable gold backed Sterling. International trade flourished in the 19th century gold standard era and saving enough for old age becomes easy to calculate and more certain to provide the necessary security.
d. Eliminate deficit funding of government expenditure once and for all.
I don’t hold out much hope of any politician bringing us back from the brink anytime soon.
I seem to remember Melvyn King saying that living standards would fall some time ago – here I think .
The problem is our politics is based around denying the facts.
Based on conversations I’ve had people would accept a harder message, but have started to wonder if the current Conservative team will give it or more importantly deliver on it.
We all need to take a long hard look in the abyss on this before we will find the courage to do what needs to be done.
‘I agree we need to tax the rich more.’ What do you define as rich? A little reminder if you needed it John. According to HMRC’s estimates, the richest 10% of taxpayers pay 53% of total income tax. The current average rate of tax for someone on GBP150/- is 31.6% (about GBP47/-) compare that to 14% for someone on GBP20/- (GBP2,800). So the former is paying 17x more tax than the latter whilst only earning 7.5x more. Not only that the former group are unlikely to get any government social benefits apart from child benefit (tax credits etc.) That looks more than fair already, in my view, but maybe not yours? What really needs to happen is to cut the civil service by 35% as we did in the 30s, and with regard to everything that both national and local government does, actually ask the question is this service necessary for survival, then maybe we wil get back to a sustainable government expenditure, cutting the deficit to asize in short order that overseas investors would be willing to finance and also reconnect people with taking responsibility for their lives and families. Actions require consequences, not just the government/taxpayer picking up the tag!
Reply: The way to tax the rich more is to have a low tax rate regime which means more people get richer and more people bring businesses to Britain. We got far more revenue from the rich at 40% tax than Labour ever did at 98%. Labour’s 10% CGT on enterprise was also an excellent way of taxing success and helping create more of it.
The only entities with fresh borrowing at 0.5% are those banks entitled to borrow at Bank Rate. I suppose the main candidates are the state owned banks, but other banks will surely fill their boots where they can: effectively it is a disguised subsidy to recapitalise them. Of course, these banks are also borrowing from savers at similar low rates.
Government itself is paying 4% redemption yield on normal gilts of 10 years and over. The most recent DMO quarterly review shows average redemption yield of 3.02% even with the distortions of the short dated market.
Where yields will move when market rigging via QE ends is an interesting open question. They will jump – how high? at the behest of those with real money to loan. It is quite likely that some of the yield available to foreigners could come in the form of an acute sterling crisis overshoot in the exchange rate. Will ratings agencies become the new arbiters of acceptable levels of government deficit to replace the IMF? Neither has any funds to loan.
The markets are likely to punish profligacy wherever it occurs: that will include such things as over-paying for green energy solutions where cheaper ones are available to tide us over. A key question is will the break in the markets occur before the election? Brown has been desperately trying to delay the breach in the dam. Perhaps perversely, if it were to look like there was a serious risk of Labour getting five more years, the markets might decide that they better try a cut and run first. It knows Brown’s new golden rule will turn out to be pyrites.
I am disappointed to see Mr.Redwood recommending income tax changes. Is this a cutting edge policy that will lift us into a new nirvana? Have not new ideas surfaced over the last decade emphasising simple and low taxation as the driver of free enterprise?
Every business and employee owes its income to a consumer somewhere, directly or indirectly. For every pound spent in the shops part of it is VAT, part is corporation tax, part is business rates, part is payroll taxes including national insurance and income taxes, and part goes towards council taxes. All of these tax costs are incurred in proportion along the supply chain and the bill is handed down to the final consumer, who buys with the spending money remaining in his pocket.
Income taxpayers are led to believe that it is a tax paid by them personally, but can you see that they are really unwitting tax collectors merely forwarding money to government that is received from consumers of their work?
It should be more widely recognised that income tax is akin to a tax on your work to be paid by buyers of your work, otherwise adding up the amounts of tax paid on income and expenditure will be found to exceed that which the exchequer actually receives. Thus, net pay after tax is what we earn and it is that which is taxed when we consume.
So if there is an increase in aggregate taxation by taxing the rich more then everyone will find an increase in the tax content of his consumption. Implicitly, the effective flat tax on consumption will rise.
The conclusion is that income taxes are neither necessary nor do they serve any useful purpose whatever other than to hide the true level of taxation inflicted on us and to mislead the voters as to who bears their burden.
Reply: I made no statement that I want to see income tax rates up – on the contrary.
I don’t like your number 6. Why, in the public sector, is it always capital expenditure that gets clobbered, not current expenditure? Do we need to pay doctors so much to retain their services? Do we need so much management in the NHS? Are there no cost savings to be had from decentralising health and education? Is all of the social protection bill really necessary? Can we not sack a few of the Little Hitlers that interfere with every aspect of our lives? Within the coming parliament, public sector pay roll costs will have to be cut by at least 20% in real terms.
Let me compare the public sector deficit now with an earlier one, over 50 years ago. At Epiphany 1958, Peter Thorneycroft, Enoch Powell and Nigel Birch resigned from the Treasury because the cabinet had foisted on them public expenditure commitments that were £50 million per annum too much. That’s right, million not billion. Admittedly, the currency has been debauched by a factor of about 60 since then, so that is £3 billion in modern money. In the current crisis, the deficit has increased from £30 billion to £200 billion, an increase of £170 million – in other words, more than 50 times greater in real terms than the amount that was considered a resigning matter over 50 years ago. That is how far our standards have fallen.