Tuesday, 6 April 2010

Taking money out of the economy

Sometimes I read something so obviously upside-down that I think I must be missing the point. So it is with the result of the long weekend's thinking by the current government spin team. In a nutshell, the government plans to increase employers' National Insurance contributions whereas the opposition say they would increase them by less. The Prime Minister and Chancellor mounted a twin attack, both of them saying the Conservatives' approach would "take money out of the economy". It's so very bizarre that I have had to wrap a cold towel around my chins in order to try to make sense of it.

As a general rule it's sensible to start at the beginning, so I will. Employers' NICs are a tax payable by an employer as a penalty for having the effrontery to give someone a job in the private sector. Income tax and employees' NICs are deducted from the gross wage or salary so that the employee receives less than the headline amount they earn. Increases in these taxes do not require the employer to pay more for the same job. But employers' NICs are a tax payable by the employer in addition to the contractual wage or salary. Any increase adds to the costs of the business.

Call me a simple fellow if you will, but it seems to me that when Mr Patel has to pay extra to employ old Doris on the till that money must come from somewhere and go somewhere. We know it comes from Mr Patel because he's the mug who pays her wages. So, paying this additional tax takes money from the economy in that it reduces Mr Patel's spending power and might mean he has to satisfy himself with fewer extras when next he visits Madame Fifi's Sauna and Hanky-Panky Parlour. In the language so beloved of our Keynesian friends, it reduces aggregate demand. The other side of the coin is that the money goes to the Treasury to be spent on something, we know not what. On the face of it the reduction in spending power caused to Mr Patel is matched by an increase in spending power for the lucky recipient of his largesse. One set all, new balls please.

It follows from this that if Labour wishes to bleed Mr Patel for an extra £15 a week and the Conservatives want to take only an additional £7.50 nothing at all is lost from the economy. The same amount of cash is sloshing about except that on one proposal £15 of it sloshes at the Treasury and on the other that £15 is split equally between the Treasury and Mr Patel. You see my problem? Where is the loss?

No doubt you could invent ways in which leaving money in the private sector amounts to a loss to the UK economy, for example if it is paid as dividends to overseas investors and therefore leaves these shores (subject to such tax, if any, that they pay on it over here). There could also be a drop in aggregate demand if some of the money is saved rather than spent and, on a particularly warped view of reality, that could be said to be a loss to the economy. Again, however, that is to look at only one side. Marginal businesses can be tipped over the edge by modest increases in their staffing costs and a reduction in profits reduces the money available for investment (I mean real investment not government-speak investment). And what happens to Mr Patel's money once the government has it? We know it will be spent but also know that a lot of it will not be spent on anything that adds value. We also know that interest payments on government debt will not all stay within the UK economy.

The argument that taking less tax removes money from the economy is moronic humbug. If they were concerned about taking money from the economy they would not have racked-up hundreds of billions of pounds of debt on which interest must be paid. And if they were honest they would say "we need to take more tax because we are spending too much and we think there might be more votes in taking it from filthy capitalist pig employers than by raising taxes that the little people will feel directly."

It seems to me there is something more sinister behind this piece of spin. Taking it at face value they are saying that government spending is of net value whereas private sector spending is a net cost to the country. It is obvious nonsense and we know it is nonsense because they claim recovery from recession will be fuelled by private-sector economic growth. Nonetheless, it sets the scene and tells the lie they want the little people to believe, namely that everything government currently does is essential and beneficial and once we are over the current difficulties the government can be even more beneficial by doing even more things. There is not a hint of them looking to cut-back the number of things government does in order to balance the books and make a start on repaying the enormous debt their incompetent profligacy has created.

What is even more worrying is that the Conservatives do not seem to want to grasp this most essential nettle either. We can argue about the benefits of street football consultants, grants to the arts, five-a-day advisors and carbon footprint investigators until the cows stop farting. Perhaps there is some benefit perhaps there is not. What is certain is that these sorts of activities are fripperies, they are luxuries, they are most certainly not essential. The only way we can make any serious inroad into the annual deficit and then into the massive accumulated debt is by cutting out spending on non-essential things.

I wonder whether the heart of the problem is the seductive concept of aggregate demand. An awful lot of UK GDP depends on consumer spending. In the private sector wages and hours are being cut so that businesses can survive and one consequence of that is that the employees have less to spend and, therefore, their local shops and eateries are suffering. There is a superficial attraction in maintaining levels of public-sector pay and employment so that the detrimental effect of private-sector belt-tightening is not exacerbated by public sector employees also spending less. The attraction is only superficial because the private sector is dealing with reality whereas the public sector is seeking to avoid reality.

There is no escaping the fact, for fact it is, that we simply cannot afford all the things we enjoyed three years ago. One could say we couldn't really afford them then but that is beside the point. We did pay for them and now we can't so we have to cut them out of our budget. There is no escaping that in the private sector because there is no magic money tree - you cut costs or you go bust. If you go bust everyone loses their job so people have agreed pay deferrals or pay cuts or reduced hours or to cover a vacancy using existing staff without any additional pay because they know the short-term saving in costs might allow them to have a job next month and next year. It is a great example of the benefits of breaking union power, a task which cost lots of jobs in the 1980s. The result is that businesses which would have had to fold a generation ago can now survive. They will still have to keep their fingers crossed about what the future holds but at least they now have a future.

You can bleat as much as you like about aggregate demand but that won't keep alive a struggling business. Only cutting its costs will keep it alive. You can say "you must keep paying your people the same amount otherwise they can't spend and other businesses might fold" to which the answer is "so you want me to fold instead and guarantee that those other businesses fold too". That is the reality.

Maintaining public sector spending will mean more cash in the tills of the businesses the public sector employees frequent but it comes at a cost. That cost is the need to raise additional taxes to pay the shortfall between current tax receipts and government spending and that has an effect on future spending power which necessarily dampens future aggregate demand which, in turn, makes it all the more difficult to generate the income from which those additional taxes are paid.

I've been more than usually circuitous today, but we are now back where we started. Taking one amount rather than another in tax does not take money out of the economy. But taking money out of the private sector inevitably prevents as much wealth and money being generated as would occur if you left that money where it was. The reason for that is that only the private sector can make the stuff to replace what we consume every day. A factory making bread doesn't just pump-up aggregate demand by paying wages that are then circulated around the system, it also makes something that is needed. Take tax from the business and from its employees and you reduce their ability to spend thereby reducing aggregate demand. Pay that tax money to a five-a-day advisor and there is no change to aggregate demand because it is taken from one person who would spend and given to another who has exactly the same amount to spend. But you don't get any bread from a five-a-day advisor's work. We are worse off not better off by keeping these non-value-added jobs.

That is what the politicians should be debating because we simply cannot afford roughly a quarter of what the government currently spends and that proportion will increase as they continue to overspend and incur further interest charges.


Mark Wadsworth said...

TFB, don't worry about it. The idea that the government can take money out of or put money into the economy is bunkum, in the grand scheme of things.

Sure, there is a basic level of stuff that has to be paid for or run collectively ('core functions') but beyond a certain point, all the government can do is transfer more money, or indeed less money, from the productive to the non-productive sectors.

I include 'land-ownership' and 'home-ownership' in the non-productive sectors, along with millions of quangocrats of course.

Stan said...

I read somewhere today that homeowners are "overpaying" their mortgages at record rates. This report also claimed that this was "taking money out of the economy" - which didn't make sense to me. If they are paying off their mortgages then surely that means banks/building societies have more money to lend - thus increasing the money in the economy?

What really takes money out of the economy, of course, is a trade deficit and every year 5% of our GDP disappears offshore never to be seen again. There are three ways to replace that.

Option 1 is to grow your economy at a higher rate than the trade deficit - but we only manage about a half of it even during good years and anything more than 5% growth can lead to "overheating" - which isn't very good either, apparently.

Option 2 is to increase our debt. We've done that and maxed at our national credit cards so ....

Option 3 is to print more money.

The next step is banruptcy.

Stan said...

Oh - I forgot the other alternative.

Run a trade surplus instead of a deficit.

Mark Wadsworth said...

Stan gives another good example of "people not taking money out of the economy".

Doug said...

When I first heard Mr Brown's statement, that not increasing National Insurance would take money out of the economy, I was convinced that I was at the Mad Hatters Tea Party because clearly the opposite is true. But then I realised that Mr Brown is a communist and that to him the economy is the public sector, the private sector is just a cash cow to provide the revenue stream for the public sector. Is he so stupid that he does not realise that without a private sector there is no public sector.

Doug Hynes

TheFatBigot said...

Welcome, Mr Doug, and thank you for your contribution. You are, of course, entirely correct as is Mr Stan. And it is so bleedingly obvious; that's what makes poor Gordon's approach so very depressing.