I was going to write something about some of the detailed fiscal plans of our next prime minister, and then I thought that would be pointless. Part of the remit of being a Tory prime minister nowadays is to lie all the time. So how do I, or Tory members for that matter, know if either of these two candidates for prime minister are going to do any of the things they have promised when they get into power? All they are doing right now is saying whatever they think Tory members want them to say.
However both campaigns do at least raise the possibility that our next prime minister will throw caution (and fiscal responsibility) to the wind and embark on an extensive tax-cutting programme. It is critical to note that these tax cuts have not been carefully crafted to shield the economy against any demand shock that might follow from a no-deal Brexit. They are designed instead to make Tory voters happier with a government that enacts the biggest act of self-harm in UK history.
How do I know that this is what the tax cuts are for, when I’m sure the future prime minister would say otherwise? Let’s just look at some of the big ticket items. Cutting income tax for higher-rate taxpayers, cutting stamp duty on buying a house and cutting corporation tax. If you were looking for fiscal policies to provide a quick boost to demand, these would be a long way down the list. Much better would be to give money direct to poorer households, because they are likely to spend most of it, or to add to demand directly by increasing public spending and, in particular, public investment. High up on my list would be to increase local authority funding to prevent some local authorities going bust. These kind of demand boosters are, however, not the kind of thing that would be attractive to Tory party members, which is why they are largely absent from the wish list of each prospective prime minister.
There is an equally important point about timing. Any demand shock following a no-deal Brexit is likely to be temporary, such as a sudden stop in investment by business or in housing. The best measures to counteract that are ones that can easily be reversed. Again, bringing forward public investment is an excellent example. In contrast, cutting taxes is politically difficult to reverse. None of the tax cuts proposed by either leadership candidate are explicitly temporary.
What we are seeing from both candidates is the fiscal policy of Donald Trump and, to be fair to Trump, also the policy of the Republican Party since the second George Bush. Cut taxes under any pretext you can, and watch borrowing increase. After a suitable interval say that something must be done about borrowing, and propose a raft of cuts in public spending or welfare payments to stop the government debt-to-GDP ratio rising. It was the right’s preferred way of shrinking the state before the 2008 global financial crisis and austerity came along.
There are two traps that the left can fall into over a Trump-style giveaway to the rich. The first, which you may find among Lexiters, is to believe that fiscal stimulus is the means by which you stop permanent damage to the economy from any form of Brexit. The danger this leads to is to support for the concept of a large permanent fiscal stimulus, even if you do not like the details. I am all for a large increase in public investment, of the kind that I hope a future Labour government will deliver, but that increase in investment should happen anyway, whatever the outcome on Brexit or aggregate demand. If the investment projects are beneficial, they should be undertaken whatever happens to Brexit.
Brexit’s main impact is to gradually hit the supply side of the economy by reducing UK trade with the EU and most of the countries the EU has trade agreements with. As we do less trade, the UK’s productivity falls. This causal linkage takes many forms, such as dynamic firms choosing to produce elsewhere, or UK participation in supply chains ending, but the net result is that the UK produces stuff less productively than it would without Brexit. The empirical evidence for these effects is very strong, and we have already seen some of it happening.
You cannot counteract this long-term loss of productivity by pumping up demand. All this will do is create inflationary pressure which will lead to higher interest rates designed to offset the fiscal stimulus. There is nothing the UK government can do to offset the negative impact of higher trade barriers on the UK. What the government can do is to help offset any Brexit-induced negative shock to demand, where demand falls more quickly than supply or falls temporarily, by using fiscal expansion alongside monetary policy.
This leads to a second trap, which is to think about the Johnson/Hunt proposals in terms of conventional fiscal stimulus to offset this temporary demand deficiency. Or in other words, to think about them in macroeconomic terms. That is not their main intent. Their intent is to redistribute money from the poor to the rich, in order to keep the party’s backers (in terms of money or votes) happy despite all the chaos of no-deal. No doubt any actual proposals made after the winner becomes prime minister will include sweeteners (this could be a bad pun) designed to distract from this purpose, but reporting and comment should not be distracted.
Which brings us to the issue of how popular any package will be. Stephen Bush rightly points out that our future prime minister, if they stick to anything like their current fiscal plans, will blow the Conservatives’ reputation for economic responsibility out of the water. The Office for Budget Responsibility will be quick to tell the next chancellor that a no-deal Brexit will create one of those famous black holes in the public finances. Yet rather than respond, as Hammond would, with fiscal retrenchment, the new prime minister wants to shake the magic money tree for all it is worth.
In contrast, Aditya Chakrabortty worries that this reputation loss will have little impact on voters, who will instead be dazzled by the goodies that are being thrown at them. If I had to choose, I would agree with Chakrabortty on this. Labour are deemed irresponsible on the economy by the media even when they are not, so I suspect the reverse will be true: the Tories will be deemed responsible even when they are not. The Institute for Fiscal Studies and the Financial Times will raise an eyebrow but their impact on most media comment will be regrettably small.
I fear we are returning to an age of deficit bias, which I have to remind younger readers was the tendency in many (not all) countries to gradually increase their debt-to-GDP ratio during the 30 years before the global financial crisis. There is always the temptation for politicians to cut taxes or increase public spending through higher borrowing to gain popularity. Austerity during the global financial crisis may be an exception to that rule, or more worryingly, deficit bias may be how right-wing politicians shrink the state in normal or good times and austerity (deficit deceit) is how they do it in bad times.
As a result, it is entirely legitimate for the left to criticise these plans on fiscal responsibility grounds, as well as criticising their impact on the distribution of post-tax income, should these plans survive either candidate becoming Prime Minister. I make no apologies for saying this again: the Labour Party is the only UK political party to have set out a fiscal framework that both prevents austerity and also prevents the kind of irresponsible fiscal giveaways that are being proposed by our future prime minister.