Alistair Darling has saved the economy. Unfortunately the economy he has saved
is the wrong one. In true Mr Bean fashion, yesterday’s Budget saved the
economies of Switzerland, Luxembourg, Jersey, Hong Kong and other low-tax
jurisdictions (polite society no longer describes them as tax havens), which
only three weeks ago his boss Gordon Brown had boasted of closing down. As
for the British economy, one can only sigh in disbelief. To cram so much bad
news and so many policy blunders into an hour-long speech was quite an
achievement, matched only by David Cameron, who managed in just 15 minutes
to prove that Britain under the Tories would fare even worse.
To understand all these statements, let us start by focusing on just one
figure, the only figure that really meant anything in the Budget speech and
the only one that Mr Cameron studiously failed to mention amid all his
ritual fulmination against zillions of pounds in borrowing and scandalously
inaccurate Treasury forecasts. This figure was 50 per cent, the new tax rate
on the rich.
Mr Darling’s forecasts of unprecedented public borrowing (£175 billion) and
economic contraction (minus 3.5 per cent) drew most attention immediately
after the Budget; but these figures will soon be forgotten, since they are
no more meaningful or relevant to economic decisions than a weather forecast
made today for the temperature or rainfall on Budget day next year. Just as
the Treasury, along with the IMF and the OECD and all the other supposedly
expert institutions, have revised their forecasts out of all recognition in
the space of just four or five months, the numbers published in yesterday’s
Budget will be overtaken by events in the next few months.
Until Mr Darling delivered his speech yesterday, it seemed more likely that
the official forecasts – which are not really forecasts but really just
forward projections of recent statistical trends – would start to be revised
upwards, as incoming statistics, especially on housing and consumption,
began to improve. On this basis, the Chancellor could reasonably have stood
up yesterday and simply said that he had already done everything possible to
ensure economic recovery and would now wait until the economy had returned
to full employment before deciding what further actions, if any, were needed
to improve public finances in the years ahead.
Unfortunately, however, Mr Darling decided to favour politics over economics.
As in his first Budget, the one that preceded the election that never was,
Mr Darling could not resist the temptation of setting what he probably hoped
would be a trap for the Tories, by challenging them to repeal a large
increase in the top rate of tax, to be introduced just days before the next
election.
This increase in the top tax rate, by contrast, is the one aspect of the
Budget that can be firmly relied on and it will begin to affect decisions on
relocating international businesses, buying and selling houses, hiring and
firing staff, from today onwards. The upshot is that a Budget that could at
best have paved the way for a surprisingly strong recovery and should, at
worst, have been a mere nonevent, has turned into an act of economic
sabotage.
In saying this, I do not wish to argue that raising taxes on the top 2 per
cent of the British workforce is necessarily unreasonable or economically
damaging. The cost-benefit analysis of dramatically changing the structure
of Britain’s tax system is a subject worth debating in its own right. It has
obvious advantages, not least that it is a way of wreaking political
vengeance on bankers and financiers. But it also has serious disadvantages.
For example, a highly progressive tax system, heavily reliant on taxing
corporate profits and high earnings, suffers from much greater cyclical
instability than one that depends mostly on consumption taxes such as VAT.
Indeed, Britain and America are suffering enormous deficits at present,
despite recessions less severe than continental Europe’s, partly because the
Anglo-Saxon tax systems are already more progressive by some measures than
those of Germany and France.
The strong political resistance to higher public spending in the US and
Britain is also partly a consequence of their reliance on income taxes
rather than less visible revenues from VAT. But whatever can be said about
the pros and cons of a dramatically more progressive tax structure, the
timing of Mr Darling’s announcement yesterday was potentially disastrous in
at least three ways.
First, the announcement of any significant tax increase, at a time when the
Chancellor was trying to restore business confidence and boost housing and
consumption, went completely against the logic of efforts of the
Government’s faith in fiscal stimulus. Mr Darling’s biggest mistake in the
PreBudget Report (PBR) was to negate the benefits of his VAT cut by
preannouncing a big increase in income tax and national insurance, but
instead of learning from this mistake he decided to repeat it.
Second, Mr Darling aggravated his PBR mistake by bringing forward by a year
the tax increases originally scheduled for 2011. By accelerating his tax
plans, the Chancellor has probably delayed and weakened the recovery that
the Treasury is expecting this year, since some people will react to
anticipated tax rises by raising their savings – and he has guaranteed
that growth in 2010 will be slower than otherwise, as the tax increases
begin to bite.
Third, and most alarmingly, Mr Darling’s tax increase has kicked the most
cyclically important part of the British economy when it is already down.
In different circumstances, when global finance was booming, when Britain
boasted of its light-touch business-friendly regulation, when law firms and
multinational companies were willing to pay telephone-number salaries to
retain London staff, a Labour government might have been able to impose a 63
per cent tax on senior employees (which is what the marginal tax rate will
amount to once income tax and national insurance are combined) without
displacing significant amounts of business.
When businesses were flush with cash and bankers were earning millions, the
benefits of living and working in London were sufficient to outweigh the
financial benefits of paying less tax in Zurich, Luxembourg or Hong Kong.
But this is no longer the case. Global finance and multinational businesses
are in a period of ruthless restructuring and cost reduction. The same is
true of all the ancillary activities such as law, accountancy, architecture,
advertising, management consultancy, design and so on, which ultimately
depend on their proximity to the decision makers in globalised business and
finance.
In the past few years, the difference between the 50 per cent of income left
after tax and national insurance in Britain and the 70 per cent left to most
residents in Switzerland might not have been enough to motivate many
corporate relocations. But in today’s more cost-conscious environment, banks
and multinational companies will be sorely tempted by the near-doubling of
net pay that they can achieve for their employees simply by moving out of
Britain before Mr Darling’s new taxes and national insurance charges are
imposed.
The result is likely to be a substantial shift of global businesses from
Britain, at precisely the time when London needs to restore its credentials
as the leading global centre for finance and business services.
In the present mood of disgust towards international finance and business,
many people will doubtless say good riddance if banks and multinational
companies decide to move their operations elsewhere. There may, indeed, be
some valid arguments for trying to reduce the British economy’s reliance on
banking in the long term and trying to redirect the nation’s energies
towards increasing manufacturing exports. The problem is, however, that this
shift is already happening, as a result of the global financial crisis. To
magnify it now by changing the structure of the tax system could well
condemn the economy to a long period of weak growth, as the industries in
which Britain has a clear comparative advantage wither, before other
industries can grow up to take their place. Moreover, it appears on the
basis of postwar experience that most of the industries in which Britain has
comparative advantage – not just banking and business services, but
also pharmaceuticals, energy, electronic technology, entertainment and
design – are dependent on workers who are both highly paid and
internationally mobile.
It is likely, therefore, that banks and hedge funds will not be the only
businesses encouraged to move out of Britain – pharmaceutical and oil
companies, architects and designers may be just as motivated by the prospect
of paying much lower tax in other business centres, whether in Europe,
America or the Far East.
Even if this large-scale migration of businesses out of Britain never actually
happens, perhaps because the business community will pressurise the Tories
to repeal the new income taxes, yesterday seemed a crazy time to take such a
pointless and unexpected gamble. But what else would one expect from Mr Bean?
