Fiscal stimulus 'Plan B' would be disastrous for UK - says IEA
by Nick Hayns
13 December 2011
If the British economy is to get back to meaningful growth, government spending must be cut far further and faster, and tax cuts must be utilised to stimulate productivity - argues think-tank
It seems to be something of a truism in politics that if an untruth is repeated loud enough and with enough frequency it becomes imbued with a de-facto plausibility. It must be a good idea if I keep hearing about it, that kind of logic. Therefore, our senses are now regularly assailed with the news that families "up and down the country" are being harmed by these "savage cuts". Government spending is being cut "too far and too fast". Barely a news report goes by without one or more of these 'facts' receiving an airing. But, the truth is that these savage cuts are, in fact, very mild – nothing is being cut too far and it is certainly not happening too fast. If families up and down the country are worried about them, it is probably just because they have been watching too many news programmes.
The latest popular myth to add to the pile is that, with economic growth proving damnably elusive, one big spending push would get us back on the move. One last fiscal stimulus, one last Keynesian gorge. One last spending spree to get things built, to get people into work, to career us towards a full-employment nirvana. It is an idea gaining alarming currency in recent discourse. The technical term for this madness is "Plan B". The fundamental problem with Plan B – and the reason it is so politically seductive – is that it might well increase output in the short term. Gross Domestic Product includes government spending at source so the initial calculation is quite basic in the first instance. Increase government spending, increase GDP - equals masterstroke.
However, the problem comes in the second year following such a stimulus package when the boosting effect starts to drop. By the third year, the effect has entirely worn off, the public debt has been inflated substantially and the necessity of repaying that debt becomes all too clear. That debt cannot be financed by further borrowing, but instead by tax rises – themselves having a further dampening effect, possibility dragging the economy back into recession. After the vast fiscal expansions that were embarked upon by many western governments following the recent crash, it is entirely possible that we are currently feeling the resultant negative effects. In fact, it is possible that - without them - we would be enjoying faster growth right now.
Indeed, with an official national debt nearing £1 trillion – although, the true level is actually closer to £5 trillion - with VAT at 20 per cent and the top rate of income tax at 50 per cent in an effort to finance it, and with growth flatlining, you would have to say that our current economic experience is adhering remarkably tightly to the economic theory. If fiscal stimulus packages are to be used, they should be financed through strategic tax cuts - which stimulate investment, work and enterprise. For example, cuts to marginal tax rates – which incentivise work – are far better than cuts to specific sectors; such as temporary VAT cuts on car purchases. In the latter example, all that happens is more people buy new cars instead of buying other goods or services; no extra wealth is actually created.
The current Plan B that is being called for by many in the media and on the opposition benches, though, is not one of incorrectly-focused tax cuts - but instead one of ever more government spending. It was an incorrect policy in 2009; now that we are so much further in debt, it would be utter madness. For those who thought - nay, hoped - Keynesianism died out a long time ago, it is a sore disappointment. Alas, like a Monty Python parrot, it was merely resting. George Osborne's autumn Statement last month was a litany of government spending projects – a road here, a rail upgrade there. While maybe not a Plan B, it was, at absolute best, a Plan A-. If the British economy is to get back to meaningful growth, government spending must be cut far further and faster, and tax cuts must be utilised to stimulate productivity. Plan B, like "too far and too fast", is a myth. A seductive one, yes, but not one that will grow our economy. Families "up and down the country" are surely more concerned about another recession.
Nick Hayns is communications officer at the Institute of Economic Affairs think-tank, in the United Kingdom
It seems to be something of a truism in politics that if an untruth is repeated loud enough and with enough frequency it becomes imbued with a de-facto plausibility. It must be a good idea if I keep hearing about it, that kind of logic. Therefore, our senses are now regularly assailed with the news that families "up and down the country" are being harmed by these "savage cuts". Government spending is being cut "too far and too fast". Barely a news report goes by without one or more of these 'facts' receiving an airing. But, the truth is that these savage cuts are, in fact, very mild – nothing is being cut too far and it is certainly not happening too fast. If families up and down the country are worried about them, it is probably just because they have been watching too many news programmes.
The latest popular myth to add to the pile is that, with economic growth proving damnably elusive, one big spending push would get us back on the move. One last fiscal stimulus, one last Keynesian gorge. One last spending spree to get things built, to get people into work, to career us towards a full-employment nirvana. It is an idea gaining alarming currency in recent discourse. The technical term for this madness is "Plan B". The fundamental problem with Plan B – and the reason it is so politically seductive – is that it might well increase output in the short term. Gross Domestic Product includes government spending at source so the initial calculation is quite basic in the first instance. Increase government spending, increase GDP - equals masterstroke.
However, the problem comes in the second year following such a stimulus package when the boosting effect starts to drop. By the third year, the effect has entirely worn off, the public debt has been inflated substantially and the necessity of repaying that debt becomes all too clear. That debt cannot be financed by further borrowing, but instead by tax rises – themselves having a further dampening effect, possibility dragging the economy back into recession. After the vast fiscal expansions that were embarked upon by many western governments following the recent crash, it is entirely possible that we are currently feeling the resultant negative effects. In fact, it is possible that - without them - we would be enjoying faster growth right now.
Indeed, with an official national debt nearing £1 trillion – although, the true level is actually closer to £5 trillion - with VAT at 20 per cent and the top rate of income tax at 50 per cent in an effort to finance it, and with growth flatlining, you would have to say that our current economic experience is adhering remarkably tightly to the economic theory. If fiscal stimulus packages are to be used, they should be financed through strategic tax cuts - which stimulate investment, work and enterprise. For example, cuts to marginal tax rates – which incentivise work – are far better than cuts to specific sectors; such as temporary VAT cuts on car purchases. In the latter example, all that happens is more people buy new cars instead of buying other goods or services; no extra wealth is actually created.
The current Plan B that is being called for by many in the media and on the opposition benches, though, is not one of incorrectly-focused tax cuts - but instead one of ever more government spending. It was an incorrect policy in 2009; now that we are so much further in debt, it would be utter madness. For those who thought - nay, hoped - Keynesianism died out a long time ago, it is a sore disappointment. Alas, like a Monty Python parrot, it was merely resting. George Osborne's autumn Statement last month was a litany of government spending projects – a road here, a rail upgrade there. While maybe not a Plan B, it was, at absolute best, a Plan A-. If the British economy is to get back to meaningful growth, government spending must be cut far further and faster, and tax cuts must be utilised to stimulate productivity. Plan B, like "too far and too fast", is a myth. A seductive one, yes, but not one that will grow our economy. Families "up and down the country" are surely more concerned about another recession.
Nick Hayns is communications officer at the Institute of Economic Affairs think-tank, in the United Kingdom
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COMMENTS
Complete economic rubbish. Britian's problem is private sector debt, plus a severe lack of jobs. The politics of austerity are worsening the position. Financial liberalisation has led us - and much of the world - into the current mess. It is not Keynesianism that failed, but modern right-wing ideological economics; with the IEA in the forefront.
Jeremy Smith - London, UK
