Sunday, 20 September 2009
The Credit Crunch – Who Pays?
The sharp rally in stock markets since March has put a spring in the step of bankers. But unemployment continues to grind higher and the spectre of a full frontal assault on public sector workers looms. The question of who pays for the credit crunch now dominates the headlines.
In essence, all three major political parties believe that public sector workers should bear the price for a huge rise in the government's borrowing. The economy may have been stabilised, but the hit to the public purse has been unprecedented outside of war.
On current projections, the Chancellor may have been too optimistic when he rocked the House of Commons in April, announcing a projected deficit of £175 billion or 12.4% of GDP for the current financial year. The latest data for August show the moving annual total has already risen to £127.3bn. The public sector finances for July were particularly dire.
The best approach to evaluating the data is to consider the annual change in £ terms. July showed a rise in the deficit of £13.0 billion compared with a year earlier. The previous record decline was set in January this year, but that showed a comparatively modest increase in the deficit of £8.5bn on an annual basis.
The deterioration in July was significant because this is seasonally an important month for tax revenues. If the 15.8% y/y drop in tax revenues is repeated in January next year – another big month for the government coffers, the Treasury may be forced to revise its forecast for the deficit higher, to 13.0% or 14.0% of GDP.
With Gordon Brown's reputation for prudence in tatters, the door is wide open for the Conservatives – and the Liberals should they join in a coalition government – to launch savage cuts on public services far beyond those seen under Thatcher, or following the IMF bailout of 1976.
The public sector deficit is unquestionably out of control. But the right wing media and its political allies have been very successful in convincing the wider electorate that public spending is the culprit.
An objective assessment of the data suggests otherwise. During the first five months of the current financial year, tax receipts have fallen by an average of 11.4% y/y (in £ terms). That is significantly worse than the 6.5% y/y decline expected by the Treasury for the full year, set out in the April budget.
By contrast government spending is rising by less than expected. So far, its has climbed by an average of 5.3% y/y (again, in £ terms) compared with a Treasury forecast of 7.7% y/y for the full year.
And it is hard to equate this increase in spending with the media image of waste and profligacy in the public sector. In real terms, it represents a rise of 3.3% y/y, a remarkably low increase given the inevitable pressures on social security payments, in response to rising unemployment.
Indeed, it is quite possible that the ratio of public spending to GDP will be less than the 43.1% projected by the Treasury, and may only be a touch above the 42.3% recorded under Thatcher, during the early 1980s' recession.
Furthermore, it is worth comparing the Tory years from 1979 onwards, with the record under New Labour. The ratio of public spending to GDP has been exactly the same - 37.1%, even with the Treasury's forecast for a rise to 43.1% included.
Much of the onslaught on public sector workers reflects a belief among the right wing press that the UK has become a high tax country. Again, the hard evidence suggests otherwise. Between 1979 and 1997, the ratio of tax revenues to GDP averaged 40.2%. Since then, it has averaged 37.5%.
Unequivocally, the Tories are the party of high taxes. Indeed, the Treasury’s projected tax revenues for this year - just 35.1% of GDP - will be lower than under any year between 1979 and 1997. Furthermore, if the data for the first five months is any guide, the final figure could be around 33.4%. The credit crunch will have indeed turned the UK into a low tax economy.
But we should not expect the public sector deficit to fall quickly even if the economy were to recover. The collapse of corporation tax receipts in particular is not a one-off or a temporary response to the credit crunch. The ability of banks and companies to roll forward their losses implies there may be a structural gap in tax revenues that persists for many years.
US investment bank Merrill Lynch provided a rare insight into this problem in August last year, before it was subsumed by Bank of America in the panic that followed the collapse of Lehman Brothers. In a regulatory filing last year, it admitted that $29bn of losses sustained on subprime mortgages in the US were being routed through its London office. According to the Financial Times, the bank was therefore "unlikely to pay corporation tax for 60 years" - even if it returned to profit levels reached at the height of the boom.
It is clear from any objective assessment of the data that new sources of tax revenue need to be found to fill the gaping hole in the public sector accounts spawned by the credit crunch. Higher income taxes are not the only answer. Companies need to be taxed if they want to do business in the UK. They can try and relocate their headquarters to Ireland, Switzerland or the Cayman Islands. But they cannot physically remove their entire operations. So they need to be taxed on the level of business or turnover. Companies need access to the UK market to sell their goods, and they should not be allowed to operate here if they are not prepared to pay their way. Economically and morally, it is wrong for public sector workers to pick up the tab for a crisis they did not create.
* Graham Turner's new book No Way To Run An Economy, published by Pluto Press is available from Bookmarks Book Shop, price £12.99