A Modest Proposal for economic growth – Part 1

A Modest Proposal for economic growth – Part 1

by Hugh Andrew
article from Thursday 11, May, 2017

Infrastructure investment without the pain

ONE OF THE BALEFUL LEGACIES of the financial crisis of 2008 has been a toxic legacy of debt, both public and private in the UK. When the crisis bit the immediate lessons of the 1930s may have been learnt, with a flood of government guaranteed liquidity in the form of guarantees, in the form of huge fiscal deficits and in the form of direct quantitative easing, but some eight years on this seems to be the limits of financial imagination as to how we extricate ourselves from the Augean stables of debt and stagnation which now sit as a baleful overhang within the UK economy.

Not only are the fundamental problems of imbalance within the British economy seemingly as entrenched as ever – chronic balance of trade, over reliance on consumption as an economic tool, lack of productivity, lack of investment – but quantitative easing and the crisis have exacerbated and contributed to a perceived growing wealth gap and social division within the country. As Adair Turner points out, the lesson of Japan stands before us – of massive debt overhang and a generation of lost growth. It seems clear that our current administration, preoccupied above all else with Brexit and its aftershocks, has no big idea or clue as to what to do beyond the Micawberish hope that something will turn up. While some are beginning to discuss the direct injection of quantitative easing into infrastructure investment, economic orthodoxy seems to fear this as an inflationary step too far.

But what an opportunity a General Election gives for some radical thinking – so (with a suitable tip of the hat to Jonathan Swift) I would like to present ‘A Modest Proposal

It is a proposal that creates potential infrastructure spend on an undreamt of scale in the UK without further inflating the money supply or indeed increasing government debt (except in a completely secured way).

Firstly, we must note that the British tax system is riddled with more holes than a Swiss cheese. In 2011 there were 1042 tax reliefs in the UK. The Office of Tax Simplification reviewed 155 and recommended the abolition of 47. Since then 48 have indeed been abolished – and 134 introduced! From 16% they now account for 21% of GDP. Some are trivial such as the relief for allowing parking in your drive, some enormous such as pension tax relief. It is fair to say that a number are integral to the tax system (such as the income tax personal allowance) but they, in the main, share one thing in common – their benefit is greatest to those who possess the most assets, whether in cash or in qualifying kind.

It has been pointed out quite accurately that even such a much trumpeted policy as the raising of the income tax threshold does not in fact bring relief to the poorest in our society who do not earn, but is of most benefit substantially higher up the income deciles. It is fair to note in this discussion that much of the rise as a percentage of GDP comes as a direct result of increases in NI and Income tax thresholds and also as a paradox of the increase in VAT where the value of VAT exemptions automatically rises as the VAT rate rises. The more reliefs there are of course the greater the opportunity for avoidance and tax leakage. A simpler system automatically increases effective take through removing these opportunities. It is, however, also true to say that removal of exemptions may cause a political firestorm – VAT on food for instance might yield some £15.8 billion (total exemptions as a result of non application of VAT are some £79.1 billion) but would it be worth the stramash?

But let us say we would be a bold Chancellor. We look at these reliefs and we start to sweep them away. Pension relief for both employers and employees alone would yield some £33 billion pounds per annum. Tax relief on the sale of the principal residence a further £10 billion or so, Inheritance Tax some £22 billion per annum.

These figures are illustrative of the massive scale of the issue and I accept that some of these reliefs or exemptions will be untouchable but let us say we manage to remove some £60/70 billion then we may indeed have given ourselves scope for radical budget surgery elsewhere, we may have helped towards our deficit targets. But what we have not done is tackle the chronic imbalances within the British economy – indeed the fiscal tightening represented by these measures would – without countervailing expenditures – be recessionary in impact. Furthermore we have created a distortion at the point of change between those who have benefited from reliefs and those after the point of change. 

Clearly the principle of retrospective taxation is a very dangerous path to go down (though HMRC applies it more than it would care to admit). Clearly too, one cannot claim back reliefs from those who have in good faith received them over the years and changed their economic behaviour as a consequence. But what we can do is quantify the value of reliefs that have been received over a period – and while allowing lifetime use to the beneficiaries – create a chargeable asset against their estate equivalent to the value of reliefs received. It is not money that was theirs in the first place but money that was either not taken by or gifted by the British taxpayer to them for a particular act at a particular point in time. Why should inheritors benefit from an act for which they were not responsible? 

The scale of potential tax recovery clearly is enormous. We might well be talking in excess of £500 billion (there are over £1.5 trillion of funds in pension schemes alone, largely tax relieved, and some £5.5 trillion under total fund management) over time – fiscal transfer on a transformative scale. And bear in mind largely from those already the richest in society. 

What then do we do with this massive windfall?  My suggestion would be the creation the One Nation Fund. That fund will use liquidity created or guaranteed by the Bank of England secured against the recovery of tax reliefs to engage in the massive scale of infrastructure and investment spend that Britain needs. A wise taxpayer may be offered generous terms to invest in the One Nation bond – an investment which can be set against the charge on estates as a ‘downpayment’. Generous terms no doubt would be offered for cash now rather than waiting for the estate to crystallise. 

The investments to be made from the Fund would be entirely in infrastructure and investment and not in consumption. They therefore act:

  1.  As a massive rebalancing of British growth towards investment and away from    consumption
  2. As an adrenalin shot to Britain’s GDP thus starting the process of reduction of National Debt as a percentage of GDP.
  3. As a massive boost to tax revenues.
  4. As an ongoing reducer of business costs as a result of increased connectivity  and efficiency. 
  5. As a reducer of unemployment

But an imaginative Chancellor would do more. British investment strategies have tended to focus on investing where the economy is already overheating. London is a case in point. A self-reinforcing cycle of investment driving further growth requiring further investment creates a society not simply increasingly divided in wealth but geographically so as well. So infrastructure spending needs to be spread very carefully and very fairly. My proposal would be that monies are made available on the basis of a calculation of 50% population and 50% geographical area. Thus thinly populated areas would receive a disproportionate benefit. These are of course the areas where most bang for one’s bucks can be delivered and have usually been the victims of chronic underinvestment caused by their lack of population and inability to make themselves heard. Marginality is a self-reinforcing concept.

The nature of these investments will tend towards bringing population and economic activity back to remote and currently marginal areas. The improvements in their connectivity will bring them into the economic mainstream. That will then have the beneficial effect of cooling the hotspots as these areas take up the strain. Bear in mind there has to come a point where ever more investment in ever smaller spaces becomes highly inefficient. Some would argue the staggering costs for business associated with London suggests this has been reached – and the economic gains thus are marginalised. 

It is of course argued by some that the state (however construed) is a very poor allocator of capital. That is not necessarily the case. Japan, South Korea and Taiwan all represent economies built on state-driven capital allocation to build an economy. Equally 2008 was hardly an advert for the benign and productive effects of private capital allocation as a mountain of speculative debt collapsed like a house of cards. And as a parenthesis, the experts deposed King Ludwig of Bavaria for squandering Bavaria’s exchequer on two architectural fantasies. These are now amongst the biggest revenue earners of the state. 

The point is not to create a system dogged by an ideology of, on the one side state, or on the other private, but a capital allocation system that works. Britain, Europe, the world are crippled by a legacy of massive debt overhang built on speculative investment and asset price appreciation. Without resolution of this issue we live in an economic crisis anaesthetised but not resolved, and always on a precipice.

Photo: Swiss Cheese Tunnel, from the art of Paul Kos

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