If you are lucky enough to have piles of money earning interest in a bank account, one thing you don’t want to be doing is facing the dreaded tax bill on the interest earned. It is for this reason that many wealthy people put their savings into bank accounts in Switzerland and other countries with strict secrecy laws. Countries, such as Liechtenstein, Switzerland, Andorra, Liberia and the Principality of Monaco have previously had laws in place to prevent the effective exchange of information. This had meant that you could keep your money in an account there and the UK authorities would be unable to obtain any information for their tax records.
However, as part of an ongoing OECD initiative against harmful tax practices, more and more countries have been opening up to the exchange of information. In recent developments, Switzerland and the UK have signed an agreement, which will see them begin to negotiate on improving information exchange. In particular, the UK will be looking at the possibility of the Swiss authorities imposing a tax on any interest earned in their accounts by UK residents. This tax would be on behalf of HM Revenue and Customs. One concern, however, with this attempted crack down on tax evasion is that ‘innocent’ taxpayers could be the ones to suffer.
The following articles consider this recent development. It is also a good idea to look at the following link, which takes you to the OECD to view some recent agreements between the UK and other countries with regard to tax policy and the exchange of information. (The OECD)
Articles
UK in talks over taxing Britons’ Swiss bank accounts BBC News (26/10/10)
Doubts on plans to tackle tax evasion Telegraph, Myra Butterworth (21/10/10)
HMRC letters target taxpayers with Swiss bank accounts BBC News (25/10/10)
Spending Review: Can the taxman fix the system? BBC News, Kevin Peachey (22/10/10)
Britain, Switzerland agree to begin tax talks AFP (26/10/10)
Treasury to get £1 billion windfall in Swiss deal over secret bank accounts Guardian, Phillip Inman (26/10/10)
Swiss to help UK tax secret accounts Reuters (25/10/10)
Reports
The OECD’s Project on Hamful Tax Practices, 2006 Update on Progress in Member Countries The OECD, Centre for Tax Policy and Administration 2006
A Progress Report on the Jurisdictions surveyed by the OECD global forum in implementing the internationally agreed tax standard The OECD, Centre for Tax Policy and Administration (19/10/10)
Questions
- Is there a difference between tax avoidance and tax evasion?
- If there is crack down on tax evasion, what might be the impact on higher earners? How could this potential policy change adversely affect the performance of the UK economy?
- If tax evasion is reduced, what are the likely positive effects on everyday households?
- Is clamping down on tax evasion cost effective?
- What might be the impact on people’s willingness to work, especially of those on higher wages, if there is no longer a ‘haven’ where they can save their money?
- How could tax reform help the UK reduce its budget deficit?
Now the details of the Comprehensive Spending Review (CSR) are known, the comments are coming thick and fast. As we saw in the last news blog, Taking sides in the war of the cuts, economists are divided over whether the cuts will be compensated by a rise in private expenditure or whether overall aggregate demand will fall, driving the economy back into recession. As you will see in the articles below, they are still as divided as ever.
At least we know the details of the cuts. The plan is for an average cut across government departments of some 19 per cent over four years, although the size will vary enormously from department to department. The government is predicting that the effect will be about 490,000 fewer jobs in the public sector. In addition to the cuts, the retirement age is to rise to 66 for both men and women by 2020 and regulated rail fares will rise by 3% above RPI inflation for three years from 2012.
Examine the details of the measures in the articles below and consider what the effects are likely to be, both on the macro economy and on income distribution.
Articles
Spending Review: Osborne wields axe BBC News (20/10/10)
Spending Review: Q&A – what does it mean? BBC News (20/10/10)
Main points from the Comprehensive Spending Review Independent (20/10/10)
Osborne swings the welfare axe Independent, Oliver Wright (20/10/10)
Chancellor spells out austerity gamble Financial Times (20/10/10)
Easier said than done The Economist (20/10/10)
Julian Callow Sees Consolidation in Europe Bloomberg Podcasts, Tom Keene interviews Julian Callow, chief European economist at Barclays Capital (21/10/10)
Spending Review 2010: Business leaders urge clearer strategy for growth Telegraph, Louise Armitstead (20/10/10)
Spending Review 2010: George Osborne leaves markets unmoved Telegraph (20/10/10)
Spending review: Osborne gambles with the economy Guardian, Larry Elliott (20/10/10)
Larry Elliott on George Osborne’s spending review Guardian video (20/10/10)
Spending review: What the economists think Guardian (20/10/10)
Spending review: The work of a gambler Guardian editorial (20/10/10)
Spending review: economists and other experts respond Guardian, various economists (20/10/10)
Comprehensive spending review: We deserve an explanation. This wasn’t it Guardian, Aditya Chakrabortty (20/10/10)
Spending review: the winners and losers Guardian, Sam Jones (20/10/10)
All in it together? BBC News blogs, Stephanomics, Stephanie Flanders (20/10/10)
The sack: Lessons for government BBC News blogs, Peston’s Picks, Robert Peston (20/10/10)
A gamble on the economics Financial Times, Philip Stephens (20/10/10)
Q&A: the devil in the details Financial Times, Chris Giles (20/10/10)
Spending Review: Poorest Take Biggest Hit Sky News, Miranda Richardson (20/10/10)
Spending Review 2010: ‘More cuts could be needed’ Telegraph, Andy Bloxham (21/10/10)
Cuts ‘will push UK close to recession’ BBC Today Programme, Martin Wolf and Ken Rogoff (21/10/10)
Spending review cuts ‘are regressive’ BBC Today Programme, Tim Harford (21/10/10)
Spending review is a full stop but history lesson is vital in economics Guardian, Larry Elliott (25/10/10)
The Spending Review document
Spending Review 2010 HM Treasury (20/10/10)
Link to HM Treasury Spending Review site
Briefing and analysis from the Institute for Fiscal Studies
Opening remarks IFS, Carl Emmerson (21/10/10)
Link to briefing presentations (PowerPoint) IFS (21/10/10)
Analysis of fiscal consolidation by the IMF
Will It Hurt? Macroeconomic Effects of Fiscal Consolidation World Economic Outlook, Chapter 3, IMF (Oct 2010)
Questions
- What is the distribution of cuts between government departments?
- To what extent can it be said that there will be a real increase in health expenditure?
- What will be the effect of the cuts and tax increases on the distribution of income?
- What will determine whether the effect of the cuts will be to stimulate or dampen economic growth (or even drive the economy back into recession)? Which do you think is most likely and on what do you base your judgement?
- Trace through the multiplier effects of the measures.
- If the effect of the cuts is to drive the economy back into recession, what should the government’s ‘Plan B’ be?
In the run-up to the Comprehensive Spending Review a battle is raging. On one side are those who argue that cuts are necessary to secure long-term growth and to maintain confidence on the UK economy. These people include leaders of 35 major companies in the UK who wrote a letter to the Telegraph (see below) suppporting George Osborne’s policy of cuts.
On the other side are those who maintain that the cuts will drive the economy back into recession or, at least, will hamper economic recovery. The Federation of Small Businesses warns that “Some small firms rely on public-sector contracts for 50 or 60 per cent of their turnover. If the cuts are swingeing and overnight, these companies will be lost to the UK economy forever.”
Read the following articles to get a clear understanding of the arguments on both sides. Hopefully this will then put you in a better position to assess the cuts and their impact.
Articles
Osborne’s cuts will strengthen Britain’s economy by allowing the private sector to generate more jobs Telegraph, letter from 35 business leaders (18/10/10)
Spending Review 2010: cut now or pay later, say business leaders Telegraph, Andrew Porter, and Robert Winnett (17/10/10)
35 business leaders back Osborne’s cuts BBC News blogs: Peston’s Picks, Robert Peston (17/10/10)
Prominent Tory donors among business leaders who backed Osborne’s cuts Independent, Andrew Grice (19/10/10)
On the tight side The Economist (30/9/10)
History will see these cuts as one of the great acts of political folly Observer, Will Hutton (17/10/10)
Osborne has taken the coward’s route Guardian, David Blanchflower (18/10/10)
Osborne reading Christian Andersen, claims economist The Herald, Ian McConnell (19/10/10)
Time to broaden the debate on spending cuts Guardian, Ha-Joon Chang (19/10/10)
Slugging it out over spending cuts Independent, Sean O’Grady (19/10/10)
Spending Review 2010: We should all fear the darkness, David Cameron included Telegraph, Mary Riddell (18/10/10)
Spending cuts: Molehill and mountain BBC News blogs: Stephanomics, Stephanie Flanders (19/10/10)
Does fiscal austerity boost short-term growth? A new IMF paper thinks not The Economist (30/9/10)
Spending Review: Forecasts rely on ‘heroic assumptions’ BBC News (20/10/10)
Spending cuts: City divided on whether cuts are good for recovery Yorkshire Evening Post (20/10/10)
Spending Review 2010: Spending cuts will hit small businesses hardest Telegraph, James Hurley (20/10/10)
Speech
Rebalancing the Economy Speech by Mervyn King, Bank of England Governor (30/9/10)
Mervyn King warns of 1930s-style collapse (Extract from above speech) BBC News, Mervyn King (19/10/10)
Questions
- What are the main arguments for making large-scale cuts to government spending at the present time?
- What are the main arguments against making large-scale cuts to government spending at the present time?
- To what extent should the government’s poplicy on the size and timing of the cuts be influenced by international economic relations?
- What role might the ‘inventory cycle’ play in the economic recovery?
- Why may the government “pay heavily unless it learns to temper its bloody cuts with humanity”?
- How will large-scale spending cuts impact on (a) consumer confidence; (b) business confidence; (c) the confidence of international financiers?
- Will monetary policy allow fiscal policy to be tightened without causing a recession? Explain the effectiveness of monetary policy in these circumstances.
National debt has increased rapidly over the past few years. In 2006/7 general government debt was £577.8bn or 42.9% of GDP. In 2009/10 it was £1000.4bn or 71.3% of GDP. It is set to go higher, with government debt forecast to be around 87% of GDP in 2011. This compares with forecasts of 82% for Germany, 87% for France, 103% for the USA, 134% for Greece and 195% for Japan.
Getting the deficit and debt down has, not surprisingly, become an issue in many countries. In the UK it has become the major current pre-occupation of the Coalition government and on 20 October it is set to announce major public spending cuts as a means of achieving this.
To get a flavour of the government’s thinking and the message that ministers are putting out to the electorate, the following are quotes from the Prime Minister’s and then the Chancellor’s speeches to the Conservative Party Conference:
This year, we’re going to spend £43 billion pounds on debt interest payments alone. £43 billion – not to pay off the debt – just to stand still. Do you know what we could do with that sort of money? We could take eleven million people out of paying income tax altogether. We could take every business in the country out of corporation tax. That’s why we have acted decisively – to stop pouring so much of your hard-earned money down the drain. We are already paying £120m of interest every single day thanks to the last Labour government. (David Cameron)
It’s the borrowing that doesn’t go away as the economy grows, and we have £109bn of it. It’s like with a credit card. The longer you leave it, the worse it gets. You pay more interest. You pay interest on the interest. You pay interest on the interest on the interest. We are already paying £120m of interest every single day thanks to the last Labour government. Millions of pounds every day that goes to the foreign governments we owe so they can build the schools and hospitals for their own citizens that we aren’t able to afford for ours. How dare Labour call that protecting the poor? (George Osborne)
Let’s unpick this a bit. Who earns the interest? The answer is that it is paid to holders of government debt in the form of government bonds (gilts), national savings certificates, premium bonds, etc. In other words it is paid to savers, whether individuals or pension funds or companies.
Does it all go abroad? In fact 29% of gilts are held abroad. The rest are held by British residents. Thus some 70% of the interest rate paid on government debt goes to British residents and supports pensions and savers. It can thus be seen as a transfer from taxpayers to savers.
Because of the record low interest rates many pensioners who rely on savings interest have seen their incomes fall dramatically. Others draw income from a ‘self-invested personal pension’. The amount that can be drawn each year is based on tables according to a person’s age and the current 15-year Treasury gilt yield (currently 3.45%). Thus the lower the rate of interest, and the less the yield, the less that can be drawn.
So who are the gainers and losers from high general government debt and attempts to get it down? Read the following articles and look at the data and then try answering the questions.
Articles
Britons have donated £7m to help pay off the national debt (but that’s a drop in the ocean) Mail Online, Daniel Martin (9/10/10)
A trillion and rising: Britain’s £1,000,000,000,000 debt means it is now paying as much in interest as it does for defence Mail Online, Hugo Duncan (1/10/10)
Spending cuts “not enough”, say small firms Telegraph, James Hurley (8/10/10)
UK public finances post record August deficit Guardian, Julia Kollewe (21/9/10)
Another paradox of thrift The Economist, Buttonwood (16/9/10)
Data
The gilt market UK Debt Management Office
Gilt market data UK Debt Management Office
Overseas gilt holdings UK Debt Management Office
Public sector: current position ONS (30/9/10)
Public sector finances ONS Statistical Bulletin (21/9/10)
Government deficit and debt under the Maastricht Treaty ONS Statistical Bulletin (30/9/10)
Contributions to the government deficit and debt ONS Statistical Bulletin (31/3/10)
Questions
- Explain the difference between central government, general government and public-sector deficits and debt.
- Who loses from a rising public-sector debt? Who gains?
- Conduct an international comparison of (a) the level of the government deficit and debt and (b) their rate of growth over the past few years.
- What is meant by the ‘yield’ on a particular gilt?
- If gilt yields fall, does this mean that the government pays less on existing gilts? Is it likely to pay less on new gilt issues? Explain.
- How do cuts affect the distribution between savers and borrowers?
If you are an Irish resident, you may be feeling very worried! As Irish debt levels reach new heights, the bill will once again fall on the tax payer. Irish government borrowing is almost 12% of GDP, but with two key banks requiring a bail out, government borrowing is expected to treble this figure to some 32% of GDP. The Anglo-Irish bank requires approximately £30 billion and Allied Irish also requires more cash. The Irish Finance Minister said:
‘The state has to downsize these institutions to prevent them becoming a systemic threat to the state itself.’
The Irish have already faced a round of austerity cuts and with the latest banking catastrophe, the next round is about to start. There are concerns that the Irish economy could move into a downward spiral, with more money being removed from the economy causing more people to lose their jobs, which will weaken public finances further and mean that more borrowing will then be required. It is hardly surprising to find a pessimistic mood on the streets of Ireland.
However, with a new interdependent world, this crisis will not only be felt by Ireland. The UK exports a large amount to Ireland – more than to Spain or Italy. With Irish tax-payers facing higher burdens and unemployment still relatively high, UK exporters may feel the squeeze. Other countries on the periphery of Europe, such as Portugal, Greece and even Spain are also feeling the pressure. There are concerns of a ‘two-speed Europe’. Below are some articles about the Irish crisis. Do a search and see if you can find any information on the problems in Greece, Spain or Portugal.
Ireland: a problem soon to be shared BBC News blogs, Stephanomics, Stephanie Flanders (30/9/10)
European recovery hope grows despite Ireland’s swelling deficit Guardian, Richard Wachman (30/9/10)
Ireland bank rescue spurs global debt concerns The World Today (ABC News), Peter Ryan (30/10/10)
Irish debt yields in new record despite better job data BBC News (28/9/10)
Euro Govt-bonds fall after overdone rally on Ireland, Spain Reuters (30/9/10)
Ireland’s love affair with masochism Telegraph, Jeremy Warner (30/9/10)
EU austerity drive country by country BBC News (30/9/10)
Anglo-Irish was ‘systemic threat’ BBC News (30/9/10)
Questions
- What do we mean by government borrowing?
- With such high levels of government debt, what would you expect to happen to interest rates on government debt? Explain your answer.
- When deciding whether or not to bail out the banks, what process could a government use?
- The Irish Finance Minister talks about the institutions becoming a ‘systemic threat’. What does he mean by this?
- Why might the UK economy suffer from the problems in Ireland?
- To what extent do you agree that there is a two-speed Europe, with the core economies, such as France and Germany making good economic progress, but the peripheral economies still suffering from the effects of recession?
- How might the situation in Ireland affect other members of Europe? Will there be an impact on the euro exchange rate?