Calls for a simplified tax and benefit system have been ongoing and many see the Coalition’s plans for a Universal Credit as a step in the right direction. However, a second suggestion set out in a report by lobbying groups is to introduce a single rate of income tax at 30%. The argument is that it will simplify the system, help lower income earners and boost growth.
As well as the introduction of a single rate of income tax, The 2020 Tax Commission’s Report also suggests an increase in the personal allowance to £10,000; scrapping National Insurance Contributions, stamp duty, inheritance tax and air passenger duty, as well as cutting fuel duty by 5p. For the typical tax payer, it may sound great – the difference between your gross and your net pay would narrow, but the wider consequences must be considered. Although a single rate of income tax would undoubtedly simplify the system, the impact on government finances must be considered. The commission predicts that overall borrowing would fall by £35bn after 15 years, but that the national deficit would increase by £49.1bn in the first year. Perhaps not an ideal solution given the current state of the national deficit!
The report does contain some radical change, but the idea of simplification is well-recognised as a necessary principle of any tax system. As the Chairman of the Commission, Allister Heath said:
It is time for Britain to make a vital choice between tweaking the status quo and letting our economy continue to be crippled by complex and punitive taxes, and drastically changing course with a radical but realistic plan for a tax system fit for the 21st century.
The 2020 Tax Commission has set out that plan and would ensure that income is taxed once at a single, much more reasonable rate. It could create the conditions to establish the UK as a global trading hub, generating renewed prosperity for all those who live and work here.
The current system is complex and many people end up paying an extremely high rate of tax, once everything has been paid. The Guardian article below gives a nice illustration. “If you earn income from shares, first corporation tax is taken out of the profits. Then you pay taxes on the dividends. Then because those profits drive up the share price you pay capital gains tax as well.” With a simpler and fairer tax system, the Commission argues that it will boost the competitiveness of the UK economy and help boost its struggling growth rate. How many, if any, of these proposals will be incorporated into the government’s plans is anybody’s guess, but it definitely presents an interesting solution and problem.
Report
The Single Income Tax The 2020 Tax Commission (May 2012)
Articles
Why it’s time for a single income tax Guardian, Matthew Elliott (21/5/12)
Business backs income tax rate of 30% Financial Times, Martin Sandbu (21/5/12)
Calls for single 30% income tax rate BBC News (21/5/12)
Single 30% tax rate ‘essential’ for growth Sky News (21/5/12)
Osborne urged to introduce 30pc income tax for all The Telegraph, Tim Ross (20/5/12)
Tax shake-up urged to empower consumers and kickstart growth Independent, Russell Lynch (21/5/12)
The Tax Reform Britain needs Wall Street Journal, Matthew Sinclair (20/5/12)
Questions
- What are the key principles of a tax system?
- Explain why simplicity is so important when reforming a tax system. How can it affect the incentive to work?
- Would a 30% single rate of income tax be equitable?
- If the reforms set out in the report were to go ahead, what do you think would be the impact on goods and services provided by the government, such as the NHS, education, roads?
- Using indifference analysis, illustrate the effect of a cut in the basic rate of income tax. How does it affect the decision to work more or less? You should consider the income and substitution effects in your answer.
- Why does the report argue that the reforms they suggest would help boost growth?
- How might the proposals affect government finances in both the short and long term?
This has been a week of gloomy prognostications. On Wednesday 16 May, the Bank of England published its quarterly Inflation Report – and it makes worrying reading.
The forecast of UK economic growth for 2012 has been reduced from 1.2% in the previous report to 0.8%. But the rate of inflation is forecast to remain above the 2% target well into next year. However, at the two-year horizon, inflation is now forecast to be 1.6% – below the target, thus giving the MPC scope for further quantitative easing.
In the introduction to the report, the Governor, Mervyn King, writes:
Over the past year or so, two factors have hampered the recovery and rebalancing by more than expected. First, higher-than-expected world commodity and energy prices have squeezed real take-home pay, dampening consumption growth. Second, credit conditions, far from easing, have in some cases become tighter. The direct and indirect exposures of UK banks to the euro-area periphery have affected funding costs as the challenges of tackling the indebtedness and lack of competitiveness in those countries have intensified.
And at the news conference launching the report, he said:
We have been through a big global financial crisis, the biggest downturn in world output since the 1930s, the biggest banking crisis in this country’s history, the biggest fiscal deficit in our peace time history and our biggest trading partner – the euro area – is tearing itself apart without any obvious solution.
The idea that we could reasonably hope to sail serenely through this with growth close to the long run average and inflation at 2% strikes me as wholly unrealistic. We’re bound to be buffeted by this and affected by it.
The following articles look at the Bank of England’s predictions and at the challenges facing the UK economy as the crisis in the eurozone deepens and as inflation in the UK remains stubbornly above target. They also look at the issue of the extent to which capacity has been lost as a result of the continuing weakness of the UK economy. As The Economist article states:
Business surveys suggest only a small proportion of firms are operating below capacity. That finding looks odd given the economy’s output is still 4% below its level at the start of 2008, and is much farther below the level it would have reached if GDP growth had continued at its long-term rate. The picture painted by surveys could be right if a chunk of the economy’s potential has been written off for good. But Sir Mervyn King, the bank’s governor, doubts this. There is “no obvious reason” why the economy could not rejoin its pre-crisis path, though it might take a decade or two to get there, he said on May 16th.
We look in more detail at the question of lost capacity in Part 2.
Articles
Bank of England cuts growth forecasts: Sir Mervyn King’s speech in full The Telegraph (16/5/12)
Bank of England sees inflation up and growth falling Independent, Ben Chu (17/5/12)
Hard going The Economist (19/5/12)
Bank of England optimism dented again Financial Times, Chris Giles (16/5/12)
Eurozone is ‘tearing itself apart’, says Mervyn King. True, but the UK’s problems are as intractable as ever The Telegraph, Philip Aldrick (16/5/12)
Inflation Report
Inflation Report: portal page Bank of England
Inflation Report: May 2012 Bank of England (16/5/12)
Additional Data
Statistical annex to European Economy. Spring 2012 European Commission, Economic and Financial AffairsAnnual macro-economic database European Commission, Economic and Financial Affairs (11/5/12) (see particularly section 6.5)
Forecasts for the UK economy HM Treasury
Questions
- What explanations are given for the rate of CPI inflation remaining persistently above the 2% target?
- Why have the prospects for economic growth worsened since the publication of the February Inflation Report?
- How might it be possible to have a narrowing (negative) output gap and yet a stagnant economy?
- Why may capacity have been lost since the financial crisis of 2008?
- Why has M4 declined despite the programme of quantitative easing? (See M4 in record fall despite QE.)
- What scope is there for monetary policy in achieving faster economic growth without pushing inflation above the 2% target?
Weather has already been partly blamed for poor economic growth, in particular in December 2010 and January 2011. April 2012 is no different – the wettest April on record is said to have caused the worst performance in sales since March 2011.
Like-for-like sales fell by 3.3%, mainly through lower demand for clothes and shoes. Supermarkets saw an increased demand for warmer food items with the colder weather and demand for home products also increased, with analysts suggesting that people decided to re-decorate their houses rather than venture outside! This was further supported by sales of gardening equipment, which also fell. However, the weather is not always bad – in March, sales were higher than expected, with the unusually warm weather, but unfortunately for growth statistics, the boost in sales in March has been more than offset by the decline in sales in April. Furthermore, there are concerns that the March ‘heat-wave’ may have encouraged consumers to do their summer shopping already and hence summer sales may suffer.
The retail data for April 2012 must be considered carefully, as comparing this month’s sales with the same period last year will be very misleading. Last April, the UK was hit with the Royal Wedding, which did boost sales of many products – underlying sales growth was recorded at 5.2% for the month. However, whilst April sales for 2012 could hardly hope to compete with April sales for 2011, the downward trend is undoubtedly going to cause concern for the government. Helen Dickinson, Head of Retail at KPMG said:
“While May will certainly be brighter than April, the health of the retail sector continues on a downward trajectory.”
Whether or not sales do continue their downward trend depends on many factors, including government policy measures to boost growth and cut unemployment. However, one other variable that may influence the trend is the weather. Here’s hoping that the sun shines and people begin to spend!
Weaker retail sales, job surveys raise risk of longer slump Reuters, Olesya Dmitracova (9/5/12)
Wettest April ‘hits retail sales’ BBC News (9/5/12)
Retail sales slide in wettest April on record Telegraph (9/5/12)
April showers wash out retail sales Financial Times, Sarah O’Connor (9/5/12)
Retail sales slip back 1 per cent as fashion stores weather April showers Independent, James Thompson (9/5/12)
Questions
- Use a demand and supply diagram to illustrate the effects of the weather on equilibrium price and output.
- What other factors besides the weather affect retail sales?
- What government policy measures could be implemented to try to boost the retail sector?
- From the information you are told are there any sectors that surprise you in terms of whether sales have risen or fallen? Explain your answer in each case.
- With sales in April falling, what is the implication for a firm’s profits? What steps might a firm take in a bid to boost sales?
Australia was one of the few economies that seemed to be somewhat insulated from the 2008/09 recession and credit crunch. However, with the UK now back in recession and global economic conditions worsening in much of Europe, Australia has now joined the list of countries that are experiencing economic conditions that are ‘weaker than forecast’.
Today’s world involves economies that are increasingly interdependent, hence the spread of the world economic slowdown. As such, with weak global demand, Australia has started to feel the effects, with demand for its goods and raw materials falling. This has led Australia’s central bank – the Reserve Bank of Australia – to cut its key interest rate (the ‘cash rate’) by more than expected. The rate had been at 4.25% and it was widely believed that a 0.25 percentage point cut would occur. However, the central bank cut the cash rate rate to 3.75% to counter the weakening conditions. The Reserve Bank said:
“This decision is based on information received over the past few months that suggests that economic conditions have been somewhat weaker than expected, while inflation has moderated …Growth in the world economy slowed in the second half of 2011, and is likely to continue at a below-trend pace this year.”
Banks’ interest rates have been falling in Australia for the past few months and this latest cut will do much to help financially squeezed households. Data show that Australian house sales have fallen, as have house prices, and retail sales have fared little better.
Lower interest rates are often a tool used to steer inflation and the Australian central bank may not have been as willing to cut rates had the inflation rate not come down in recent months. Keeping consumer prices under control remains a top priority for the central bank and so it will be interesting to see the impact that these rate cuts will have on the Australian economy.
Articles
Australia cenbank surprises with aggressive half point rate cut Reuters, Wayne Cole (1/5/12)
Australia cuts rates by than forecast to 3.75% BBC News (1/5/12)
Banks unlikely to pass on full rate cut The Australian, Wall Street Journal, Peter Trute (1/5/12)
Australia cuts rate to support economy Financial Times, Neil Hume (1/5/12)
Australia slashes interest rates by 0.5pc to boost economy The Telegraph (1/5/12)
Australia cuts interest rates as economy slows Guardian, Phillip Inman (1/5/12)
Banks must pass on rate cut: businesses Sydney Morning Herald, Ehssan Veiszadeh (1/5/12)
Bond prices rally after rate cut Sydney Morning Herald (1/5/12)
Surplus remains appropriate: Swan Sydney Morning Herald, Colin Brinsden (1/5/12)
Webcasts
Reserve Bank of Australia Cuts Rates by 50 Basis Points to 3.75% CNBC video, Lauren Rosborough (1/5/12)
Further `Modest’ RBA Easing Possible, ANZ Says Bloomberg, Tony Morriss (1/5/12)
Australia’s central bank shifts focus to growth BBC News, Duncan Kennedy (1/5/12)
Questions
- Which factors will a central bank consider when setting interest rates?
- Explain the components of aggregate demand that will be affected by a lower rate of interest.
- Using diagrams to illustrate the process, explain both the interest-rate and the exchange-rate transmission mechanisms of the fall in interest rates.
- How are interest rates used to target inflation?
- How will lower rates of interest help the Australian economy recover from weakening global economic conditions?
- Why are Australia’s banks unlikely to pass on the full rate cut to consumers?
- Why did bond prices rise and the Australian dollar depreciate after the rate cut? Why does this suggest that a 0.5% cut was greater than anticpated by markets?
How much value do you place on that wonderful long weekend that a Bank holiday brings? The extra lie in; the ensuing 4 day week; the time you spend with your family. Some would say it’s invaluable – you can’t put a price on it. But those some people would not be economists! Each Bank holiday is worth about £2bn – at least that’s how much it costs the economy.
According to the Centre for Economics and Business Research, if the UK got rid of its Bank holidays, GDP would increase by approximately £18bn.
Some businesses will do well out the Bank holidays, but according to the research, the sectors of the economy that suffer are far greater, causing losses in productivity and hence in GDP. Indeed, the extra Bank Holiday we had last year for the Royal Wedding is thought to have been part of the cause for the slow down in growth to 0.1% during the second quarter of 2011.
Based on this data, there are unsurprisingly concerns that the extra Bank holiday this year for the Queen’s Diamond Jubilee could also cost the economy. Not particularly good news, considering how vulnerable the economy currently is. Although the Queen’s Diamond Jubilee will undoubtedly generate huge amounts of spending, it is thought that this will be more than offset by the sectors that are expected to lose out because of the loss in working hours and hence productivity.
Given the cost of Bank holidays to the economy, the CEBR says that they should be spread more evenly throughout the year. Is this the solution &ndash if one is needed – or should they be abolished altogether! The following articles consider the issue.
Do we really need bank holidays? Asks CEBR Telegraph, Emily Gosden (30/10/11)
Bank holidays ‘cost economy £18bn’ Independent, John Fahey (9/4/12)
Bank holiday costs UK economy £2.3bn Sky News, Tadhg Enright (9/4/12)
Bank holidays ‘cost economy £19bn’ BBC News (9/4/12)
Bank holidays cost UK economy £18bn and ‘should be spread out’ Mail Online (9/4/12)
Questions
- How could we use marginal utility theory to measure the ‘value’ of a Bank holiday?
- Which sectors will generally benefit from Bank holidays?
- Which areas of the economy are likely to contribute towards lost output because of a Bank holiday?
- Why does CEBR suggest that spreading out Bank holidays more evenly across the year would be less costly for economic growth?
- How can the value of lost output during one day be calculated?
- Does a Bank holiday add to somebody’s well-being? How could we measure this?
