Bill Jamieson: Cut taxes, keep spending? Old orthodoxy turned upside down

There comes a time when beliefs we held for a lifetime come to be discarded like a beloved but broken chair or a frayed old shirt. It’s never easy to part with things that have long been part of our lives.

Covid-19 has taken a wrecking ball to the economy. Picture: Getty/iStockphoto

Thus it is with economic orthodoxy in the face of this coronavirus pandemic – the economic wrecking ball that has smashed through jobs and livelihoods. It is blowing apart our notions of financial convention and “good sense” – ones to which we clung as eternal truths and golden rules.

Soaring debt and budget deficits surely required urgent corrective action. But tax increases? Spending cuts? The old orthodoxy that has prevailed at the Treasury for generations?

Quite the opposite would now seem more sensible: do not raise taxes, but cut them. Do not cut back on infrastructure spending but boost it where possible. Previous thinking needs more than temporary readjustment. For this is where old orthodoxy has come to die.

Latest Office for Budget Responsibility forecasts predict GDP falling by 35 per cent and unemployment hitting 10 per cent, while a leaked Treasury paper last week pondered hefty tax increases in the face of a £337 billion budget deficit this year and debt hitting 96 per cent of GDP.

Faced with this, the orthodox response looks utterly misplaced to the point of absurdity, like setting out to cut down forests with a rusty scythe.

Indeed, preparing to raise taxes when household finances have been poleaxed and consumer confidence has collapsed would almost certainly worsen the slump – and the budget deficit.

Coming to terms with the onset of this disaster in human terms is hard enough. But this is only part of a global picture, and these forecasts are predicated on a quick V-shaped recovery and return to normal which many economists now dispute.

Chancellor Rishi Sunak warned last week that the UK faced “a significant recession” – but this was the most genteel way of conveying to the public the onset of by far the worst slump in the modern era.

There is no reliable precedent on which the orthodoxists can fall back and counsel repetition. Spending was not cut in the immediate onset of the global financial crisis in 2010 but was increased with the introduction by then chancellor Alistair Darling of a $20bn fiscal stimulus. Vast sums were made available to the banking system.

Taxes were not raised but cut – with a temporary reduction in the standard rate of VAT from 17.5 per cent to 15 per cent at a cost of £12.4bn. With VAT now at 20 per cent, many households are discouraged from embarking on home improvements and extensions.

With consumer spending flat on its back and large swathes of the high street facing terminal closure, this is surely no time to be putting a check on consumer demand – even less so when tax revenues as a share of national income are already at their highest sustained level since the 1940s.

And financial circumstances have changed markedly over the past decade. Interest rates have fallen sharply, with the official Bank of England rate now down to 0.1 per cent.

Many might fall back on that famous quote of John Maynard Keynes – “When the facts change, I change my mind – what do you do, sir?” But there is more contemporary advice to hand, in the form of the prize lecture by Professor Olivier Blanchard to the American Economic Association last year, pointing out that “public debt may have no fiscal cost”, when economic growth rates can outstrip interest rates.

Thus, looking ahead, it is possible that the Bank of England will turn to more quantitative easing to enable the economy to grow its way out of the crisis.

The immediate concern is the predicament faced by many companies bent double under the weight of debt and which could put a brake on recovery. Policy options range from a long period of near-zero interest rates, through a stepped-up supply of cheap debt and equity, to a programme of debt forgiveness. Indeed, many smaller companies may require a full debt write-off if they are to have a chance of survival – solutions that in another era would have been unthinkable.

For the government the fiscal conundrum is not just how to deal with the deficit surge caused by the pandemic but at the same time to meet and sustain substantially higher spending on health and social care services. Even though the NHS is in need of reform after the exposure of management shortcomings during the crisis, voters will demand a substantial uplift in its annual budget to equip and prepare for any future pandemic.

Tough choices will still have to be made, ranging, for example, from a cutback in the international aid budget to save £7bn-£8bn a year to cancelling or postponing Phase 2 of HS2 – which hardly seems such a pressing priority now (if ever it did) given the massive increase in digital communication, home working and video conferencing.

What is becoming clear is a step change under way in the way we work – and the extra resources this will require. According to the Open University a quarter (24 per cent) of the UK workforce are learning new skills to mitigate against coronavirus uncertainty. As many as five million expect the pandemic to dramatically change their role – with course enrolments during the lockdown on The Open University’s OpenLearn platform now exceeding 950,000. It is urging organisations to harness this appetite for learning to adapt for the future and retain valuable talent.

This is just one example of how both educational and working environments are set to change in the wake of this devastating pandemic. But it will also compel changes in what has come to be regarded as “economic orthodoxy”. From previous assumptions about debt tolerance and policy responses to a massive economic downturn, we are in a world truly now turned upside down.