THE TAX THAT DARE NOT SPEAK ITS NAME

 

I wrote the article below in March 2021 and everything I predicted in relation to inflation in 2022-23 has come true. Do have a read!

This is not an easy time to be in government. “Damned if he does, damned if he doesn’t” is the ineluctable dilemma for the Chancellor trying to navigate the public finances as we emerge from the pandemic and survey the economic fallout. This article is not an attempt to analyse the measures the Chancellor has adopted – although I obviously welcome the help he has provided to the hospitality industry and its related sectors. Rather, I want to offer a brief thought-piece on where this leads us.

Firstly, let’s look at debt and deficit. The TV and newspaper pundits have been busy telling us that the debt the government has incurred to support people and businesses during the pandemic will all have to be paid back, that higher tax will be needed to “pay back the borrowing sooner or later”. This is economic nonsense and a missed opportunity by the MSM to educate the public about the difference between private debt (households/individuals) and public debt (money owed by a state).

There are two consequential differences between private and public debt. Firstly, most people settle their debts in their lifetime, or upon their death – either they have the assets needed to do so upon their demise, or they don’t and it’s written-off. But a nation state doesn’t have a natural end, in theory it continues in perpetuity.

Secondly, individual borrowing is limited by the individual’s ability to repay the loan. That is not the limiting factor for government. For fifty years successive British governments have not repaid debt. Government’s deal with debt in three ways: they roll it over (old loans are repaid by taking out new ones); they inflate it away so that it falls in real terms while remaining the same in nominal terms; or they monetise debt – the central bank creates digital money out of nothing to retrieve debt from the private banking sector so that it is held by the government’s own bank, thus reducing interest charges. This is called “quantitative easing” (QE).

So, what limits the government’s ability to borrow money is not its ability to repay debt, but its ability to service the stock of debt it owns. In other words, interest payments. Tax rises – both the obvious ones and the disguised ones – will be needed for two purposes: to pay interest on our national debt, and to control inflation. The Chancellor has rightly expressed concern about our ongoing ability to service our stock of debt – currently at approximately £2.2 trillion. Which is why we have seen so much QE. The Bank of England will soon hold fifty percent of the government’s stock of debt. If you owe a large amount of money to a bank you own – do you actually owe that money in any real sense at all? An essay question for ‘A level’ economics students, perhaps.

But as well as servicing our stock of debt, tax rises will be needed to control inflation. It may seem counter-intuitive to talk of inflation in the context of the biggest recession this country has experienced for three hundred years, but I think it is what we will see in 12 to 18 months’ time. The old adage “There’s no survival in the long-term if we don’t survive the short-term” was the Chancellor’s dilemma. This was a budget to get us through the short-term – and the fear was immediate tax increases would strangle the economic recovery. The Chancellor has made the right decision in putting them off. But putting them off will have consequences.

An economist might define inflation thus: “Inflation is where an increase in the units of money is needed to facilitate the same volume of transactions”. We have seen a vast expansion of broad money aggregates over the last year – with the government’s annual budget deficit rising to £394 billion – that equates to 17 per cent of our national income in one year. This was the right thing to do – people and businesses can’t survive on thin air in a government-mandated lockdown. But such a vast increase in broad money happening in the context of a 9.9% fall in GDP are the classic ingredients of inflation. And here is the problem for the Chancellor: there are time lags between excessive monetary stimulation and the inflationary response – typically around 12 to 18 months. When the Chancellor’s tax rises do kick-in a certain level of inflation will have been baked-in by not acting now.

The government must decide how much stock of debt it can afford to service. The inflation level in 12 months’ time will be a measure of how much they’re not prepared to service. Inflation is a disguised form of tax increase. If government raises taxes consumers have less money to spend. If instead they allow inflation to rise, then consumers have the same nominal amount of money to spend but it will buy them less. The outcome is the same.

The OBR’s budget forecast is that inflation will remain within the two percent target for the next five years. When that turns out to be wrong the Bank of England will invoke the myth of cost-push inflation and say it was down to factors beyond their control. Inflation is the tax that dare not speak its name.

For the trade, the focus must be on the short term – getting open with as few restrictions as possible. The unintended consequences of short-termism will become the next set of problems the government and the trade have to solve.