Chancellors should pay less lip service to golden rules, and more attention to the law of unintended consequences. Proof, if it were still needed, came in this week’s pre-Budget report.
While Alistair Darling was proudly declaring that “the government met both its fiscal rules over the last cycle” – as justification for increasing government debt to a record £1,000bn, or 57 per cent of national income, by 2012-13 – a more telling announcement was the temporary increase in the threshold for empty commercial property relief. One of Gordon Brown’s last acts as chancellor had been to restrict this relief, which exempted empty offices, industrial sites and warehouses from business rates, to discourage the retention of unused buildings at a time when demand outstripped supply. The intention was to encourage owners to renovate and re-let them. It had the opposite effect. Owners simply demolished their empty properties to avoid paying the tax, further restricting supply.
So it seems the levers of fiscal policy can be as unreliable as those on a bulldozer outside a rickety factory shed: pull the wrong one accidentally, and your premises start to look decidedly shaky.
Much of the manipulation in this week’s £20m economic stimulus package appears equally clumsy – employing not so much Adam Smith’s “invisible hand” of economic self-
interest, as Alistair Darling’s fat finger. This wouldn’t be the first time that tax changes had unintended consequences – the window tax of the 1700s simply diverted potential tax revenues into the pockets of stonemasons, and probably made those empty bricked-up buildings harder to knock down. But now is arguably the worst time to be deterring taxpayers and private investors from reinvigorating the economy.
Here are some of the pre-Budget non sequiturs.
● Cutting VAT to 15 per cent for 13 months. Economists and retailers have pointed out that a sign declaring “Sale: 2.5 per cent off!” is hardly going to get shoppers queuing up. Pedants have also pointed out that the cut only really equates to 2.13 per cent off shop prices. And my colleagues have printed out 20 per cent discount vouchers from a range of high street retailers without apparently turning into Woolworths-saving shopaholics. Even the claim that lower VAT on estate agents’ bills could get the housing market moving is spurious – on a £500,000 property, the average saving would be £250. Consequences: no increase in spending, higher business costs for reprogramming accounting software, reauditing and reprinting. ● Removing the personal allowance from those earning more than £100,000. The chancellor said this would end “the long- standing anomaly by which the personal allowance is worth twice as much to higher-rate than basic-rate taxpayers”. Then the Institute for Fiscal Studies (IFS) did the sums. Anyone with an income of more than £100,000 will see their personal allowance reduced by £1 for every £2 of income above £100,000, until the allowance is halved in value. But as each £1 of the allowance was worth 40p to a higher-rate taxpayer, an individual earning £100,001 will lose 20p as the allowance is reduced, and pay 40p tax on that £1. This effectively creates a 60 per cent rate for those earning between £100,000-£106,450. Consequences: six income tax rates, more payroll complexity, limited incentive to upgrade jobs, less taxable income declared, more charitable giving, lower tax revenues.
● Raising the higher-rate income tax threshold from £40,835 to £43,875 in 2009-10. Consulting firm Watson Wyatt calculates that middle income earners, on around £45,000 a year, now have a reason to maximise their pension contributions and get the higher-rate tax relief while they still can. Consequences: no incentive for Middle England to spend.
● Introducing a 45 per cent tax rate for income over £150,000, from 2011. PricewaterhouseCoopers, working on the assumption that pension tax relief will then be available at 45 per cent, says high earners are likely to defer their pension investments for the next two years. Consequences: less investment in the pension assets favoured by high earners – shares, commercial property, unlisted start-ups.
Of course, every fiscal lever moves in both directions. But would it not have been better to use tax incentives to encourage investment that will create new private sector jobs and businesses – such as the now largely abandoned venture capital trusts?
Robert K Merton, the US sociologist who identified the law of unintended consequences, concluded that one reason for them was paradoxical values: a work ethic “leads to its own decline through the accumulation of wealth and possessions”. But there is a danger that this pre-Budget report will fail to arrest decline, by encouraging us to hold on to what little wealth we’ve got left.
matthew.vincent@ft.com
