Size matters. But as we approach George Osborne’s Budget on March 21, Britain appears to have lost the ability to distinguish big from small.
Political games are being played over ideas ranging from income and wealth taxes to employment legislation.
But can any of these ideas actually make a material difference to medium-term growth and the supply side of the UK economy? This is a difficult question, but I have a simple method I call the “King jobs test” to sort sheep from goats.
The name arises because I am indebted to Sir Mervyn King, governor of the Bank of England, for its invention. As a young researcher, I spent a lot of time estimating the effects of tax and benefit changes on employment and I was particularly pleased by the positive effects we had simulated for one of the early 1990s reforms to family credit.
But when we presented the work to Mr King, then BoE chief economist, he dismissed the results as the equivalent of one good month of unemployment data.
At the time, his comment seemed to crush the value of about two years’ work. But in a liberating moment some time later, I realised he was right.
The King jobs test is an incredibly easy hurdle to clear. All it requires is for a policy to distinguish itself from the monthly 50,000 or so rises or falls in the number of people unemployed. To be worthy of serious debate, proposed policies must do better than that. The important question is whether they clear the hurdle.
Austerity, the chancellor made clear on Tuesday, will continue as planned, telling manufacturers that “the days of unfunded giveaways are over”. This is big: Treasury figures show the government is planning £15bn of new spending cuts and £3bn of new tax rises in 2012-13, amounting to a fiscal tightening of 1.1 per cent of national income. (Although this is not quite as big as the squeeze Britain endured this year or in 2010-11.)
The scale of the planned cuts must be remembered when evaluating new policy ideas. The net effect of the measures being discussed around Westminster will make almost no difference to overall demand.
In the Budget, the most likely tax change is an increase in the income tax personal allowance from the proposed 2012-13 level of £8,105 to a figure closer to the coalition’s £10,000 target. This target will probably be met in full in 2013-14.
If Mr Osborne raised the allowance to £9,000, the same size of increase he announced last year, the change would cost the exchequer around £1.8bn a year and increase the monthly take-home pay of most taxpayers by a not-so-princely sum of £15. Few tax changes spread over 30m people go far.
Even though the 2010 Liberal Democrat manifesto is right to say that such a move “provide[s] an incentive to work and save,” that incentive is of an order of magnitude smaller than those I studied in the 1990s which had such a pitiful effects. The Lib Dems might boast that this is their signature achievement of government, but it will only make the history books if the authors lack basic numeracy. The King jobs test is failed.
On the Tory right, little stirs passions as much as the prospect of cutting employment rights along the lines suggested by the Beecroft report. Would it boost growth? Probably, but with Britain’s already loose employment protection laws and a high employment rate, not by much.
Giving evidence to parliament last month, Sir Mervyn applied a version of his test to these proposals. “This is not itself likely to change our view substantially about the size of the output gap or the amount of spare capacity,” he said. If the BoE is not bothered, Beecroft gets chalked up as another fail.
The vexed issue of the 50p income tax rate also prompts vocal opponents to claim the economy would be much stronger after its abolition. There is no doubt that without the rate, people paying 50p tax would be richer and the living standards of the top 1 per cent would rise. But in a fiscally-neutral setting, there is precious little evidence to suggest higher top-end inequality boosts growth. We experienced it throughout the noughties, a decade unlikely to be remembered for its economic triumphs. There is little to suggest a pass mark here either.
The same logic applies to proposals for softening the blow of child benefit removal from richer families in 2013 or for the so-called mansion tax. Each creates some big winners and losers, but the wider economic and fiscal effects are almost certainly tiny. Judging by its response to jobs packages in the last Budget and in the Autumn Statement, the Office for Budget Responsibility will agree and leave economic forecasts unchanged.
So, as Budget day approaches, enjoy the politics and the speculation. Cheer if you are lucky enough to be a winner. But resist attributing a wider economic significance to your good fortune. The King jobs test suggests it is most unlikely to be true.