Kwarteng's plan might have failed because his hopes for the economy clashed with a major insititution's policy. Photo / AP
Kwarteng's plan might have failed because his hopes for the economy clashed with a major insititution's policy. Photo / AP
Opinion
OPINION:
UK PM Liz Truss and her fired finance minister Kwasi Kwarteng have become a morality tale: Cut the top rate of tax and the markets will destroy you. But is that the moral of the story?
Truss wanted to increase growth. Despite North Sea oil, the UK economy from1955 until 2022 has been growing at an average of 0.56 per cent. The British are becoming relatively poorer.
The British government is slashing the EC red tape that choked enterprise.
The UK government still takes 51.6 per cent of GDP. Kwarteng's solution was to promote growth by slashing taxes. A bigger economy would reduce the government's share of GDP.
Kwarteng's plan might have failed because his hopes for the economy clashed with a major insititution's policy. Photo / AP
His plan failed because his policies clashed with the Bank of England's policy to defeat inflation and interest rate rises. Stimulatory fiscal policy means higher interest rates for longer. The market immediately priced in higher interest rates. Within days Britain was paying more money to borrow than Greece.
Truss and Kwarteng are not wrong in thinking the government taking over half of everything produced in the UK is hurting the British economy.
Thanks to huge sacrifices in a Chinese experiment we know what happens when the government takes everything, people stop working. The result is famine. Thirty million Chinese starved to death in the Great Leap Forward.
Taxation does not only affect the incentive to be productive, it is costly. It costs money to collect tax. We have to fill out forms, keep records and hire accountants, just to pay tax. It is called the dead weight of tax. The greater share of GDP collected, the higher the cost. There comes a point when even if the rates of tax are increased it is so damaging to the economy the total revenue from taxation cannot increase. Tax rate increases can result in less revenue.
We have world-leading research in New Zealand on what the dead weight of tax is and the point that rate of tax becomes counterproductive.
In the 1990s IRD commissioned some world-leading economists. They accepted because IRD gave access to the tax department's data. The economists were asked: "What is New Zealand's dead weight of tax?" "What percentage of GDP can the government take before it affects the economy's ability to pay?"
The government was at that time taking 34 per cent of GDP. Dr Sully and Dr Knox Lovell found the dead weight of tax was not 8 cents as Treasury thought but for every extra dollar of tax the cost was a staggering, $2.64. Their modelling indicated once the government was taking 20 per cent of GDP any further taxation reduced the economy's ability to pay.
The Treasury hired an Australian economist, Ted Sieper, to review the research and disprove it. Sieper did his review and found that once government was collecting 15 per cent of GDP any further tax was counterproductive. Treasury's response was to close down the project and ignore the results.
The damage being done to the UK economy by the dead weight of taxes has got to be enormous. It must be a reason for Britain's low growth rate.
It is likely that Kwanteng's lower tax rates would have raised more revenue than Treasury's forecasts. When the Lange government reduced the top rate of tax from 66 cents to 33 cents the new top rate raised far more revenue than Treasury's model predicted. The projections of the Office of the Budget are never right. In part because the models fail to predict how incentives change behaviour.
The British economy is suffering from a more deadly threat than low growth and inflation. IMF Managing Director Kristalina Georgieva said last week "fiscal policy must work with, not against, monetary policy. To avoid stoking inflation, any new spending must be offset by savings or new revenue."
To be credible Truss and Kwanteng had to cut spending which they ruled out. The monopoly Soviet-style National Health System, that the British are so proud of, is an inefficient money-sucking monster. The demand for free services is infinite. Governments must adopt the ideas of reformers like New Zealand's Professor Robert McCulloch and Sir Roger Douglas and create patients' health accounts. Then we will be incentivised to manage our health costs. Otherwise rising health costs will destroy our economies.
No country can afford to have government spending over 30 per cent of GDP. In New Zealand government's share of GDP has risen from 35.64 per cent under Bill English to 42.94 per cent last year. Treasury predicts this will fall but, as we have noted, treasury predictions are rarely correct.
If he had announced a programme to reduce government spending so the tax reductions were neutral the market and the economy would have rewarded him. This is the real lesson of the Liz/Kwasi morality tale.
Is either Labour or National listening?
• Richard Prebble is a former leader of the Act Party and a former member of the Labour Party.
