Obamanomics offers just what Osborne needs

economy, taxation, US politics

Author(s):  Eric Beinhocker, Nick Pearce
Published date:  13 Mar 2012
Source:  The Times

Cutting 2p from national insurance will provide the jolt to escape the low-growth trap.

As we approach the Coalition’s third budget, Britain faces a big problem: how to break out of stagnation. While the prime minister and chancellor are in Washington this week they may seek some answers on that side of the Atlantic.

Last year, the US economy grew by 1.7 per cent versus 0.8 per cent in Britain. US employment grew 1.2 per cent while Britain lagged at 0.7 per cent. And US growth appears to be accelerating: it was 0.7 per cent in the final quarter of 2011 compared with a decline of 0.2 per cent for Britain.

An important reason why America is stronger is that President Obama has maintained his commitment to fiscal stimulus while the UK has focused on austerity. The biggest danger in the UK is not Greek-style default but Japanese-style stagnation. But even if the government won’t change its fiscal stance, there is something to learn from America.

The primary tool for US stimulus has been a payroll tax cut introduced in 2010 and recently extended with cross-party support through 2012. The cut reduced the rate of an employee’s contribution to social security from 6.2 to 4.2 per cent, putting $1,000 per year into families’ pockets. This has injected $92 billion a year of stimulus into the economy and US consumer spending increased by 2.2 per cent last year while it shrank by 0.8 per cent in Britain. One might think this extra spending was at the expense of debt reduction, but the reverse is true — US households have reduced debts by 11 per cent since the bubble burst as against only 5 per cent for Britain.

This combination of increasing consumption and reducing debt is the key to recovery. Businesses in Britain and around the world are sitting on record piles of cash: $2 trillion globally. But they won’t invest that cash and create jobs until they see the demand for their products and services rising. And squeezed consumers won’t create that demand until they have confidence they can spend a bit more and manage their debts.

Senior Tories and the CBI have called for cuts to business rates and others want to abolish the 50p top rate. But a cut to business rates won’t help if businesses are already sitting on piles of cash they won’t invest because of too little demand, and the 50p rate misses out most of the middle class.

A middle-class stimulus — roughly equivalent to Obama’s — would be a 2p cut in the employee share of national insurance (NI). This would immediately inject £7 billion per year of stimulus into the economy and would yield a further £2–4 billion of growth through the ‘multiplier effect’, lifting GDP 0.2–0.3 per cent per year. Most of the benefit of such a cut would go to squeezed middle-class families.

The question, of course, is how to pay for it. A 2008 OECD study of tax structures and growth points the way. The study shows property taxes to be the most growth-friendly way to raise revenue. An NI cut for the middle class could be paid for with a ‘mansion tax’. This would shift a share of the tax burden from income to property, thus providing a stimulus for growth and increasing tax efficiency.

A 2p NI cut would cost the Treasury around £5.5 billion per year (£7 billion in cuts less £1.5 billion in extra revenues from increased growth). A 1 per cent levy on houses valued over £2 million would likely bring in £1.7 billion per year — not enough to cover the NI cut in a single year.

But the NI cut could be run for two years and the mansion tax run for six. The cost to the Treasury would then be £11 billion for the two-year cut, offset by £10 billion from a six-year mansion tax. The remaining amount would probably be covered by higher revenues from growth as the effects of the stimulus would last beyond the two years of the cut.

The basic principle is sound: put money directly in the pockets of Britain’s squeezed middle and pay for it from those who benefited most from the housing boom. This is of course not all we need to do to return to growth, but we need a jolt to get us out of the low-growth, high-unemployment trap we are currently in.

 
 

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