A stimulus Osborne can live with
Next Wednesday's Budget will be yet another reminder of the tough economic climate we're in. Over the past year, real GDP has increased by just 0.8 per cent, and forecasts for 2012 are not looking any better.
George Osborne will deliver his Budget against a backdrop of anaemic growth, high inflation, and unemployment rates not seen for 17 years. Consequently, he is under pressure to announce another Budget for growth. Expect Osborne to point to a previously announced cut in corporation tax to 25 per cent from April.
But one has to question if this is the best way forward, or if the Chancellor has got it the wrong way around. Sluggish growth has primarily been a result of both weak demand and squeezed household incomes. And the barrier facing companies is not high taxes but the uncertain outlook for demand. Given this uncertainty, companies are currently making a choice not to invest, or recruit employees - in effect intensifying the problem. An alternative and targeted solution would be to increase public spending, directly addressing faltering demand.
According to OBR analysis the effects of a change in spend are estimated to be two to three times greater than the effects of changes in taxation (although it focused on changes in personal tax rates rather than corporation tax). Increased public spending has a greater multiplier effect on the economy because more of the money goes straight into the UK economy, whereas cutting taxes can simply lead to people saving more and when they spend a substantial proportion of the stimulus is 'lost' overseas in the form of higher imports.
The best way to stimulate growth is to increase infrastructure spending. This would give the economy the kick it needs, boosting demand. Additionally, the benefits extend to the long term as infrastructure spending not only increases growth but adds to the UK's productive capacity. Yet there is no sign that the Chancellor will drop his rigid austerity agenda despite its poor track record - over 2.67 million people out of work - and waning support.
So what's the second best option given Osborne's unwavering political commitment to spending cuts? Personal tax cuts offer an alternative - and quick - method of boosting demand and a number of options exist. Temporary cuts in VAT or the National Insurance contribution would both serve to put more money directly into people's pockets, boosting demand and encouraging businesses to invest and create the jobs we desperately need. This could be largely paid for - over a six-year period - with a "mansion tax", which would hit only the very wealthy and so have little impact on the economy.
The economy is flatlining. To get the economy back up to speed we require measures that address the root of the problem - weak demand. While higher public spending offers the most 'bang for your buck' it is unlikely to happen. The next best thing would be to use temporary personal tax cuts to increase consumer demand.