Dan Lewis: Why tax cuts could bring a benefit to Britain

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WHAT a relief for mortgage-holders and cash-starved small businesses. As of noon yesterday, the Monetary Policy Committee agreed to keep the key rate at 0.5 per cent and the quantitative easing programme unchanged at £200bn.

There’s no serious doubt that the monetary hawks of the MPC have been perplexed by the weakness of the recovery over the last few months. And not least by the recently departed überhawk, Andrew Sentance.

Britain’s negative growth of -0.5 per cent in the final quarter of 2010 was atrocious. When it was subsequently downgraded to -0.6 per cent, that was abysmal.

Now we have – not unlike in late 2008 – an oil price surge, a faltering economy and some members of the MPC believing that inflation is the primary problem.

The trouble is that the UK’s inflation problem is highly unconventional. If you look at the inflationary inputs, they are not inflationary wage spirals. They are external shocks – oil prices, VAT rises and now food.

It’s not quite true to say that raising interest rates will have next to no influence on these – a higher pound from higher interest rates will reduce the import bill of commodities.

Unfortunately, higher interest rates will also raise the cost of borrowing for the rest of us. And one must also surmise that if we had had a higher pound over the last year, UK manufacturing would not be growing at its fastest rate in 16 years with exports rising to £25bn.

Nor should we overlook that the closest most Brits gets to a 0.5 per cent interest rate is either on their savings account or what they read in the newspaper.

For the vast majority, the real interest rate is a great deal more, and with inflation at four per cent, they are getting poorer. Clydesdale and Yorkshire Banks are currently offering a two-year fixed rate mortgage of 3.49 per cent. And small businesses are finding it very hard to get working finance.

One entrepreneur friend I know has had a lot of trouble with late payments by suppliers. The bank won’t give him a measly £1,000 overdraft at £100 a year, but they are very happy for him to cover the shortfalls to the tune of several thousand on his credit cards at around 15 per cent per annum.

But I don’t want to bash the banks too much. We forget that they are not there to help us but to make money for themselves. We are where we are and should instead look to new ways to stimulate cost-effective lending for both sides, like peer-to-peer services and increasing competition and innovation in financial services which thanks to government and EU regulation, is stalling.

It is, though, the political macro-economic backdrop that troubles me deeply. Before the election, the Tories made a big deal about the spending getting so out of control the UK was heading for bankruptcy.

Granted, it was too much but it was nothing like that bad. What actually happened was that tax revenues collapsed. Countries that were heading for bankruptcy like Greece were paying a huge premium on their bonds as measured by Credit Default Swaps but the UK was paying a small premium above Germany and was really quite safe.

The rhetoric, though, was so effective that the Conservatives inadvertently made it impossible to talk about tax cuts. In fact, they even now think there’s something macho about raising taxes.

Meanwhile, Labour got and continues to get it wrong too. There is an argument for very occasionally, government spending increasing aggregate demand. But we are not in such a situation, especially if the cuts haven’t even started which they haven’t.

If you want to boost demand quickly, tax cuts transfer far more rapidly into the system. The tax revenues they enjoyed for the last 15 years boosted by a property bubble and foreign direct investment are not coming back. Labour needs to grow up and get real about achieving more services with less revenue.

And so to pensions. Somehow, we in the UK have become a society that works for its assets like mortgages rather than owning assets like pensions that work for us. Iain Duncan Smith’s simplification of pensions is to be welcomed. Yesterday’s Hutton report was another step in the right direction, with John Hutton, the former Labour minister, suggesting that six million public sector workers would have to retire later and pay more for a less generous scheme. The money is just not there.

Sadly, as our population ages and our tax base erodes, there will have to be many more unpopular long-term decisions along these lines.

Dan Lewis is chief executive of the Economic Policy Centre. www.economicpolicycentre.com