There\’s an interesting little economic theory out there. Sure, you can cut taxes in order to try and boost demand. But if people know that taxes will rise in the future to pay back the borrowing then they\’ll not spend the money, they\’ll save it. Save it to pay the future higher taxes.
Thus your tax cut doesn\’t in fact boost demand.
Now, there\’s a certain controversy over whether this actually holds. David Ricardo, who first considered it, thought it didn\’t and people have been arguing ever since.
But whether it does or it doesn\’t hold depends rather on what people believe. Is this a permanent tax cut? Or just a short term one which will have to be paid for?
Lord Mandelson, the new Business Secretary, said that there would need to be "a medium term adjustment some years ahead" to pay for a "fiscal stimulus" now to revive Britain\’s ailing economy.
His remarks were seized on by David Cameron, who warned that a tax "bombshell" was being stored up.
In a Commons exchange with Gordon Brown following the G20 summit in Washington, he told the Prime Minister that "discretionary borrowing now" would mean "higher taxes later."
The Tory leader said: "Isn\’t it the case that Labour\’s borrowing bombshell will soon become a tax bombshell? And let\’s be clear about what that means. Borrowing £30 billion now will mean an income tax bill for the average earner of nearly £1,500 later.
Oh, well done everybody. If you\’re going to remind everybody that these cuts will need to be paid for then you won\’t in fact get any boost to the economy from the tax cuts in the first place.
Don\’t these people that we hire to administer parts of the economy know any economics at all?