Nice try from Janet Daly here but no cigar

I can remember arguing with a very distinguished economist that the tax burden on the poor should be reduced. He accepted that this might be morally desirable but he was adamant that it would have no affect on the wider economy because, he said, the poor do not spend enough to have an impact on overall economic activity. If you want to pull the country out of recession, he said, you must cut taxes for the better off. They are the ones whose consumption will make a difference.

So it may help the Tory image to say that they have halved income tax for the lowest paid, but it is unlikely to do anything to aid recovery. It is those who earn between about £40,000 and £60,000 per year whose decisions about whether to buy a new car or build an extension on the house will be immediately affected by a sudden increase in their take-home pay. They are the spending classes who buy goods and invest in services in large enough numbers to result directly in the growth of businesses and the creation of jobs.
Much as
it would be lovely to believe it I\’m afraid that I don\’t. If stimulus there is to be it should indeed be going to the poor: or, indeed, to everyone. As Keynes himself was known to have said:

I am converted to your proposal…for varying rates of contributions in good and bad times. (June 16, 1942). Keynes, Collected Writings, vol. 27, p. 208.

…[Y]ou are able to show fluctuations in income of an order of magnitude which is significant in the context… So far as employees are concerned, reductions in contributions are more likely to lead to increased expenditure as compared with saving than a reduction in income tax would, and are free from the objection to a reduction in income tax that the wealthier classes would benefit disproportionately. At the same time, the reduction to employers, operating as a mitigation of the costs of production, will come in particularly helpfully in bad times. (July 1, 1942). Keynes, Collected Writings, vol. 27, p. 218.

Given that there is indeed a cap on employee contributions this is a nicely targetted tax cut. Everyone in work gets it (even those working part time on minimum wage) and no one making over about twice median wage gets any more of it. It\’s also stunningly fast to implement. The effects would be felt within 45 days of chaging the rates as money failed to be extracted from pay packets.

And we also avoid what is my greatest criticism of naive Keynesianism. That the solution to any ill could possibly be giving Ed Balls more of our money to spend. Which leads to, even if the fiscal stimulus argument does work, OK, let\’s do it quickly, by leaving more money fructifying in the pockets of the populace.

The only problem with this proposal is politics of course. The aim of going into politics is not to enable the populace to do more of what they want to do. It\’s to force them to do more of what you want them to do. So a policy of leaving them with more of their own money will not attract as much as one allowing you to spend more of their money. There\’s an asymmetric incentive there sadly.

9 comments on “Nice try from Janet Daly here but no cigar

  1. Nad of course, the legendary “marginal propensity to consume” for “the poor” is approximately 1. :)

  2. I am not so sure. I am dubious about anything Keynes has to say but let’s assume that it is unfair to write everything he says off. Then we should recognise that he was writing in the immediate post-Victorian era. A very innocent time as far as tax policy goes. Taxes were low over all. So I am sure when taxes are not that significant, giving more money to the poor is a good idea.

    However consider a situation where the poor pay 10% and the rich pay 90%. Is it still true that a cut to the poor’s income tax rate is going to have a better impact on the economy than a cut to the wealthy’s?

    The question is where Britain lies in this. I don’t think taxes are so high that a cut to the rich will have the best impact – but they may have been in the 1970s. Certainly there are some countries where that would be true.

  3. On that basis, wouldn’t it have been better to have given all the QE and Funding For Lending money to us rather than the banks?

  4. Well, Keynesianism is bollocks. But if we ignore that for the moment, we come back to the MPC. A rich man may be paying more tax, but if he weren’t taxed, he probably wouldn’t rush out and “consume” the money. Whereas a poor man almost certainly will. It’s specifically about increasing consumption, this.

  5. On that basis, wouldn’t it have been better to have given all the QE and Funding For Lending money to us rather than the banks?

    Yes, but they never do. Hence Milton Friedman’s wry observation that “they don’t drop it out of helicopters”.

  6. The problem with all discussions of tax policy in the media and political world is that it begins from the point of view that spending cannot be reduced much if at all. Too many five year plans to stick to and lobby groups to please.

    From there any talk of cutting taxes for one section of society or another, or everyone, always has a cost to it – either the low paid benefit and others lose out or the other way around, or we all lose out in the long run through paying for the tax cut with borrowed money.

  7. Clearly, taking a pound less from the populace leaves them with a pound more to spend. That the rich will buy cars and the poor will buy baked beans affects which part of the economy is most stimulated, but the overall effect is the same. And quite apart from the obvious moral issue, raising the tax free allowance together with the lower threshold for NI will reduce the number needing to be taxed- and hence the cost of collecting it.

  8. I’m not sure this is all as simple as people like to suggest. Altering tax rates doesn’t necessarily just equate to £1 more in someones wallet is £1 more they will spend.

    Take a couple of cases. My Dad would, if he worked all year round earn well over the higher rate tax threshold. In practice, he decided he can’t be bothered working for the government to waste 40%, so he earns just enough a year (after allowing for considerable charitable giving, which is effectively pre-tax) to not remove mum’s child benefit – and then goes on “holiday” for a month or two till the next financial year. He doesn’t really need the money, and the fact that the government ends up with over half by the time he’s paid income tax, Nics and VAT is the final straw.

    Move the higher rate tax threshold up some, and he would probably work more every year.

    Then consider me – I earn far less than he does, doing specialized industrial fabrications (He writes computer software at a very senior level). I currently earn about what I spend a year – and any extra I get goes straight on the mortgage overpayment (which effectively is much the same as me adding to my savings in terms of it’s medium term effect on the banking system).
    I don’t clock in a lot of overtime at “proper” work, because the marginal tax effect doesn’t make it worth the effort – at the moment I could book 20 hours overtime a week if I wanted it.

    Instead, I work weekends moonlighting for two or three other firms freelance, where I can knock my costs off against tax (obviously it’s totally unheard of and immoral for payment for such work to be by brown envelopes which the tax man doesn’t get to see inside).

    Cutting my marginal tax rate on overtime would have a massive effect on who I worked for (and by implication the chancellor would probably be the winner rather than loser) – but the probably the upshot would either be I’d book less total hours or my “savings”(i.e. mortgage overpayment) rate would increase – neither of which sounds likely to help the economy much.

  9. “Well, Keynesianism is bollocks.” Very possibly, but yer Worstall is discussing what Keynes actually said, which is a horse of a different colour.

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