Fiscal Policy

Ricardo Rules OK?

This week’s newspaper headlines have been dominated by the £2.7 bn tax bribe (whoops .... tax adjustment) announced by the embattled Chancellor Alastair Darling to compensate for the fiasco over the abolition of the 10% starting rate of income tax. The FT this morning linked the economic effects of this tax cut to one of the most celebrated and controversial ideas of moden macroeconomics - Ricardian equivalence theory ..... how sexy does macroeconomics get!

Stabilising demand - will the tax rebate work?

It is an interesting case study in how to stabilise demand and output at a time when consumer confidence is declining and the domestic economy has been hit by a sharp negative shock emanating from the housing market. The fiscal rebates will soon be landing in the post boxes of millions of US households ... the key question is how much of a temporary stimulus will this provide for the economy? The Financial Times has a good article on this today.

“The difference depends on how much of the rebate package will be spent and how much will go on imported goods. It is also related to the time-frame over which it is spent, and whether this expenditure will, in turn, trigger knock-on spending ..... In effect the government will nationalise part of US household debt – socialising some of the costs of the economic downturn. In doing so it may reduce the risk of a sudden pull-back in spending by overstretched consumers, even if it does not actually boost spending by much. Analysts estimate anywhere from 20 per cent to 50 per cent of the rebates will be spent over a period of four to six months.”

The impact will depend on the marginal propensity to save and spend the extra income and also the marginal propensity to import goods and services. With a weaker dollar raising the prices imported products, perhaps the propensity to import might be a little lower at this key stage of the economic cycle? The tax rebate is also targeted at Americans on incomes below the top of the pay ladder - whose marginal propensity to spend might be expected to be higher than the super-rich.

According to ABC news:

“More than 130 million U.S. households are eligible for the checks. Individuals could get up to $600, couples up to $1,200 with an additional $300 per child. In total about $120 billion will be doled out over the next two months.”

The rest of the FT article is here

US economy awaits stimulation from Bush’s tax rebate (Guardian)

Revision: Bonds

This two page revision note is aimed at A2 economists and provides a bried overview of the bond market and a look at what has been happening to bond yields in the UK over the last twenty years or so.

Revision: Progressive and regressive taxes

A row has been brewing within the Labour Party about the decision by Gordon Brown when he was Chancellor – confirmed in the 2008 Budget – to scrap the 10 per cent ‘starting rate of income tax’ partly as a way of reducing the basic rate of income tax from 22% to 20% (from April 2008). One of the related issues to this is how the income tax system affects the final distribution of income in the UK and, in particular, the distinction between progressive and regressive taxes. This revision note is for AS and A2 students and considers amongst other ideas, the progressivity of the UK income tax system.

Revision note article
Revision_Progressive_Regressive_Taxation.pdf

Revision: The Tax Burden

This revision note for AS and A2 economists looks at changes in the overall burden of taxation in the UK and some of the economic consequences.

Tax_Burden.pdf

Getting personal regarding the rules?

Gary Duncan, writing in The Times today, examines the conflict (perhaps personal as well as economic?) between Mervyn King, Governor of the Bank of England and Gordon Brown, Prime Minister and former Chancellor.

If a fretful Gordon Brown was watching on Wednesday as the Bank of England unveiled its latest strategy for the British economy, the Prime Minister may well have wondered whether he might end up feeling much the same way over his decision last month to hand Mervyn King a second term as Governor of the Bank.

Mr King’s flinty and uncompromising message on Britain’s economic prospects was bleak enough to leave any occupant of No 10 wringing his hands over the likely evaporation of the country’s “feelgood factor”.

MP calls for tax-or-charity reform

How best to encourage a giving culture where more of us are incentivised to give a share of our income to good causes? The Labour MP Frank Field delivering the Allen Foundation Lecture has called for reforms to income tax so that the top income groups earning £150,000 or more would be given a choice - give some money to charity or face a 10 per cent tax surcharge. Field claims that the inspiration for his idea came from a conversation with Margaret Thatcher!  The full text of his lecture is available here

Another cut in US interest rates

The United States Federal Reserve has once more moved to lower interest rates in an aggressive move to bolster confidence and demand in their flagging economy. This BBC news audio-visual clip looks at the immediate market reaction. Just about every macroeconomic policy lever is now being pulled in terms of monetary and fiscal policy and it will be fascinating to see what impact the loosening of macroeconomic policy has on the economy.

Ben Bernanke has indicated that he is prepared to cut rates even further if necessary, a stark contrast to the inactivity at the Bank of England. The fact is that the drivers of monetary policy decisions in the United States tend to err on the side of economic growth whereas the sober bankers on the Monetary Policy Committee take a sterner line on inflation risks. Whose side are you on?

The rich are racing away

Despite rising taxes for people on high incomes, the super-rich continue to race away as the gap between the haves and the have-nots gets wider and wider. This is one of the findings of new research on inequality in the UK from the independent Institute for Fiscal Studies.

‘The incomes of the richest 0.1% of the population increased at an annual rate of 6.6% a year during Labour’s first five years in office. They then fell by 2.7% a year on average in 2002-03 and 2003-04. They picked up again in 2004-05, the last year for which we have data. But the subsequent strength of the stock market suggests that the growth in their incomes may have accelerated again over the past three years, increasing inequality further despite additional attempts by the Government to help the less well off. It remains to be seen what impact recent problems in the banking sector and financial markets will have.’

The richest 0.1 per cent of the British population could fit snugly into the City of Manchester stadium - there are around 47,000 people in this category and the entrance fee for membership of this elite group is a gross income in excess of £375,000 per year. Relative to all tax payers, people in the top echelon of the income distribution (they are overwhemingly male) have an income 31 times that of the average for the UK as a whole.

The average income per tax for the top 0.1 per cent of income earners is £780,000 of which around £275,000 is then paid in income tax - an average tax rate of 35 per cent. This can be compared to the tax burden of people on average incomes. In 2004–05, the IFS found that the average income tax payer had an annual income before tax of £24,769 in 2007–08 prices and paid just over £4,400 in income tax - an average rate of tax of 15.8 per cent.

The IFS study also finds that the gini coefficient - a measure of the scale of income and wealth inequality in a country - has started to increase again having fallen in the first five years of the Labour government.

‘After falling for three years, the Gini coefficient has been rising since 2003–04, and is now slightly higher (0.35 compared with 0.33) than when Labour came to power in 1996–97 – an increase that is statistically significant’’

Source: Institute for Fiscal Studies

More details available from the IFS at http://www.ifs.org.uk/publications.php?publication_id=4108

Further reading:

Tutor2u revision presentation on poverty and inequality
Weath rise boosts unequal Britain (BBC)