Reform held a panel discussion on 19 March 2013 entitled "Pre-Budget Briefing 2013: Making fiscal policy sustainable." It featured a panel comprising Ben Gummer MP, Sam Fleming (Economics Editor, The Times), Piers Ricketts (Partner, KPMG), and Dr Patrick Nolan (Chief Economist, Reform). The discussion was kindly hosted by KPMG and resulted in a wide-ranging discussion, summarised below.
Ahead of the 2013 Budget, an article published on the Huffington Post blog outlining how the Chancellor of the Exchequer should remove ringfencing of departmental budgets, and tackle the structural problems with the economy.
Reform roundtable seminar on "The landscape for infrastructure finance", with Lord Deighton of Carshalton, Commercial Secretary to the Treasury.
Reform roundtable seminar on " Innovation economics: the race for global advantage", with Stephen Ezell, The Information Technology and Innovation Foundation, Washington, D.C.
Reform roundtable seminars on "Strong corporate governance", with leading representatives from the UK and Scandinavia on Monday 10 September 2012.
Reform roundtable seminar on "Promoting global growth of UK SMEs", introduced by Crispin Simon, Managing Director, Trade SMEs, UKTI, on Thursday 6 September 2012.
Reform roundtable seminar on "Shaping up to slow growth." Introduced by Vicky Pryce, Senior Managing Director, FTI Consulting
By Patrick Nolan
Reform roundtable seminar on childcare on "the costs of debt financing" on Tuesday 3 July 2012. Introduced by Jonathan Portes, Director, National Institute of Economic and Social Research.
By Patrick Nolan
The record low cost of government borrowing in the UK has led to calls to use debt financing to fund capital spending. Jonathan Portes, Director of the National Institute of Economic and Social Research, has estimated that with an interest rate of 0.5 per cent increasing debt by £30 billion would cost £150 million a year. This estimate generated debate over how much debt financed public investment actually costs. What is the impact of inflation? Should the tactic be to simply refinance debt in the future? What would it take to trigger a flight from gilts and are there implications of this borrowing for future generations?
To explore these issues in greater detail Reform recently held a Reformer lunch with Jonathan Portes on the costs of borrowing and the implications for fiscal policy. This event was the second in a series of “austerity debates” and was held under the Chatham House rule.
The first area of discussion was the causes of low long term interest rates. This is significant as if long term interest rates are driven by weakness in the economy and not by deficits and debt then further borrowing could have little impact on rates in the future. It was argued that the risk from greater borrowing could be relatively low as there is significant spare capacity in the economy (implying less crowding out). But it was also noted that even if the Government can currently borrow at low rates this cannot continue indefinitely (there is no infinitely lived indexed linked gilt) and at some debt level market confidence would be lost.
Further, just because borrowing is cheap it should not be assumed that more borrowing will automatically increase growth. Borrowing should not be seen in isolation from what it is spent on. Areas for possible spending include infrastructure and house building and borrowing to fund tax reductions. Yet there was concern that extra spending by government would fail to be growth enhancing and that increased borrowing could reduce the efficiency of spending by reducing pressure on budgets. There was a view that with government spending 46 per cent of GDP there is scope to increase growth through improving the efficiency of existing spending rather than borrowing to spend more.
The role of the business and household sectors was also noted. The Government is not the only actor that can borrow at low interest rates and yet many businesses and households are reducing their debts. This may reflect liquidity issues but could also reflect a desire of businesses and households to build up balance sheets in the face of uncertainty. Problems in the Eurozone are a major cause of uncertainty. (As an aside it is important to note the difference between the UK’s position and that of other European countries as the UK can continue to borrow in its own currency.)
Uncertainty can also reflect doubts over a government’s medium term plan for the public finances. Borrowing will have to be paid back and so more borrowing now means taxes would have to be higher or consumption lower in the future (depending on the growth effects of more debt and what the borrowing is spent on). This, in turn, reduces incentives for investment (although there is debate over whether these conditions (Ricardian equivalence) hold when there is spare capacity in the economy).
Government borrowing also has implications for intergenerational equity. But, again, this reflects, among other things, what borrowed money is spent on. If it is used to create an asset which is passed onto future generations then this may be equitable, but there is much less of a case for borrowing to maintain current consumption. Borrowing can also create a “dead” area of public spending (spending that is “lost” on servicing debt). In this context it was discussed how the Government now is spending more on debt servicing than education, although this is not, by historical standards, unusual.
The difficulty in sticking to a medium term plan to reduce borrowing should not be underestimated. Not only is there the challenge of identifying when the “short term stimulus” should end and be replaced by fiscal prudence, in the face of an ageing population fiscal prudence will involve increasingly difficult policy choices. The UK public has a revealed preference for, for instance, keeping taxes below 38 per cent of GDP, providing public services free point of use, projecting military power onto the world and maintaining free social care to protect children’s ability to inherit houses. Yet it is not possible to have it all. It is inevitable that at some point the bill will have to be paid and the political process will have to answer some hard questions. With the speed at which the UK population is ageing this need to face up to hard decisions will come much sooner than expected.
Reform roundtable seminar on "why is UK growth so slow?" on Monday 2 July2012. Introduced by Richard Jeffrey, Chief Investment Officer, Cazenove Capital Management.
By Lauren Thorpe
Earlier this week Richard Jeffrey, Chief Investment Officer at Cazenove Capital Management, introduced the first of three austerity debates hosted by Reform. This debate was on the topic of “why is UK growth so slow” and was held under the Chatham House Rule.
The answer to the question was straightforward but politically tough – over recent “boom years” the economy had accumulated debt at a rate faster than could be matched by income growth. The wealth that was being consumed had not yet been earned, and after the party the UK found itself burdened with onerous amounts of public and private debt. This increase in debt reflects failures in fiscal and monetary policy. Interest rates were too low for too long and spending increased too quickly.
Looking forward as well as back the messages are just as hard. The UK needs to reduce its historically high levels of debt. Domestic demand needs to grow at a lower rate than GDP and fiscal policy must rebalance. Importantly, expectations for growth will need to be more realistic. The economy will be doing well to have a real rate of growth of two per cent, prolonging a recessionary feel. In short, austerity will be the new normal.
So what does this imply for government policy? A key implication is that the task of delivering growth is not just for the Government. Indeed, the best thing the Government could do for growth is to create the conditions for the private sector to expand. This should come from supply side reform. Efforts to prop up demand would either be too small to have a material impact or would need to be so large as to damage overall fiscal credibility. Curbing the overreach of the Government will also help reduce the degree to which it crowds out private activity (evidence of this crowding out can be seen through lower capital investment).
There are a number of supply side reforms that the Government could look to. The four main pillars that affect investment and growth in the private sector are: access to skills, the tax environment, regulatory burdens, and the quality of infrastructure. On skills, standards in schools must be raised so that employers do not have their productivity stifled. On tax the emphasis must be on creating an environment that is stable and consistent. Rather than increasing regulatory burdens, the Government should try to reduce them, particularly for small businesses. And finally, it is necessary to find a way to encourage private sector investment in infrastructure projects in the UK.
The picture for growth in the UK has changed. The UK is likely to experience shorter economic cycles where inflation plays an important role in shaping the real rate of growth. The next few years will require a prolonged and severe period of deleveraging. In simple terms, people need to spend less than they are earning. This may sound straightforward but following a decade of overspending, it will feel tough.
Reform roundtable seminar on tackling tax avoidance through a General Anti-Abuse Rule on Thursday 21 June 2012. Introduced by Graham Aaronson QC, lead author of GAAR study into tax avoidance and responsible tax planning for HM Treasury.
By Lauren Thorpe
“It’s a game of cat and mouse. The Revenue closes one scheme, we find another way round it”. This is how an accountant this week described the tax planning practices adopted by his firm. A General Anti-Abuse Rule, currently under consultation by HM Treasury, would seek to target tax avoidance schemes that are found to be abusive, while at the same time protecting normal tax planning. Yesterday Reform held a roundtable discussion on “tackling tax avoidance through a General Anti-Avoidance Rule (GAAR)” with Graham Aaronson QC, lead author of the GAAR study into tax avoidance and responsible tax planning for HM Treasury last year.
This lunch could not have been more timely. Newspaper headlines have this week been dominated by cases of high profile tax avoidance. No tax law has been broken, but the use of complex and novel investment vehicles has been described as an error of judgement and immoral. This can be disputed, yet a tax rule focusing on “abuse” rather than “avoidance”, is being widely touted as a mechanism to prevent the ‘fancy footwork’ that some use to limit their tax liability.
There was a general consensus that a GAAR now seems inevitable, but we should not expect too much. Though a GAAR would represent a stronger approach to tackling tax abuse than currently in place, the lunch raised a number of concerns over the unintended consequences of any legislation.
There was concern that a GAAR could increase the complexity of our tax system further, contradicting the current UK tax policy objective of tax simplification. One strength of the UK tax system, though complex, is its rule-based and consistent application. Frequent changes to the tax system are a major concern to businesses and investors in the UK, and a GAAR would introduce an element of uncertainty into the tax system. Rulings on tax affairs would be determined by advisory panel on the basis of what is “just and reasonable”.
Those who believe that reducing tax abuse will improve the UK’s fiscal position will be disappointed. The last published figure for the tax gap (the difference between the tax collected and the theoretical amount that should be collected) is £35 billion. This includes £10 billion of tax avoidance and ‘legal interpretation’ and £4 billion of evasion (i.e. deliberate under declaration of tax liability) – in total just 2 per cent of annual Government spending. In addition to focusing on increasing tax revenue, the Government should continue to target Government spending reductions.
In spite of these arguments there was support around the room for a GAAR. The UK is one of few countries that doesn’t already have some form of anti-abuse rule in place, and many hoped it could pave the way for a change in culture and attitude towards tax planning. With a rule in place, individuals and tax planners could be less likely to participate in tax schemes that put them at the margin of what is considered acceptable. This would no doubt benefit society by rebuilding trust between business and the public, and reducing the opportunities to attack wealth creators – there was consensus that this harms the UK PLC and is contrary to the pro-business message that the Government seeks to deliver.
Reform roundtable seminar on family finances on Tuesday 15 May 2012. Introduced by Lord Wilf Stevenson, Chair, Consumer Credit Counselling Service.
By Patrick Nolan
Earlier this week Reform held a roundtable event on Putting family finances on a sustainable footing. Lord Wilf Stevenson, Chair, Consumer Credit Counselling Service (CCCS), introduced the event, which was held under the Chatham House rule.
Many UK households are on a financial knife edge. CCCS research shows that 8 per cent of households in Great Britain spend more than half their incomes on total debt repayments and the average household pays nearly £200 per month in interest payments. 30 per cent of households have no spare cash at the end of the month and more families are turning to high cost credit. These challenges are not confined to a relatively small group of low income families; CCCS research has shown that families on higher incomes are struggling with debt too.
The upshot is that many families would struggle to cope financially if they experienced a drop in income, increase in expenses, or other changes in circumstances. And they are likely to remain vulnerable for a while. The labour market outlook is weak and prospects for real wage growth are not great. Concern has been expressed over food, fuel and utility bills, HMRC debt recovery procedures, and increasing rent bills and mortgage rates. Already 10 and 6 per cent of CCCS clients are in mortgage and rent arrears, respectively.
Policy changes, such as the public sector wage freeze and reform of the welfare system, have increased pressure on some families. The Universal Credit will test families’ financial capability through paying benefits monthly and paying housing benefits to recipients not to landlords. Problems with debt can often be part of a downward spiral – with there being, for example, a link between problem debt and depression.
While it is relatively easy to point to problems, developing workable solutions and identifying the role that government should play in these solutions is harder. Developing solutions will require facing up to some hard questions, which will be the subject of future Reform events. These questions include, for example:
- Is the supply of credit to some vulnerable communities too high? What would be the best way to influence the supply and level of credit in these communities? Or, indeed, should government set out to influence this?
- Should interest rates of, for example, 4,000 per cent per annum be allowed (bearing in mind that an annual rate can be misleading for a loan with a term shorter than a year)? Or should interest rates be capped? Would capping interest rates restrict the supply of credit (including to people who can afford to borrow) and risk other charges or fees going up to compensate?
- How should financial products, lenders and debt management companies be regulated? Are current regulations sufficient, and is the only problem one of enforcement? What role should financial services (e.g., self-regulation through voluntary codes and kite marks) and employers play in improving standards and helping people make the right choices? How can confidence in financial services as a whole be improved?
- What should happen when people get into problems? Should the attitude towards debt forgiveness change? How can consumers be directed to the right sorts of advice?
But perhaps the biggest question raised at the event was whether the broader attitude to debt in the UK needs to change. A model of growth driven by consumption funded by household borrowing requires ever increasing capital gains on housing assets or increasing real wages. A “borrow now, pay later” model will always face problems when growth stalls or when the economic environment changes (e.g., when the population ages and dependency ratios increase). The big question is how to ensure sustainable growth in household incomes in the long term – simply borrowing more cannot be the answer.
Reform roundtable seminar introduced by Dr Adam Posen, member of the Bank of England’s Monetary Policy Committee, on Thursday 29 March.
By Lauren Thorpe
Long-time students of central banks are often surprised at the degree of interest, and strength of feeling, that this topic currently generates. But this should be no surprise. Since the Bank of England started its Quantitative Easing (QE) programme in March 2009, it has pumped £325 billion into the UK economy. Any intervention on this scale will have major economic effects.
To provide an insight into thinking on QE and its likely economic effects, Reform held a round table seminar on Thursday 30 March with Dr Adam Posen, member of the Bank of England’s Monetary Policy Committee. This event was held under the Chatham House Rule. Some of the key points raised included:
- 1. Impact on pensions of QE. The National Association of Pension Funds (NAPF) recently published an estimate that the latest £50 billion asset purchase added £45 billion to the deficit of UK companies’ final salary pension schemes. The challenge is to assess whether any gain to the economy from QE exceeds these losses to pensions (there are no easy answers to this). To understand the full implications of QE it is also important to consider the counter-factual. What would the UK economy (and thus pensions) look like if QE had not have taken place?
- 2. Regulatory impact on pensions. There was concern that the effects of QE on pensions may have been increased by a lack of response from the regulator. Pension schemes report receiving inconsistent messages from the authorities, with pressure to transfer their investments into riskier assets while at the same time being encouraged to de-risk. Finding the right approach to regulation will become more important when the Bank of England needs to unwind its position and return gilts to the market.
- 3. Role of bank lending. An asset purchase programme should increase the amount of money in the economy and encourage bank lending. Yet there is a concern that banks have used much of the money to shore up their own balance sheets, rather than injecting cash into the real economy. This highlights two issues. First, is credit allocation by UK banks good enough? One view is that institutions in the US do a better job of this than our capital markets, given the larger reliance on bank lending in the UK and lower levels of competition in the sector. Second, QE should cause an increase in asset prices by allowing corporates to raise debt more cheaply, in turn generating wealth creation as consumption increases. While this has happened, evidence suggests that the impact is much smaller in the UK than in the US.
- 4. Circumventing the banking system. It has been suggested that the Bank of England could issue money closer to the market, by-passing the banks. In the US this can happen more readily given the existence of government backed organisations such as Fannie Mae and Freddie Mac. Yet there are two challenges to going in this direction. The first is scale – to match the tranches of QE already completed the Bank of England would need to buy a significant majority of the UK corporate bond market. The second is political. It would require “picking winners” which has well-known challenges.
These discussions aside, there is also a wider concern over the potential impact of QE on expectations. Will it increase moral hazard in markets? If QE is successful, are we likely to behave differently in the knowledge that the Bank of England can prop up the economy in this way? It is perhaps these dimensions of QE that will have the longest long-term effect.