Sunday, May 17, 2020
There's no need for tax rises now, and maybe not later
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

In a moment I shall have something even more interesting to say on the economics of this pandemic, but first let me deal with the great lumbering elephant in the room. This is the extent of the government’s support for the economy during the crisis – including Rishi Sunak’s extension of the furloughing scheme last week – and how we will pay for it.

It is a question I get asked a lot. How much will taxes have to go up to pay for this and, whether Boris Johnson uses the A-word or not, will it mean a new round of austerity, or the cancellation of previously announced “levelling up” infrastructure spending?

That there is a lot more money sloshing around is not in doubt, though it is important to distinguish between different kinds of government supports. Some of the most eye-catching numbers, for example, the £330bn of loan guarantees announced a few weeks ago, are contingent liabilities.

That there has been actual spending is not in doubt. The Office for Budget Responsibility, the fiscal watchdog, updated its estimates on Thursday. It now thinks that the policy response to the crisis will cost £123billion this year, of which the bulk, £118bn, is extra spending.

It estimates that the addition to borrowing will be more than that. Its new estimate for the budget deficit this year, public sector net borrowing, is £298bn, up from £273bn in its first coronavirus scenario in April. That is roughly 15% of gross domestic product and compares with a March forecast, prepared before the extent of the coronavirus crisis and lockdown were clear, of just under £55bn. £298bn is almost double the maximum annual deficit, in cash terms, in the financial crisis.

The increase in borrowing goes beyond the direct effect of government measures because of the recession’s impact on tax revenues and the effect of significantly higher unemployment on the welfare bill.

It is a very big fiscal hole. What should the chancellor do about it? This year’s deficit has to be regarded as a sunk cost, an emergency increase in borrowing, for entirely understandable reasons, that cannot and should not be recovered.

That still leaves the question of what happens beyond this year. How quickly does the deficit come back down again, or has this crisis opened up a permanently much larger gap between government spending and tax revenues? And, as well as this, do the fiscal rules still matter, or has this crisis provided a cast-iron excuse for abandoning them? Before he was diverted on to other things, the chancellor said he would review the rules in his autumn budget.

Nobody sane would suggest that tax rises are the right thing to do when the economy is emerging from its deepest recession in modern times, so in the short term, talk of higher taxes should be safely put one side.

The question is what happens later, say after two or three years, and here the latest projections from the National Institute of Economic and Social Research (Niesr) provide a useful way of thinking about it.

The Niesr projections suggested that there will be a longer-term impact on the public finances from this crisis. So, in 2-23-24 and 2024-25, government debt is more the 90% of GDP – the permanent addition from around 80% as a result of this crisis, and the budget deficit is about 3% of GDP, higher than it has been recently; in 2018-19 it was less than 2%

Most importantly, in terms of the existing fiscal rules, the current budget deficit, excluding public investment, settles at about £20bn a year. The government is committed to borrowing only to invest, in other words balancing the current budget. This £20bn, rather than £300bn or even £500bn, provides a guide to the kind of extra revenues the government might want to raise in the medium term. It is a lot of money but in fiscal terms a drop in the ocean. We should not worry unduly about big tax rises to come.

Nor should we worry that this crisis will mean that the government’s infrastructure programme will have to be scrapped. The rules specifically allow investment spending, up to 3% of GDP and, as long as the government can borrow, this should not be threatened.

Whether it can continue to do so depends, at least in part, on the length of this lockdown-induced recession. Last week I bemoaned the fact that, while scientists have been greatly involved in the decision-making process around the coronavirus, economists have not.

Today I can offer the best of both worlds, an economist, Professor David Miles, a former member of the Bank of England’s monetary policy committee, working with an Oxford scientist, Oscar Dimdore-Miles, who happens to be his son. Their joint paper, “Assessing the spread of the novel coronavirus in the absence of mass testing”, is published in a new Covid Economics collection from the Centre for Economic Policy Research.

Their paper addresses a key problem in assessing the spread of the virus. There have not been enough tests, and there may not be for some time. In the absence of such testing, however, there is another way, which is to use a so-called SIR model (susceptible-infected-recovered), coupled with actual data on cases, and the fact that many people will the virus will be asymptomatic, to try to work out the spread.

Without wanting to blind you, or myself, with science, the paper suggests that many more people have been infected, perhaps 200 times more than we know about, in Britain and in other countries (the model was also tested on the data for America, Italy, Spain and Sweden).

It raises the fascinating possibility that at the end of April, 60% of the population may have been infected, the overwhelming majority of them asymptomatically, compared with an official estimate of well under 1%. This is entirely separate, by the way, from earlier research by Oxford epidemiologists.

And, when we look at the UK’s success in flattening the infection curve, the paper offers a choice. It could as a result of the lockdown, as the government would claim, but it could also be, as the authors say, “that the infection has spread so far that new infections naturally slow down”. In their study, as they point out, “in all of the countries whose data we analysed, the best fit to that data favours the second explanation”.

They are careful not to overstate it and admit that we are dealing with “a fog of considerable uncertainty”. But their work says that the evidence supports a further easing of lockdown restrictions and that this can occur alongside a continuing fall in the number of new cases.

If that occurs it will come as a relief to the chancellor. The extension of his unprecedented (in the UK job retention scheme – fully to the end of July and then in partnership with employers until October 31 – is consistent with most sectors of the economy getting back to normality over the summer, with a further recovery in activity by the autumn. If the science and the economics can agree on that, it will be a very good thing.