Adam Smith Institute get it very, very wrong

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My attention has been drawn to an Adam Smith Institute (ASI) report of 24 November in which they suggested the personal allowance for all people in the UK should be raised to £12,000. I'm not sure which tax year they propose the change in: I'll assume 2009/10 when the allowance will be £6,475 as opposed to £6,035 this year. They said this "would take 7 million low-paid workers out of the income tax net altogether. People earning the minimum wage or less would pay no income tax at all."

There are some considerable problems with that claim. For a start national insurance is for all practical purposes a tax on income. I note they took no measure to stop this highly regressive tax being charged on people in that income bracket, which is odd. And there are other very odd elements to this plan. Take this summary of its consequences as a start point:

This tax cut would put almost £19bn per year back in people's pockets, allowing considerable additional spending and investment in the productive, private sector economy. This is the key to overcoming recession and restoring economic growth.

If the higher rate threshold were kept at its current level, rather than raised in line with the personal allowance, this policy would cost the Exchequer just £18.9bn a year in lost revenue (it would cost £25bn if we raised the higher rate threshold too). Of course, this calculation is based on a static analysis, and because of the effects outlined above, the actual loss could turn out to be smaller.

Either way, I argue strongly against the government financing this tax cut with increased borrowing, suggesting they balance it by reducing public sector waste and cutting spending on non-essential programmes instead. The taxpayer already spends more than £30bn a year on servicing government debt, and we shouldn't add to that burden when there is so much fat to be trimmed elsewhere.

The ASI and their supporters argue there is a fiscal stimulus in here. That's completely untrue. First of all note they plan to cut government spending by an amount equal to the tax cut. That's hard to interpret as a fiscal stimulus. At best it is neutral. I suggest even that is unlikely for whilst the ASI may not have noticed it, government spending does actually result in real economic activity in the UK economy. Cutting that spending will mean real loss of income which the tax cut need not make up. And contrary to the implicit ASI belief that cutting taxes creates growth because they believe the UK is on the downward sloping, post peak, part of the Laffer curve there is no evidence whatsoever to support that analysis.

Second, despite all their repeated claims of government waste I always note how hard it is for people who transfer from the private sector to actually find any to eliminate within the public sector. I also have watched with amusement the claim by Jersey made three or so years ago that it would cut just £20 million out of its government spending as a result of eliminating waste - and that they have so far (despite their right-wing stance) completely failed to do so, state spending having risen year on year. The net result is that this target of reduced spending will only be achieved by real spending cuts - probably hitting the poorest in our communities who have the highest spending ratios, and who will therefore contribute the most to ending recession.

Third, a significant part of the tax cut the ASI propose will go in large part to those on highest income - for someone earning from about £12,000 to £40,000 the saving will be worth £1,105 (£12,000 less £6,475 = £5,525, multiplied by the 20% tax rate = £1,105 a year - which makes the claim they will be £100 a month better off look slightly odd). The ASI ignore the fact that those on higher rate will enjoy a saving of double that - £2,210, which is odd, don't you think?

Last, they also ignore the fact that there is in recession no evidence at all that extra cash is spent on "considerable additional spending and investment in the productive, private sector economy". Maybe they haven't noticed that the whole problem of the 1930s was that the private sector was entirely unable by itself to end the recession: the whole basis of Keynes' work was to show how once in recession the private sector and the savings it generated were, if anything, likely to exacerbate its effects and the only way out was for the state to inject funds to kick start spending again. But the ASI policy is to do exactly the opposite. They want to give money to individuals who are highly likely to use it to save or repay debt - and so compound the fiscal deflator of the cut in government spending they propose and so compound the depth of the recession.

I am of course well aware that Gordon Brown and Alastair Darling have used VAT for a fiscal stimulus - a policy I oppose - but at least people have to spend to get the advantage of that. Under the ASI plan even that is not needed. Rarely have I seen a plan better designed to increase the impact of a recession.

Is that what they want? Or is ti just a matter of dogma before people?

Either way this is very, very misguided.