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Economic policy

Reviewing Starmer’s Conference speech

1st October 2022 by newtjoh

Keir Starmer’s 2022 Labour Party conference speech sketched out his strategy to occupy the political ground vacated by Trussonomics.

Labour would put working people interests over those of the rich, be the party of opportunity, of aspiration, of fairness, as well as of sound public finances and of economic competence.

Kwasi Kwarteng’s September mini-budget comprising £45bn of tax cuts – the biggest since 1972- with its immediate economically and politically disastrous aftermath provided a helpful backdrop to resonate his message to define the ideological blue water between Labour and Conservative, largely hidden during the May and Johnson administrations.

Trussonomics is essentially Reaganomics (relying on tax cuts on the rich to spur growth) mixed with Modern Monetary Theory – it is basically OK for governments that issue and borrow in their own currency to resort to money-printed deficit funding until an unsustainable inflation inflection point is reached.

In short, it is the Conservative free market equivalent of Corbynism, save that: the rising tax unfunded deficit will be the result of taxes being cut rather than of spending increased; John McDonnell was more wedded to fiscal sustainability and would have unlikely to have introduced discretionary spending unfunded increases to take the deficit to 7.5% of GDP, and if he had, would have prepared the ground better with the financial markets in a more pragmatic fashion;  the aim is to achieve a 2.5% headline growth rate just before a 2024 election – regardless of its sustainability and the ability to fund future health and other core social welfare activity – is more political cynical and single-minded in its pursuit of perceived party over national interest.

It is unlikely that will come to pass even on its own terms. Evidence is lacking that tax cuts concentrated on the top five per cent will lift growth – Reagan’s tax cuts in the 80’s led to a ballooning public deficit that had to be closed later.  It suggests instead that increased inequality retards rather than helps sustainable growth.

Embarking on unfunded borrowing to pay for tax cuts at a time when the public deficit is near to a record high, the balance of payments current deficit is widening, inflation is at a 30 year high, and when sterling was already weak, was asking for trouble. It soon came as the following chart showed.

Fiscal and monetary policy are now actively working against together to such an extreme that the Bank of England had to resort within days to a £65bn purchase of long-dated government bonds (gilts) to stop a calamitous sell off by pension funds facing margin calls due to bond prices collapsing in response to the sudden rise in gilt yields.

Most commentators expect mortgages rates to approach 6% by 2023. Combined with sterling at near parity with the dollar (which increases import costs) living standards on the vast majority will be squeezed that much tighter and first-time buyers thwarted as mortgage costs become unaffordable.  Outcomes that will heavily weigh down on growth making the tax cuts self-defeating in the process.

The political optics of reducing taxes on the already rich at a time when most working households are struggling to juggle their budgets with many without savings facing real hardship was also dire.

Kwarteng thus gave Starmer practically an open goal to shoot at. Shrouding his speech with his family backstory, parental struggle in a pebble-dashed semi, their hard work and aspiration accorded with the approach suggested in Starmer’s Story Must Be Labour’s Story. 

The headline flagship of his speech was 100% clean energy by 2030. Public-private partnerships spearheaded by a new Great British Energy state undertaking established within the first year of a new Labour government would unlock investment in domestic renewable energy sources to create a “million new jobs training for plumbers, engineers, software designers, technicians, builders” as well as insulate 19 million homes.

Complementing the £8bn National Wealth Fund that the shadow chancellor, Rachel Reeves, had announced the previous day, all this was rather suggestive of a green updating of Harold Wilson’s White Heat of Technological Revolution pre-1964 election banner, creating British jobs on the back of British innovation and investment.

Growth would also be bolstered by targeted capital allowances and borrowing to invest for long-term economic benefit within a wider fiscal framework where the current budget would be balanced: a resurrection of Gordon Brown’s golden rule. Fiscal rules would require debt as a proportion of GDP to reduce, with all policy commitments fully costed and funded, guided by (a previously announced) Office for Value for Money.

To support the customary Labour commitment to safeguard the NHS, more nurses, midwives, and doctors would be trained, funded from the proceeds of a reimposed 45% higher rate; in effect, a sleight of hand, insofar that reversing a cut simply restores to previous position: by the same logic reinstating the national insurance increases and Health and Social Care Levy would create the opportunity for £16bn of spending on new commitments.

70% home ownership would be sought by a policy framework favouring first time buyers (FTB) rather than Buy-to-Let investors and second home purchasers. Foreign purchasers would be charged a higher rate of transaction stamp duty, while a Mortgage Guarantee Scheme would aim to reduce FTB deposit requirements.

Such a commitment without some systemic reform of the current housing system based on private business models dependent on rising house prices, appears to risk becoming a false target akin to the Conservative 300,000 homes one, diverting attention from the substance of strategic policy change although mention was made to “reform planning so speculators can’t stop communities getting shovels in the ground”, which, however, is a slogan rather than a policy.

There were some other specific taxation pledges, namely retaining the reduced 19% basic rate and not reversing the national insurance increase – and relatively unremarked on – abolishing business rates, replaced with an alternative system (undefined) that would provide for early payment of revaluation discounts.

In that light, no indication was given how Boris Johnson’s existing September 2021 social care package – let alone an improved fairer one – would be financed nor was note made of the impact of Kwarteng’s tax cuts on its current progress.

Taxes on workers and employers have deadweight effects on employment, wages, productivity and growth, but given the public finances will be in mess if and when Labour forms a new government, such commitments beg questions as how spending on rising health care and social care needs in an aging society, on further education conducive to growth, on investment in affordable housing and bringing private sector housing up to Decent Homes Standard, is to made compatible with Labour’s proposed fiscal framework.

To square that circle is a long odds gamble on growth and lower interest rates coming to the rescue of the real crisis of the fiscal state: the mismatch between the public expenditure requirements of the UK and the political and electoral willingness for them to be met through forms of taxation that are efficient, sufficient, and transparent.

Honest and deep debate on public funding requirements matched to sources is accordingly avoided, invariably subverted instead to short-term political presentational purposes. The impoverishment of public services and an almost default governmental resort to hidden stealth or inefficient forms of taxation is the inevitable end-result.

In that light, it was disappointing that Starmer’s speech appeared to accept the Conservative take on the that taxes need to reduce, resorting to a New Labour-type tactical triangulation response, such as the linkage of increased spending on doctors and nurses with a reimposed 45% tax rate.

He could have focused instead on the trade-off between investing for growth and tax cuts, highlighting the impact of frozen tax allowances as a prime example of taxation by stealth on the hard-working majority, linking it to the need for system reform across the health and social care, housing and education sectors.

Strategy and tactics need to be rebalanced over the coming year.

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Filed Under: Economic policy Tagged With: Labour, Starmer

Time for a Modern Land Tax?

3rd September 2022 by newtjoh

1          The Vision of Henry George Revisited.

“Let the individual producer keep all the direct benefits of exertion. Let the worker have the full reward of labour. Give the capitalist the full return on capital.  The more labor (labour) and capital produce, the larger the commonwealth in which we all share.

 This general gain is expressed in a definite and concrete form through the value of land, or its rent. The state may take from this fund, while leaving labour and capital their full reward. And with increased production, the fund would increase commensurately.

 Shifting the burden of taxation, from production and exchange to land value (rent) would not merely give new stimulus to the production of wealth – it would open new opportunities. Under this system, no one would hold land without using it. So land held from use would be thrown open to improvement.

 The selling price of land would fall, and land speculation would receive its death blow. Land monopolization would no longer pay. Millions of acres, where others are now shut out by high prices, would be abandoned or sold at trivial prices.

 This is true not only on the frontier, but in cities, as well”.

Henry George, Progress and Poverty, 1879.

 Progress and Poverty sold more copies in America in the 1890s than any other book except the Bible, making Henry George a popular author across the English-speaking world and beyond.

It continues to well repay reading both as work of economics and philosophy. George –self-taught of humble origins, who worked as a seaman, typesetter, and printer before becoming a journalist – set out in accessible English a coherent world view centred on a tax reform that modern economists of differing political persuasions have re-awakened to as an efficient and equitable means to bolster growth.

His overarching tenet was that while people possess the right to the fruits of their labour, natural elements or ‘Nature’s (God’s) bounty’ not produced by human effort – air, water, sunshine, and land – should be vested with the community.

Private ownership of land would mean continuing suppression and exploitation of working people by the landowning class – a process that would intensify as land values rose with the population and with economic and urban development, so allowing landowners to subtract more and more wealth from the community.

George offered a solution – even a panacea.  Not political revolution in favour of the proletariat where the state took control of capital and labour, as well of as of land. Not progressive systems of taxation levied on income.

Rather, a single tax on the economic rents derived from land ownership as the: “The simple device of placing all taxes on the value of land would, in effect, put land up for auction to whoever would pay the highest rent to the state. The demand for land determines its value. If taxes took almost all that value, anyone holding hold without using it would have to pay nearly what it would be worth to anyone else who wanted to use it.”

The eighteenth and nineteenth founders of modern economics, including Adam Smith, David Ricardo, and John Stuart Mill, following the pre-revolutionary French Physiocrats, had earlier identified that land as a fixed factor of production in inelastic supply – the value of which depended on its use and location rather than its intrinsic characteristics – provided scope for its owners to capture massive unearned gains for reasons connected with the wider development of society (initially increased demand for food from a rising population, then for urban space in accessible locations), not the owner’s own actions.

As to what is meant by economic rent, or, more precisely in in this case, land rent, definitions include:  the difference between what land (or other factors of production: labour and capital) currently earns and what it would do in its next best use, regardless of the acts of the owner; and payments to a factor of production (including land) greater than the minimum needed for it to be supplied.

George’s single tax on land – meaning that it would replace and render unnecessary other taxes – involved taxing land rent at a 100% marginal rate, minus an allowance to prevent plot abandonment to obviate any need for the state to take ownership and to lease it out with accompanying risks of inefficiency and corruption.

Conceptually, if a land plot fixed in supply and is taxed according to its best possible use regardless of its current use, its owner to prevent financial loss will either put the land to that best use or sell it to someone who can or will.

A tax on land, in theory, is the most economically efficient tax, predicated on the assumption that the supply of land is perfectly inelastic or zero – its supply does not change at all in response to any change in its price.

In accord with that assumption, owners of land plot(s) cannot respond to the imposition of the tax by restricting its supply. Alternatively, if did respond by increasing its price, demand will fall returning the price again to its previous level.

The tax will be completely borne by its existing owner, therefore: its imposition will not alter or distort economic decisions concerning the current or subsequent use the plot is put, save that where the tax is levied on its best use, the plot owner will be incentivised, as noted above, to put it to that use.

If its value rises as result of a future change in its use, any consequent higher land tax liability will follow and not cause that change in use, avoiding – unlike other forms of taxation – economically harmful deadweight effects.

The 2011 Mirelees Review of Taxation defined deadweight loss, albeit less eloquently and less fired by belief than did George, as follows:

“By increasing prices and reducing quantities bought and sold, taxes impose losses on consumers and producers alike. The sum of these costs almost always exceeds the revenue that the taxes raise — and the extent to which they do so is the deadweight loss or social cost of the tax”.

Wider costs of tax collection and avoidance can also add to the deadweight cost of tax.

On the other hand, desired ‘merit’ (lower consumption of drink, alcohol, gambling, sugar, or other products deemed harmful) or externality (taking account of pollution, congestion or other effects resulting in costs not borne by the producer) impacts that can produce positive social benefits or ameliorate externality disbenefits that may subtract from deadweight cost.

Mirelees went on to emphasise, however, that reform should be driven by the core objective of minimising, as far as possible, the deadweight loss of the overall system.

George himself likened a single tax on land rent to “removing an immense weight from a powerful spring”, because it lifted the need for other taxes on labour, production, and on exchange: taxes that would otherwise reduce effort, output, trade, consequently constricting the community’s wealth.

Workers instead would keep the full fruits of their labour, capitalists their full return on capital, generating more income, investment, and wealth.

Such a tax would therefore “drive (rather than) act as a fine on improvement” in a dynamic and self-sustaining cumulative process. Landowners whether building or improving an orchard, homestead, or factory on a plot would pay no more in tax than they would if they kept it in its former unimproved state.

That would be true regardless of the cost of any improvements made, which would no longer have to absorb the input cost of other taxes on materials and labour.

George also identified that the incidence of a tax (whom its actual economic burden will fall) will not necessarily correspond or vest with the economic agent – whether company or individual – that formally pays it in cash.

In a telling, and ever timelier, answer to his own rhetorical question as to why – if a tax on land values is so beneficial – does the government resort to so many other taxes, he replied that it was the only tax that cannot be passed on to others: borne by landowners, it provides that group with a powerful interest to lobby and resist its imposition.

In contrast, businesses feel less need to oppose taxes, such as levies on inputs that they can then ultimately shift to consumers, especially when they “come in such small amounts, and in such invidious ways, that we (the consumer) do not notice them”.

Indeed, one could imagine how scathing George would be on the default propensity of modern UK governments to indulge in stealth taxation, such as tax bracket creep: the insurance premium tax fits his diagnosis to a tee.

National insurance employer contributions that increase the cost of labour – depending on the relative market power of firms, workers, and consumers – reduce wages to a point lower they could have reached otherwise and increase consumer prices: deadweight effects.

Land value taxation thus offers to bridge the socialist or communitarian nostrum that unearned wealth based on ownership of nature’s bounty (land and natural resources) should be harnessed for the benefit of the community with that of the premise that wealth-creation requires the lifting of economically burdensome and incentive-sapping taxation (deadweight) effects on business and individuals.

George’s prognosis that governments would be reluctant to impose a single tax on land however has proved almost entirely correct, however, for reasons that later Sections will explore.

2          The Modern Gradualist Georgist Approach

 Contemporary advocates of a Georgist approach to taxation straddle the UK political spectrum, encompassing the Labour Land Campaign, the Alter Group of the Liberal Democrats, and the Scottish Land Revenue Group.

Free market-oriented think tanks, including the Institute of Economic Affairs and the Adam Smith Institute, have also expressed past support for the principle along with many, if not the majority, of mainstream economists, including in the UK, the independent and influential Institute of Fiscal Studies (IFS), most notably in its flagship 2011 Mirelees Review.

The American Nobel Prize winner in a 2015 paper, Joseph Stiglitz, linked the enormous widening of wealth inequality in America since 1980 to two main causative factors: first, changing tax, education, health, anti-trust, regulatory, and monetary public policies; second, to an explosion in economic rents, especially land rents and values (expressed in rising real estate values).

He ascribed rising land and real estate values as the main driver of the increased wealth-output (and income) ratio recorded across most advanced economies since 1980, noting that productive capital (contributing to future growth of output, profit, and wages) is only a subset of total wealth, 42% of which was owned by the top 1%, with the top 0.1% owning 22%.

He concluded that such an unequal distribution and ownership retards and hinders economic and social opportunity, providing an underpinning reason why contemporary America, far from being the ‘Land of Opportunity’, offers to most of its people one of the lowest levels of equality of opportunity amongst the high-income countries.

Moreover, as land is a store of value dependent on its future expected value, land prices are prone to untethered self-fulfilling rises, resulting in speculative bubbles that, in turn, can and often do give rise to wider economic instability with its attendant costs.

Stiglitz, endorsing George’s arguments that Section One summarised, concluded that: “a tax on the return to land, and even more so, on the capital gains from land, would reduce inequality, and by encouraging more investment into real capital (plants, machines, research and development), actually enhance growth”.

Recent relevant data tends to vindicate George and Stiglitz. A dataset produced by the Organisation of Economic Co-operation and Development (OECD) found that across its membership the share of total non-financial assets taken by land was within the 40-60% range.

The UK Office of National Statistics (ONS) May 2022 national balance sheet estimates, covering the 1995-2021 period, puts the value of UK land (exclusive of the value if dwellings and other building structures that may be built upon it), in 2021, at £7.0 trillion (seven million million), around 60% of the UK’s assessed total net worth.

Table 2 of the same estimates reports that the total value of produced non-financial assets (best proxy for productive capital) was £1,684,803million in 1995 when the total value of land (non-produced financial assets) was £1,066,725million, but by 2021 that position was transposed, with land accounting for £7,011,740 compared to £5,100,144 million of non-produced financial assets (capital).

A July 30th 2022 Economist  opinion piece noted that in 2020 the world’s largest asset class, real estate, accounted for around 68% of the world’s non-financial assets – a category that includes plant and machinery as well as intangibles, such as intellectual property.

It went on to argue that, whether in the ‘West or China’, such rising values are tending to divert capital from productive uses, constricting both national business investment and productivity, before concluding that taxing and reducing land values could counteract that adverse trend with beneficial macro-economic effect.

A pure land value tax (LVT) is now usually defined as a periodic and recurring charge on the assessed (usually rental) value of a demarcated parcel of land (plot), exclusive of the value of what may be built upon it.

 Modern such treatments invariably shun the original Georgist conception of a near 100% tax on land rent, in favour of a more gradualist approach, where it is phased-in over several years to reach rates usually closer to five per cent than 100%.

The primary reason is practical. The sudden fall in land and housing asset values that could be expected to follow the announcement of a near-100% tax on land value, along with the associated wider economic uncertainty, would almost certainly produce irresistible political pressures for the quick repeal of such a tax; pressures, in practice, that would prevent its introduction in the first place.

Tony Vickers, in a paper for the Liberal Democratic aligned Action for Land Taxation and Economic Reform (Alter) pressure group, while recognising that a pure LVT introduced at a low starting rate would yield total proceeds insufficient to replace all other taxes, noted that its rates could be increased over time and that such phasing was preferable to successive failed post-war attempts to use betterment taxes or other more complex instruments to tax planning betterment gain.

Applying assumptions that all land plots would be revalued annually and taxed at a LVT set at one per cent of their assessed capital value in their “optimum permitted use” (except agricultural land, valued at its existing use), Dave Wetzel  (formerly the Greater London Council’s transport  chair in Ken Livingstone’s early eighties administration, who led on the Fare’s Fair Programme that although was ultimately vetoed by the Law Lords set an important marker), in a paper for the Labour Land Campaign (LCC), posited that such a LVT would yield £50bn – a figure then based on a 2017 Office of National Statistics (ONS) £5 trillion valuation of all UK land.

If that rate was then progressively increased to four per cent over a “two-term ten-year Parliament” the LVT yield would commensurately rise to over £200bn, enough, Wetzel argued, to “abolish” national insurance contributions (NICs), council tax and business rates, and to allow income tax “to be significantly reduced or eliminated altogether for low and some middle-income earners”.

Updating to a 2021 seven trillion-pound land value subject to a one per cent pure LVT, would potentially generate £63bn (63 thousand million) per annum. A four per cent rate would raise c£250bn per annum.

Such projected LVT receipt levels compare with 2021-22 VAT tax receipts of c£143m, total National Insurance Contributions (NICs) of c£160bn and Pay as You Go (PAYE) income tax receipts of c£193bn.

Such figures should be considered as a consciousness-raising indicative examples of the potential of a LVT, insofar that they simply assume that a stated percentage tax on total land value, as reported in the National Accounts, will be realised – which itself assumes that plot valuations in practice (assuming necessary valuation arrangements are put in place) will total up to the NA estimate; will be accurate and non-contestable to a point that the tax can be collected; and that the LVT and the expectation of progressively rising LVT rates will have no impact on future land values, as will the impact of changes in the macro-economic environment on such values.

The projections will also depend on the likely time lag between LVT levies and countervailing tax reductions, and the overall political feasibility and sustainability of such a programme.

In more technical contribution that addressed some of these issues (mainly at an econometric modelling level), the former Bank of England senior advisor and LSE professor Charles A Goodhart  (the originator of Goodhart’s Law: when a measure becomes a target, it ceases to be an good measure) with other distinguished American economists, in a 2021 Centre for Economic Policy Research (CEPR) discussion paper, recommended that a Land Value Asset Tax (LAVT) should be levied on the capitalised value of future after-tax land rent values inclusive of price appreciation, in accordance with “a tax on a stock, the capitalised value of future after-tax land rent values inclusive of price appreciation.”

Using American institutional data, they modelled that over a 20-year period, such a LAVT reaching a rate of around 5.5% in 0.5% increments – assuming balanced budget tax cuts on labour and asset incomes – would spur output gains of close to 15% and 3.4% in welfare gains.

Such a gradual speed of implementation, according to the authors, would smooth the windfall and cash flow impacts of the proposed LAVT and accordingly alleviate political opposition to it.

Increasing the LAVT rate further up to a 20% – a rate they perceived as a cap consistent with political feasibility – would generate higher gains and raise up to 55% of total tax revenue.

The largest proportional gains, however, would still be realised at low LAVT rates, and remain large until a 10% LVT rate was reached.

The flame of George’s vision has begun to burn brighter again, with mainstream economists increasingly joining dedicated and longstanding disciples of disparate political backgrounds.

Very rare does one encounter both groups waving the same torch, inducing the almost exasperated gasp as to “why can’t the politicians simply bite this golden bullet”.

Two of the more immediate apparent issues are now addressed, the valuation of land for LVT purposes, and the institutional environment (in the UK context) that is a major determinant of actual change in land values.

Valuation issues

Henry George’s proposed 100% tax on land rent was a theoretical construct that largely ignored practical issues of implementation, including the assessment of the value of diverse plots in their best use that tend to change over time.

The paucity of observable land price data generated at scale by a functioning competitive market means that even today direct measurement of land prices by government agencies is the exception rather than the rule.

Without such measurement, estimation of plot land value to a degree of accuracy that can command confidence and legitimacy for LVT purposes becomes even more difficult.  

EuroStat provides useful background from a national accounts (NA) perspective on some of the underlying valuation methodological issues.

South Korea provides one of the few exceptions. Since 2006 it has been mandatory for real estate agents brokering transaction, involving residential buildings or land, to report actual transaction prices (ATPs) to the relevant local government body within 60 days.

The ATP data – as elsewhere, only a small proportion of plots are traded each year – is then compared with publicly appraised and noticed prices (PNPs) that are secured from an annual sampling survey inspection process.

Both sources are then used to value delineated plot(s) at market prices or market price equivalents for land taxation and compensation purposes.

Across many Organisation of Economic Co-operation and Development (OECD) countries, available information is instead largely restricted to real estate values – combined land and structure/dwelling (CV) plot value – and involve the use of indirect land value estimation methods that require the estimated separation of land and CA values.

Estimating the land-to-structure (LSR) ratio and the residual value of land are the two main approaches taken.

The ONS advised in a March 2022 methodological paper that the UK uses the residual approach for NA purposes. This is because estimates of residential investment are only produced at the national level in the UK, while the value of land varies considerably both within and across its regions.

This residual approach takes CV as the starting point of the calculations using the available Valuation Office Agency (VOA) and HM Land Registry data.

Because English dwellings were last valued for council tax purposes in April 1991, historic valuations are converted into current prices using regional price indexes based on the Land Registry data.

Estimates of the net capital stock (gross new and improvement investment, depreciated or consumed according to set assumptions) value of the dwelling/structure is then subtracted from the plot CV, to produce a residual land value estimate.

It is an imperfect process, largely replicated for non-domestic business property, that suffers from a range of methodological and data source problems.

Given that urban use values can rapidly change, a pure LVT would require regular, if not annual, land value valuations for tax liability to be computed accurately and transparently.

Both VOA and Land Registry data sources fail to identify accurately all dwelling and property attributes including area and neighbourhood, condition, and other characteristics, with resulting inaccuracies.

The ONS is seeking to make to improve CV estimates before reviewing the relationship between CV and underlying land values.

It plans to publish updated indicative estimates of land underlying dwellings and land underlying other buildings and structures by the end of 2022.

Goodhart and colleagues recommended that the building residual valuation method should be adopted instead. This is where the value of its land in its highest and best use is subtracted from the market value of a development plot (combined value of land and building/structures placed on it) to obtain the residual value of the building rather than the land element of the CV.

The land residual method, they observe, can undervalue land value. The valuation of the buildings (based on their depreciated construction cost) tends to take insufficient account of their on-going locational (in contrast to their physical) obsolescence, citing, as evidence, the widespread conversion of centrally located commercial property to residential use in the United States.

American conditions may not apply across other national planning environments. Also, the building residual model presupposes an accurate mechanism to measure the land value directly or, at least to separate the respective values of the land and structure within the combined plot value.

Many LVT advocates argue for plot valuations to be based on their capitalised rental value, pointing out that the Valuation Office Agency (VOA) already compiles and updates – at roughly five-year intervals – a rating list for each local authority in England and Wales.

That process involves the computation of an estimate of the annual rental of all its non-domestic properties, based on their individual locations and attributes (see Section Six: LVT and Business Rates).

Such an annual list with input from the Land Registry could then be extended to include the boundaries of each property and its area measurements, which could assist any future move to the separate valuation of plot land and building elements.

The government in October 2021 indicated an intention to shorten that valuation cycle to tri-annual, as a possible (tentative) first step to annual valuations.

Where there is a will, there is the way, as the saying goes: the overriding problem is that such will has largely been absent.

Garnering and harnessing the political will of sufficient strength and resilience to put in place a pure LVT linked to the wider political acceptability and feasibility of pure and partial LVT variants is the real challenge that later Sections will consider.

Valuation methodological issues are a related subsidiary albeit significant issue, insofar that a pure LVT to be acceptable and sustainable would require accurate land valuations, notwithstanding these are likely to be contestable, regardless of their methodological robustness.

Take prime estate in the West End of London: the valuation for LVT purposes of an eighteenth-century square used for mixed residential and business purposes is still likely to prove far from straightforward and simple, where different forms of beneficial ownership that can often be obscured by opaque legal arrangements would need to be unravelled and tracked.

That said, legislation was recently brought forward and expedited to crack down on the flood of ‘dirty money’ into Britain in the wake of Russia’s full-scale invasion of Ukraine.

A new register will now require anonymous foreign buyers to now disclose the beneficial owners, with verified information, to Companies House — before any application to the UK’s land registries can be made.

Its relatively rapid and seemingly worked-through implementation suggests what can be done – given the will to do so amid and engendered by the existence of wider amenable political circumstances.

Politicians will probably need to mould such circumstances to support LVT introduction, when their commitment and willingness to do that is not present or apparent currently.

The institutional environment

Although the supply of land in total might be finite and fixed, and thus perfectly inelastic in supply (excepting reclamation, or loss due to natural calamity or natural process by flood or erosion), uses to which a plot can be put and hence its value or price are subject (and can vary) not only with its own physical characteristics, (topography, soil fertility, and other factors impinging on the cost of bringing into, or changing a particular use), but, crucially, also with the related institutional and other processes that govern how it is regulated, traded, and then used.

In the UK, the planning system largely governs the institutional framework in which land is traded and used.

It attempts to reconcile competing – and often conflicting – economic and social objectives, including the enhancing of urban amenities, the preservation of green belts around towns and cities, as well as the wider environment, including National Parks, designated areas of natural beauty and other green spaces, the provision of adequate transport, education, and health social infrastructure, as well as the meeting of additional housing requirements.

The planning system determines changes in designated development use, including the intensification of an existing building use, the redevelopment of an existing use, as well as the switching of use from, say, agriculture to residential use. Planning permission for change of use usually crystallises changes in the plot’s development value.

The supply of land for business or residential use, therefore, is not completely fixed in the contemporary UK environment. The supply responsiveness of land for specific development purposes can vary significantly according to local and national planning policy processes and their application.

These processes can add time and other costs to the development process. The current value of hectare of agricultural land is c£22,000; when attached with a planning permission for residential development across many areas its average value will tend to exceed £2m:  a hundredfold increase; on the face of it indicating a massive windfall for any lucky farmer waking up one morning and finding that their land has been zoned for residential housing.

It is, of course, not quite that simple. The farmer will invariably need to share that gain with a development partner prepared to invest in the cost of obtaining planning permission.

Section 106 planning and affordable housing obligations and infrastructural levies, as well as infrastructural servicing costs, and then construction cost, will sometimes eat into some of that apparent return, which can, however, remain substantial.

The degree to which a LVT will be partly or even predominately borne by plot owners will still largely depend how price inelastic that supply is: the lower the price elasticity of land supply (when the demand for residential or other use is more price elastic or sensitive), the higher will be both the potential development value and taxation potential of that plot(s).

The empirical delineation of such relative elasticities is incomplete and uncertain, however, varying with area and with the reservation (lowest) price each individual landowner will willingly sell an individual plot(s).

The measurement of land rent that could potentially be available for taxation continues to constitute a central problem in LVT design and implementation, especially in interaction with the prevailing institutional environment, in this case the planning system.

In that light, valuations would need to take account of all current planning conditions and rules relevant to each site.

The government’s 2020 Planning White Paper proposals to move towards to a zonal rules-based system have largely been kicked in the long grass. The planning system in England and Wales is likely to remain to a significant extent discretionary based, contributing to valuation uncertainty.

It follows that a treatment where each plot is valued according to its “highest and best use” or its “optimum permitted use” consistent with applicable planning and zoning rules, it would be set (such as land in current agricultural use but zoned for housing use) with reference to a postulated value that subsequently may not be necessarily realised.

Assuming that planning permission would be granted in line with an assumed zonal valuation could also consequently risk rejudging that decision, giving rise to possible to compensation claims from landowners not securing the planning permission they could argue was consistent with its zoning, although the application of that assumption would tend to act as a nudge, rather than a non-resistible shove, for them to progress change to “optimum permitted use”.

Even though option or other agreements between developers and owners could provide an indication of market valuation of ‘hope’ values based on the expectation that a change in planning use sometime in the future will secure permission would be hypothetical and even more uncertain in realisation.

Another consideration is that a pure LVT levied at a gradually rising rate within the one to five per cent range is not really designed to capture high levels of windfall gains or land rent as defined by Ricardo, as understood by George, meaning that it is likely that planning gain windfalls would still need to subject to other development levies, such as Section 106 affordable housing requirements.

In short, real-world conditions are far more complex than was the case when George proposed his single land tax solution.

Section Three shows that governments across America and European industrial countries – at least in practical policy terms – to all intents and purposes were largely unreceptive to his solution – and have remained so since.

A twist in that tale is that Georgist prescriptions have been successfully applied in high density East Asian urban environments – in a customised society-specific fashion – during the last third of the twentieth century.

3          George’s international legacy

Expectations of the transformative potential of LVT have greatly outreached outcomes.

The use of land value taxes started from a low base around the turn of the twentieth century (Japan had already established one) and have since tended to recede.

LVT practice in local municipalities in the United States (US) – Pennsylvania in particular; Denmark, and then New Zealand – are often touted as positive examples of LVT application, when, in practice, they provide testimony rather to its limited application.

Post war outlier exceptions are concentrated in post war East Asia, including the four east Asian ‘economic tigers’ – Singapore, Hong Kong, South Korea, and Taiwan – which enjoyed sustained annual economic growth rates of seven per cent across recent decades.

Singapore’s application of Georgist principles from its beginning as an independent city state combined with their centrality to its chosen development model and institutional arrangements, provides an exemplar example of effective integration of land assembly, planning, taxation, and housing policy development.

Its exceptional geographical and political institutional characteristics suggest, however, limited direct replicability.

United States (US)

LVTs have tended to metamorphose into wider combined taxes on property that include the value of the structures built upon a plot, and – depending on their design and the frequency of revaluations – of any subsequent improvements made to such structures.

The United States (America) is a prime example. Its cities and states over time have levied property tax variants rather than a pure land tax, before progressively ceding to pressures to reduce their limited coverage and incidence.

That receding trend is not difficult to understand. In 1978, Proposition 13 – a ballot referendum measure in California – capped property taxes to one per cent of a property’s assessed value and that to its original purchase price (rather than its current market value), save for an annual allowance of two per cent. Owners in areas of rapid house price appreciation, such as San Francisco, were thus given a disincentive to move.

Proposition 13 encouraged similar measures across states and localities. It also discouraged state and municipal politicians – fearing similar local taxpayer revolts – from going down the LVT road.

Local governments have tended to become a prisoner of the local homeowner vote: modern American democracy as it has turned out is hardly as George envisioned.

The exception (or possibly the exception that proves the rule) is Pennsylvania. Municipalities there, however, have primarily applied a split-rate tax (a partial LVT where land is separately taxed at a higher rate than is the buildings sat on it), rather than a pure LVT.

One demonstration example in that state often cited is Harrisburg, whose city authorities in 1982 more than doubled the tax rate on land while reducing it on buildings.

The city, according to economist Jerry Jones, in another Labour Land Campaign paper, subsequently enjoyed a rejuvenation in economic activity, in housing supply, and in public revenues.

Another is the former steel city of Pittsburgh. After it lowered taxes on buildings relative to land in the late 1970s, the city experienced a reported ‘building boom’ that ameliorated the impact of deindustrialisation, at least in comparison to other deindustrialising cities, such as Detroit.

The City of Altoona in central Pennsylvania is notable insofar that between 2011 and 2016, according to the Federal Highways Administration (FHA), it was the first and only city in the US to rely on a pure land value tax, alongside 16 cities and two school districts that levied a land tax together with other taxes on buildings (partial LVT), including, presumably, Harrisburg.

In Altoona, a split-level tax was levied on 20% of assessed land plot values in 2002; the plot rate on buildings was concurrently reduced to 80%. The land plot rate was then increased annually by 10% as that on buildings was reduced by 10%, until, in 2011, it became a 100% tax on the land value of the plot and zero on buildings: a pure LVT.

The FHA reported that the assessed value of all land in Altoona accounted for one-seventh that the combined total value of its land and of buildings (real estate value).

The corollary of that low proportion was that the pure LVT tax rate needed to increase sevenfold to match the revenue that the predecessor combined property tax generated.

More generally, where land plot values represent a relatively low proportion of total combined land and building value, a pure LVT must be charged at a much higher rate across a much lower base (on land only, rather than combined land and structure value) to secure the same amount of revenue or yield that a previous combined land and building property tax did or would need to.

In Altoona, notwithstanding its higher LVT rate, 72% of its municipal payers faced a lower tax bill than they previously did under a combined tax regime.

Property owners with land valued less than one-seventh of the total assessed combined land and building value of their plot paid less in total. Conversely, owners with land valued at more than one-seventh of the combined land and building value of their home paid more, as did owners of vacant or underdeveloped plots.

Taxes on agricultural land were not changed under this new land value tax regime.

But no clear link between the LVT and positive subsequent urban outcomes across the city were established – at least by the official FHA evaluation.

In short, the Altoona LVT did not prove a magic bullet and was shelved in 2016. The demise of Altoona LVT , according to its mayor, resulted from two main reasons.

First, the continued existence of other county and the school district-imposed property taxes narrowed the scope for LVT to generate its own incentives, accounting as it did for just a small fraction of the overall property-related tax take.

The second and related reason was that residents and businesses struggled to understand the potential benefits of moving to or investing in the city that the LVT potentially offered.

Its novel exceptionalism meant that businesses might have been deterred from investing by the apparent relatively high rate of tax on land plots, not understanding that as the plot tax rate on buildings was zero, the effective plot rate was usually lower than was the case previously and elsewhere.

City officials noted that the LVT attracted interest from national media and “places as far away as England and elsewhere in Europe intrigued by land value taxes”, underscoring the need such informational perception failures to be overcome in the future.

The FHA noted that the it possibly did improve distributional outcomes, helping to push up property values in a low value area, and encouraging, at the margin, some intensification of use with associated greater economic activity, concluding that a LVT is: “is well suited to established cities and smaller growing cities where there is a need to build new mixed-use infill projects… regular reassessments are essential with the land value tax if municipalities need additional tax proceeds”.

Denmark

Across the Atlantic, in Denmark a land tax accounted for around 50% of local and national government revenues, calibrated to an agricultural yield benchmark historically based on what could be grown on the best quality land. That was in 1903 before it was abolished.

Subsequently, the secular tendency has been for income and other direct taxes to increase as proportion of public revenues.

Direct personal taxes now account for over 50% of its public revenues, the highest of any OECD country (see OECD link reference below).

A separate tax on land value remains alongside a wider property tax calibrated to property values, where a higher marginal rate is levied on higher value properties.

According to the most recent relevant Organization for Economic Cooperation and Development OECD  publication data published in 2021, property taxes represent a relatively insignificant feature in the country’s taxation landscape, not discordant with  a wider international long-term trend where “Between 1965 and 2019, the share of taxes on property fell from 7.9% to 5.5% of total tax revenues on average across the OECD (Figure 6). Canada, Israel, Korea, the United Kingdom and the United States had property tax revenues that amounted to more than 10% of total tax revenues”.

In this high-income Scandinavian country blessed with an enviable taxpayer-funded post-war welfare state, where high levels of direct taxes that might otherwise be expected to be distortionary and inefficient finance high levels of social expenditures that tend to reduce labour costs, supported by high levels of social solidarity, LVT appears more as historical anomaly than a transformative tax instrument, as envisaged by George.

That said, its property and land tax design may well offer pointers for future incremental property tax reform across the UK and elsewhere.

A more detailed and updated case study would be helpful in that regard.

New Zealand

A study of the New Zealand (NZ) land tax noted that from 1894 that it was levied on land value only. The following year it provided around three quarters of total land and income tax revenue.

But fast forward to 1965, its revenue had dwindled to a mere 0.5 per cent of total land and income revenue.

By 1982 only five per cent of its total land value was taxed, reflecting a secular trend for the national LVT to wither on the vine. Agricultural and land residential land had been effectively exempted from its base, before it was finally abolished in 1992.

Instead, local property rates provided the principal source of NZ local authority revenue, while income and other taxes provided the primary base of national taxation revenues.

Some NZ local authorities do, however, continue to impose their own limited land tax. Although these are informed by comprehensive property valuations carried out triennially by the central government, the total yield of all NZ property taxes, including land taxes, by 2018 only totalled around 2% of its GDP – close to the OECD 1.9% average, but less than half the c4.1% recorded for the UK.

Local land-value taxes are common in Australia, but residential property is mostly exempted, thereby restricting their base and yield.

Singapore

The legacy of Henry George in many ways has shone far more brightly in Singapore than it has in his native New York.

A British colony until 1959 when it became self-governing, Singapore then became fully independent from Malaysia in 1965 as a sovereign city state.

Its subsequent story is one of remarkable rapid economic transformation and success, moving from low-income poverty to high income self-sustaining success.

According to the Charter Cities Institute per capita income increased, staggeringly, from c$428 in 1960 to $65,000 in 2018 and is an exemplar of “excellent governance’’ among planned cities.

Singapore like Hong Kong, hemmed in by the sea, was forced to grow by necessity upwards rather than radially, generating exceptionally high urban population densities of over 6,000 persons per square kilometre, notwithstanding that since 1960 land reclamation enabled the extension of its spatial area by a quarter.

It is one of only a few jurisdictions in the world to have successfully implemented a comprehensive system of land value capture mainly through the direct state ownership and leasing of land. Hong Kong’s development also involved the government leasing and collecting land rent from state-owned land.

The resulting revenues helped to induce a virtuous cycle where development unlocks the funds necessary to bring forward the infrastructure needed to unlock further productive development.

From the outset, in accordance with the Georgist principle that no private landowner should benefit from development financed or supported by the community, government land ownership in Singapore largely prevented individuals from capturing rising land values and rents.

Its Land Acquisition Act 1966 provided broad powers to state and other entities to compulsorily acquire land for any public purpose where, “in the opinion of the Minister, it is in the public interest to do so”, at a price that disregarded the contemplated future value of the subsequent development.

A massive and systemic transfer of land from a small number of wealthy landowners to the state followed. Subsequent rises in land values generated by rising and concentrated levels of economic activity were then captured by the Government and used for infrastructural investment. The state continues to own c80% of the city state land mass.

Singapore’s example (as is Hong Kong’s) is one of effective land reform and state ownership and value capture by proactive state direct action – in its case helped by a stable wider macro-economic and political environment.

As such, it can be broadly characterised as a state capitalist model that is wedded to free trade principles, welcoming to foreign inward investment.

Although Singaporean taxes are low by advanced economy standards, it still levies VAT (GST), income taxes, stamp duty, and other taxes, including a property tax that is progressive (rates increases in line with value thresholds and differ between owner-occupied and non-owner-occupied residential properties) based on annual rental value.

The long-term stewardship of land assets by the Singaporean state underpins its widespread provision of 99-year leasehold homeownership to its citizens; an investment in social capital that, in turn, supported its wider economic model, which aimed to keep wages and other business costs low to make Singapore an attractive investment opportunity for foreign firms.

An Asian Development Bank study of Singaporean housing policy provides more detail on the relationship of Singaporean housing policy to its wider economic success.

Between 1961 to 2013, the Housing and Development Board (HDB) – the public housing authority – built more than one million high-rise housing units. It functioned also as a housing finance intermediary, harnessing domestic savings through housing-linked accounts.

Singapore’s public housing was primarily sold to middle-income buyers. Purchasers not only possessed the right to live in their flat, but also sell it on at a market-rate price, or to lease it to a tenant until their 99-year lease expired.

Despite the high levels of state land ownership, rising house price and affordability still proved a problem – land is sold or auctioned at market value for housing – forcing the government to introduce a package of ‘anti-speculation’ measures in 1996.

These included capital gains taxes on the sale of any property within three years of purchase, stamp duty on every sale and sub-sale of property, the limitation of housing loans to 80% of property value, and limiting foreigners to non-Singapore-dollar-denominated housing loans

And, since the noughties, a series of purchase grants tied to household income were introduced that allowed the HDB to price its flats more responsively to a household’s ability-to-pay.

HDB also provides public housing for rental, comprising smaller units, such as one- and two-room flats. They are mainly provided for lower-income households and to those waiting for their purchased flats, and, as such, are attached with lower income requirements compared to units offered for sale.

Reportedly, almost all employed citizens own their home, subject to age and other social eligibility restrictions.

These can be restrictive, however. Young people needed to marry or wait until they attained the age of 35 to qualify, for instance. Economic migrants making up c15% of the total population are not eligible for HDB housing.

4          A Panacea Stillborn in the Twentieth Century

 “The landlord who happened to own a plot of land on the outskirts or at the centre of our great cities ……sits still and does nothing. Roads are made, streets are made, railway services are improved, electric lights turn night into day, electric trains glide swiftly to and fro, water is brought from reservoirs a hundred miles off in the mountains – and all the while the landlord sits still.  Every one of those improvements I effected by the labour and at the cost of other people. Many of the most important are effected at the cost of municipality and of the ratepayers. To not one of those improvements does the land monopolists as a land monopolist contribute. He renders no service to the community, he contributes nothing to the general welfare…the land monopolist only has to sit still and watch complacently his property multiplying in value”. Winston Churchill, The People’s Rights, 1909.

“Henry George failed…because he had been studying the world as it had been for generations and centuries, and arrived at certain conclusions on that basis, and the conclusion he arrived at was that land was practically the sole source of all wealth. But almost before the ink was dry on the book he had written it was apparent that there were hundreds of different ways of creating and possessing and gaining wealth which had either no relation to the ownership of land or an utterly disproportionate or indirect relation”.

Winston Churchill, Speech to Parliament, 5th June 1928, quoted in Churchill Project.

Henry George had published Progress and Poverty in 1879 into a rapidly urbanising and industrialising democratic society marked by high levels of immigration and internal migration, yet, unlike Britain, in terms of population, was still predominately agricultural and rural based.

The last Section showed that George’s prescription of a single tax on land removing the need for all other taxes, ushering in an era of plenty and equality according to desert, proved more a chimera than a panacea in his own country and its closest economic peers.

At some levels conditions appeared potentially ripe for the introduction of a Georgist land tax given rising democratic pressures to protect the majority from poverty amidst riches, while government expenditures remained below 10% of GDP until the turn of the century with commensurate taxation requirements.

This Section considers why his single tax idea was stillborn. Although mainly using Britain as a case study, parallels with his native land are clearly discernible, including that of other issues dominating political discourse and attention, the associated lack of sustained political focus, the lack of a powerful electoral coalition in favour rather than opposed, and the institutional lack of capacity as well as willingness to implement it.

The growing importance of government within the economy necessitated by the First World War and resulting increase in expenditure and taxation requirements then largely resigned the Georgist agenda to the status of historical curiosity.

Historical context

Britain, as the nineteenth century wore on, was increasingly imbued with the democratic influences that post-Revolutionary America already possessed.

The Conservative Disraelian 1867 Reform Act had given the vote to all householders and to those paying more than £10 in rent in towns – enfranchising some of the urban working class for the first time. Gladstonian Liberal legislation in 1884 did likewise for rural workers.

In Britain, the numbers of urban workers increased absolutely and relatively as a proportion of the total franchised population. By 1874 trade unions had already sponsored two working class Liberal MPs.

Trade union membership spread both in size and reach during the next two decades to encompass the unskilled majority.

Urban riots involving workers and the unemployed attracted heightened political concern. Joseph Chamberlain, ex-Mayor of Birmingham, when Liberal President of the Local Government Board during the mid-1880s, for instance, made speeches that yanked together the inequities of inherited wealth inequality to the need for “property to pay a ransom for its security”, presaging Winston Churchill twenty years later.

Yet Chamberlain and other like-minded Social Liberals diverted the focus of their attention to Irish Home Rule (the cross-cutting Brexit issue of that era), displacing the development of a socialistic liberal agenda based on Georgist principles, responding to embryonic demands for the state to intervene to provide at least some minimal level of social protection and security at least to the ‘deserving poor’.

By the turn of the century Chamberlain had reinvented himself instead as the leader of the Liberal Unionists propagating a tariff reform and imperial preference political programme.

By then socialist-oriented political organisations, such as the Marxist Social Democratic Foundation, and then in 1893 the Independent Labour Party (ILP) had formed to further the specific class interest of workers politically. Intellectuals wishing to translate nascent collectivist responses to Victorian laissez faire into more concrete and universal policy programmes also established the Fabian Society.

Along with the trade unions these and similar organisations together provided the nucleus of the Labour Representation Committee soon to become the Labour Party, which would replace the Liberal Party as the main electoral alternative to the Conservative Party.

The government’s need to finance both growing social and military expenditures, including on a rudimentary national insurance system for working men, and on a basic non-contributory old age pension of five old shillings payable at age seventy, as well as on battleships or ‘Dreadnoughts’ to keep pace with the growth of the German fleet, provided the fiscal backdrop to the 1909 People’s Budget.

Its prime movers were the humbly born Welsh chancellor, Lloyd George, and, following his switch to the Liberals from the Tories, the President of the Board of Trade: the more aristocratic Winston Churchill.

Both in their speeches excoriated, as did George, the inequity of poverty spreading amid abundance, highlighting, very much on Georgist lines, the ability of landowners to expropriate the benefits of rising land values generated by community actions and investment, such on water supply and streetlighting.

The 1909 budget, on top of an increased and more progressive income tax, including reliefs for those at the bottom and an additional supertax for those at the top, also proposed a land tax.

At a time when one per cent of the population, some 33,000 people, owned two-thirds of its wealth, a Georgist LVT that could be levied on a wealthy minority for the benefit of the franchised majority (excluding women until 1918) appeared an attractive proposition for a radical government to grasp.

Although it provoked sharp opposition from the opposition and the Conservative dominated House of Lords, the Liberal Prime Minister, Sir Henry Campbell-Bannerman’s pledge “to make the land less of a pleasure ground for the rich, and more of a treasure-house for the nation” resonated with the growing democratic tenor of the age, seemingly aligned on Georgist lines.

But Lloyd George struggled to persuade parliament to introduce a workable LVT that could be implemented quickly. He seemed himself confused as to how it would work.

His package included a 20% tax on the unearned land capital gains revealed on sale, a capital levy on unused land, and a reversionary tax when leases expired, making the proposals more akin to a development tax than a pure LVT.

It presaged post war – and similarly unsuccessful – efforts to tax betterment gains rather than representing a distillation of Georgist principles into a practical policy programme. It was soon abandoned in 1920 on the stated ground of valuation difficulties.

Instructively, in the light of the waxing and waning of Chamberlain’s Georgist star twenty years previously, many historians consider that the radical Liberal duo had had touted a land tax more to provoke the House of Lords so to reject the People’s Budget – and thus set up a ‘People versus the Lords’ election that their then party expected to win – than it was a committed effort to shift the tax base onto landed wealth.

Boris Johnson’s 2019 efforts to provoke the Commons to dissolve Parliament and so precipitate a ‘Get Brexit Done’ election that he banked on then to return him with an unassailable majority, perhaps, provides a modern political example of that same, and far from uncommon, political phenomenon.

And, in any case, free trade versus tariff reform continued to compete for hegemonic political attention, fragmenting political alliances that could otherwise focused on Georgist land reform.

The Georgist moment – even if it had really existed – had passed.  Most of the additional tax ultimately raised after the two People’s Budget elections were sourced through income tax.

The fiscal institutional environment

For much of the nineteenth century, custom and excise duties, along with the ludicrous window tax (which had the deadweight effect of householders blocking in their windows – an effect sometimes still visible in Georgian houses and terraces) accounted for most of the government’s revenue in Britain.

In 1874 – five years before George published Progress and Poverty – customs and excise contributed £47m to the government’s total revenue of £77m, which itself accounted for approximately six to seven per cent of Gross National Product (GNP).

A national income tax had been first introduced during the Napoleonic Wars, was made permanent in 1842, increased temporarily to meet the exigencies of the Crimean War, and then reduced and applied at a low rate for the remainder of the century. It was not paid by the bulk of working population.

Its imposition, requiring personal information to be provided to the state was perceived as a potential threat to personal freedom, contrary to the prevailing liberalism of the age.

Across continental Europe, industrialisation was accelerating across the nascent national state democracies. Growing nationalism, militarisation, power rivalry, and political upheaval followed in its slipstream.

Bismarck increased military spending to further his Prussian territorial ambitions embracing a greater Germany. The first national insurance scheme (funded on a tripartite basis by workers, employers, and the state) for workers, as well as old age pensions, was introduced during the 1880s to stave off discontent and to build up solidarity within a fledgling fragile democratic national Germany polity.

The First World War then dramatically further spiked-up public expenditure requirements in the UK as did earlier the Boer War in  a more muted way.

Income tax rates reached an unprecedented 52%, even though much of the needed revenue was borrowed.

Across the Atlantic, federal income tax in America was introduced in 1913. Although its standard rate in response to wartime financing demands was temporarily increased to six per cent alongside a surtax rate that reached 77%.

As a federal state, local and state taxes remained relatively more significant within a fiscal environment where multiple local government bodies collected over half of all federal, state, and local government revenues. In Britain they accounted for over a third.

Wallis characterises the American fiscal environment the period between 1840 and the early 1930’s as one dominated by local government deploying property taxes as its main revenue base.

It was not until the Great Depression the trend began for the federal government to become more active and increase its share of total government expenditures and revenues as it shouldered increased infrastructural, defence, and social security, expenditure requirements

In the aftermath of the First World War in Britain, or its deluge, as one historian put it, the world had changed. A freshly universally franchised working-class population that had borne stoically the sacrifices required by the first ‘total’ war, no longer was prepared to tolerate precarious poverty and squalor as a way of life.

Wartime levels of taxation, which in incidence largely fell on high income households, could not be returned to pre-war levels. Surtax remained in place, as it did until 1973.

Peacock and Wiseman, authors of a 1961 seminal study of UK public expenditure 1890 to 1955, described that as a “disturbance effect” – where expenditures previously considered desirable, but politically difficult, to introduce become possible, using the graphic metaphor that “It is harder to get on the saddle on the horse than to keep it there”.

Clark and Dilnot termed it, perhaps, more precisely as a “ratchet” effect: in short, war-related imperatives ballooned public expenditure up; the subsequent post war level, although reduced, remained substantially above its pre-war trend level.

War-related social upheavals also imposed new and continuing obligations on governments, forcing governments and their populations to focus on latent problems, such as poverty and poor housing impacting on population health that undermined national economic and military capacity. This Peacock and Wiseman described an ‘inspection effect’.

Appendix Table A-6 reports their computed consistent historical total government expenditure as a percentage of gross national product series, recording that percentage as around 12.5% during the Edwardian era compared to c9% in 1890 (with a disturbance or ratchet jump to 14.4% in 1900 related to Boer War spending requirements).

Although it then dropped back from the over 50% wartime levels to c26% in 1920, it remained ratcheted-up during the inter-war years at more than twice Edwardian levels, notwithstanding government efforts to trim back some social expenditures as part of ill-advised attempts to balance the budget – efforts that in 1936 would be exposed to the critique of James Maynard Keynes.

The experience of the 1917 Russian Revolution had concentrated post war government minds on the need to placate an increasingly non-deferential and potentially rebellious electorate. Increased public spending on social services was perceived as an ‘antidote’ to a revolutionary virus that threatened to replicate domestically.

In that light, the 1919 Addison Act provided for ‘Homes for Heroes’. It introduced generous government subsidies for new public housing with generous space and quality standards, supported by an imposed duty for local authorities to provide such housing, where local housing conditions required it.

Although these subsidies were trimmed back as part of an economy drive, later Housing Acts provided a workable subsidy framework that allowed four million new homes to be built during the interwar years.

Winston Churchill by then had pivoted back to the Tories. As Chancellor of the Exchequer in 1927, he was using his formidable powers of exposition in Parliament to make the argument (quoted at the beginning of this Section) that its consideration of a LVT would simply divert attention from the current and pressing imperative to develop new needed forms of taxation on Britain’s industrial economy.

But given the wider context of the UK in the 1920’s and the part that Churchill played in its economy and politics – including his suppression of the 1926 General Strike and his reimposition of the deflationary gold standard – it could be that he was simply re-exerting the interest of the prevailing ruling class, of which he was such an eloquent and colourful member.

Income and other taxes, not LVT, across both sides of the Atlantic emerged as primary tax sources to finance the upward step-change in public expenditure and hence revenue public requirements, although income tax only began to be paid by most peacetime working households, however, after the Second World War.

Phillip Snowden, chancellor in the National Government did seek to introduce a LVT in his 1931 budget, briefly enacted in that year’s Finance Act, but at the limited rate of one penny for each pound of the land value for every unit of land in Great Britain.

The Hansard record of the time provides some pointers as to why legislators were reluctant to give it traction: limited revenues relative to the costs of collection; valuation challenges amid doubts over of relevance of a Henry George single tax LVT given the massive rise in public expenditures and revenues that had occurred during the intervening fifty years; as well as the spread of individual home ownership on plots with relatively low land values.

One MP observed that Henry George, in effect, had extrapolated from the particular –dramatically rising land values of virgin land that due to their (Californian) location were ripe for development – to a general principle that did not hold in inter war Britain.

Following the 1931 election, conducted in a period of political tumult as the Great Depression took grip, Snowden’s half-hearted land tax, lacking any real political wind or momentum behind it, was soon repealed.

Labour MP and LVT campaigner Andrew MacLaren did introduce a private member’s bill in 1937 but that, too, was defeated.

Soon afterwards in 1939, across the Thames, Herbert Morrison, leader of the London County Council, began to progress a Land Value Tax Bill before that was scuppered by the outbreak of the Second World War.

That conflagration resulted in another unprecedented but unavoidable spike in government spending, borrowing, and taxation, with government expenditure this time reaching 72% of national output.

When Churchill was elected Prime Minister in 1951, government spending was stabilising around 40% of national output – a historic peacetime high.

The introduction of a LVT did not seem even to cross his mind as a practical policy or taxation tool to raise the revenues that a modern emerging welfare state required.

Why was a Georgist LVT was stillborn?

An academic economist turned permanent secretary in an influential post-war and multi-edition book declared that the: “writings of Henry George, although still enjoying a wide circulation, have ceased to command much attention or to be an important force in the world today. They are no longer considered even so dangerous by the academic economists as to be worthy of vituperation or rebuttal. And, in the working class movement they have long since been superseded by other theories”.

Eric Rolls, History of Economic Thought (p.386, 1992 Penquin fifth edition; first edition published in 1938)

Rolls, put the “meteoric rise and almost equal rapid exhaustion of (George’s) power” down to “his mixture of oracular presumption, insistence of a single idea, and muddle-headedness on economic problems”.

That may have reflected the academic consensus of the time but such a dismissal of George’s ‘single idea’ (although echoing the 1927 Winston Churchill quote, reproduced at the heading of this Section) now comes across as short-sighted.

A much more rounded understanding of why a Georgist tax on land rent did not take off and continues – at best – to be left on the political backburner, is required.

In a 2019 paper Whitehead and Crook assert that the: The simplest models of land taxation (starting from Henry George, 1879) assume that land is homogeneous, its total amount is fixed and that all land will be taxed at the same rate. If that is the case the price of land is demand determined by the highest valued use and any tax will simply have to be absorbed by the landowner. The same applies to taxing increases in land values. However, this model bears no relation to the real world. As only a small part of total land is actually developed, more land can be made available as prices increase and land can be taken out of development if taxation makes it unprofitable. More importantly land has very different attributes and therefore the highest value productive use differs between plots – so planning and taxation will modify both the total amount of land made available and the allocation of land to different uses.

George could not be expected to have foresight of future foreign institutional systems, nor was he offering an analytical abstract economic model with consistent micro-foundations. His work was rather a call for action based on analysis and argument.

Polemical over-simplification is not an uncommon characteristic of such works. It is a fair charge that can be laid at George’s door.

That said, his central theoretical construct of capturing land rent through the imposition of a near 100% tax to avoid what are now commonly called the deadweight effects of other taxes is coherent on its own terms based as they were on Ricardo and others, made more cogent as the wider tax burden as a share of national output and average household budgets has grown.

As Section Three noted Georgist ideas in essence have been successfully implemented in Singapore – a point that Rolls ignored or escaped his notice.

What George neglected to consider carefully was that taxable land rent will differ between plots. He did not specify how liability would be determined and collected with reference to the institutional environments of his own time and place.

He did correctly predict that vested interests were quite likely to capture government and smother his proposed LVT at birth.

Federal and state governments chose or had earlier chosen to give land grants to railroad and other moguls at sub-market prices, rather than auction at market prices or introduce a LVT.

They likewise offered large tracts of virgin or Indian dispossessed land in the Great Plains and West through Homestead Acts to settlers (but often purchased by land speculators) at rock-bottom prices.

There was an economic rationale for this. Government lacked the wherewithal or taxable capacity to plan and fund such economic infrastructure and relied instead on private corporations and individuals to drive development. A less legitimate reason wa that many if not most legislators enjoyed getting the associated bribes, kickbacks, or donations that often followed.

Indeed, during a period when national politics in America was notoriously corrupt, clientist, and ‘spoils-based’, it is not apparent that a 100% tax LVT would be electorally popular or understood by a still largely rural and agricultural population. Farmers of varying holdings were electorally significant, while Homestead settlers, as landowners could not be expected to welcome it.

Prussian aristocratic landlords, large American landowners, or the English aristocracy basking in an Edwardian Indian summer of privilege were other powerful interests standing in the way of a Georgist tax within their own societies.

Politicians then, as now, pursue multiple objectives for mixed motives that often conflict. Their short-term focus, subject as it is to contingent events impacting on their own ambitions and interest, makes it difficult for a single overarching idea or principle to retain traction and momentum.

In 1883, Henry George, himself, highlighted continuing immigration into a now often ‘overcrowded’ country whose lands had filled up, as a primary issue, asking in a shrill, and to our ears seemingly racist, voice: “What, in a few years more, are we to do for a dumping ground. Will it make our difficulty any the less, that our human garbage can vote?”. Hugh Brogan, p393, the Penquin History of the United States, (new edition.)

Policy programmes or initiatives, most particularly an overarching one like a Georgist LVT, if they are to be implemented, must first command and then maintain hegemony and attention for a prolonged period.

The fleeting flirtation of Chamberlain and Churchill with an incompletely and vaguely conceived idea of a land tax lacking institutional machinery to implement, demonstrated that in Britain.

In George’s America, cyclical depressions with deflationary wages and agricultural prices often necessarily became of paramount political concern. During such times, with railroads, corporations and farmers going bust, a 100% LVT would be as welcome as a bullet in the head.

Tariff reform, as for example in the 1892 presidential election, became a pressing national political issue there, as did the relative arguments for, and the respective interests advanced by, keeping to the Gold Standard, moving to a bimetallic standard, or simply relying on a paper ’Greenback’ fiat currency.

Obstacles or crisis events, more generally, (such as Ireland Home Rule in the nineteenth century; the Great Depression in the early twentieth; the Global Financial Crisis (GFC) of 2008-009; and, most recently, the Covid pandemic) can rear their head out of the blue, as do other internal and external shocks, such as the agricultural depression of the late nineteenth century and the current cost of living crisis.

The subsequent cumulative rise in public expenditure and taxation requirements that marked the last and hitherto this century mean that shifting the tax burden onto a single land tax has now become akin to turning a tanker around in a tumultuous sea of economic and political uncertainty, rather than bringing a horse to water in a nineteenth century agricultural community when even that proved not possible.

5          The Feasibility of a Modern Gradualist LVT

It follows that a sudden transformation to a single Georgist LVT simply won’t happen. Modern democratic economies and societies are just too complex and encumbered with accumulated institutional baggage and entitlements.

Indeed, putting one eggs into a LVT with stated single tax ambitions, given the uncertainty of future events impacting on the economy and their short term to medium term interaction with such a future LVT, would render it an unwise hostage to fortune that would be almost certain to be shot down politically before it left the runway.

The experience of the 2017 general election is not promising in that regard. The manifestos of the Labour Party, the Liberal Democrats, and the Green Party included (very outline) proposals for a LVT, with p.86 of the Labour manifesto announcing that: “We will initiate a review into reforming council tax and business rates and consider new options such as a land value tax, to ensure local government has sustainable funding for the long term”.

Carol Wilcox of the LCC later noted that such a “mere mention of ‘considering’ LVT in their 2017 manifesto did for the Labour Party. Along with the dominant Tory press, headlines blazing from every high street and supermarket – Your Council Tax will treble and House Prices will plunge – leaflets were pushed through millions of doors. It may have lost Labour the election”.

Most LVT advocates in recognition of such practical political difficulties, propose an incremental phased-in approach that can command sufficiently strong support to get off the starting blocks.

Goodhart and colleagues, for instance, in their study recommended over a 20-year period a gradual rise in the LVT rate from 0.5% to 5.55% that would result in both substantial output and welfare gains and allow reductions in other taxes.

According to their modelling, to raise 55% of American public revenue (on a balanced-budget assumption), enough to allow income taxes to be abolished, the LVT rate would need to be increased to 20% – a level they considered represented the limits of political feasibility.

This Section identifies the main issues and possible problems connected with even such an incremental approach within a UK where land underlying dwellings has progressively accounted for a rising and increasing predominant share of national wealth.

Wealth and the British Housing Story

The inter-war years saw the establishment of a secular trend of displacement of private renting by owner occupation, across England especially. It was fuelled by a growth in salaried employment, in building society mortgage finance and in the availability of cheap land suitable for speculative and, in some cases, public housing development.

In the forefront of that trend were railway companies wishing to offer affordable new suburban semis in areas that their new lines had now made accessible: a prime example was the Metroland created around the Metropolitan line that now crossed Middlesex before reaching Buckinghamshire.

A landowner was now less likely to be a distant aristocrat or plutocrat, but – especially across southern and other areas left relatively unscathed by the Great Depression – could hail (at least as mortgagees) from a growing group of humbly born salaried workers, possessed with rising aspirations to escape into more virgin territory from the crowded dirty cities, forging a fresh future for their usually young families.

The post-war economic expansion amid accompanying full employment amid growing mass affluence that brought most wage earners into the income tax base also allowed increasing numbers to step onto the housing ladder. By the early seventies owner occupation was the majority tenure.

During the Thatcher era of the 1980s, the financialisaton of the economy (encompassing the globalisation and international integration of national capital markets, the liberalisation of domestic financial and credit markets, and the mounting and related importance of financial services within the economy), the right-to-buy programme coupled with the cessation of council building programmes, all turbo-charged the tenure.

Under New Labour, helped by a reducing but stable interest rate trend, it touched a peak of c70%, before receding.

Growing numbers of young people were priced out by real house prices – responding to the rise in monetary demand for housing enabled by a liberalised mortgage market offering loans at rising income and house price multiples – rising much faster than their incomes, while supply failed to keep pace and become progressively more inelastic in supply.

Nevertheless, extolled by both Labour and the Conservatives as the natural and default tenure of the aspirational majority, homeowners have become and remain an increasingly pivotal electoral swing constituency.

Rising real house prices rises – most marked in areas of buoyant economic activity and rising house prices, largely concentrated in London, the home counties, the south-east, and other places within commuting distance of secure well-paid sources of employment, where new supply was constrained by the planning system and by market failures in an increasingly concentrated housebuilding industry.

Housing wealth owned by households (composite value of dwellings and of underlying land) across those areas has progressively taken larger shares of national net worth (wealth).

Meanwhile the real construction cost of building new homes changed relatively little, meaning that the value of the land underlying dwellings accounted for most of that rise, with increased housebuilder profits also taking a share.

According to a ONS March 2022 methodological paper, land in 2020 was the most valuable asset in the economy, estimated at £6.3 trillion in value – nearly 60% of the UK’s net worth, with land underlying dwellings accounting for £5.4trillion of that value.

Table 11 of the latest May 2022 ONS national balance sheet estimates indicates that the value of land underlying dwellings owned by households as a proportion of total land and structure value (including dwellings) rose from 25% in 1996 to 68% in 2021.

Although such estimates should be considered with caution due to valuation and other uncertainties, it is undoubtedly true that residential land has assumed an increasing share of national wealth at the expense of produced non-financial assets (proxy for productive capital).

Significant implications follow. First, it provides evidence in support of commentators, such as Stiglitz, who argue that increased land values can dampen investment and productivity, as well as incomes, increasing wealth of the paper rather than the productive kind.

Second, it strongly suggests that across high value areas in the UK, the pure land value (land underlying dwellings) will often exceed 70% of the combined land and building residential plot value, presenting a sharp comparison to the one seventh that Section 3 reported as prevailing in Altoona, Pennsylvania, when a pure LVT was applied there. The ONS does not break the UK data down regionally, unfortunately.

Third, such high land values strengthen the potential scope and capability of a pure LVT levied at relatively low headline rates to raise enough revenue to be replace council and potentially other taxes; but, by the same token, the incidence of such rates will still be high in cash terms with associated saliency and political acceptability implications.

Political acceptability and feasibility

Given the uneven distribution of house prices, the replacement of, say, council tax, with a pure LVT levied on the value of land underlying dwellings is likely to involve the creation of myriad gainers and losers, sometimes involving significant magnitudes, across the ‘Middle England’ households and older aged groups.

Taking an average priced c.£500,000 house in London and some other high value areas, assuming a 70 per cent land value (underlying the dwelling, excluding its value), a one per cent annual pure LVT would come to £3,500 (the rate roughly required UK-wide to secure proceeds approximate to the current council tax), rising to £14,000 if a four per cent rate was levied.

Even the revenue-neutral rate could prove a problem for homeowners with limited disposable income, net of housing, childcare, and other essential expenditures, as it would be for asset-rich but income-poor pensioners. It certainly would at higher rates.

Where it was believed that the tax will be levied and phased-in as announced and not repealed in short order by a future government – its impact would also be capitalised into capital losses, proportionate to its incidence.

Changes that impose large, unexpected losses relative to previous expectations can be considered ‘unfair’ insofar they infringe the ‘legitimate expectations’ of owners at the time when they purchased their asset.

A LVT introduced at a low but gradually increasing rate should dampen house prices and not precipitate a crash, however.

Nevertheless, combined with a recession impacting on income and employment or with other shocks, that outcome remains possible and is one that is likely to be highlighted by opponents.

Impacts on individual household and business budgets mitigated by transitional arrangements, variable rates, allowances, exemptions, reliefs, and deferments until death or sale of property or by other payment holidays, would tend to cloud and blunt the potential beneficial effects of a LVT, wedging new layers of complexity and confusion into the overall tax and benefit system, reducing net revenues in the process.

‘Gaming’ of the process by economic actors to minimise their tax liability under such transitional arrangements could also undermine or subvert the core intention of reform.

Essentially, a trade off exists between maximising revenue raising capacity of a LVT (and ability to replace other taxes) and minimising its possible lumpy salience, its volatility, and overall cash flow impacts that could surpass the immediate ability-to-pay capacity of individual taxpayers.

The introduction of a LVT gradually and in partial form, perhaps as part of a wider and long-term reform to council tax or business rates introduced on a revenue-neutral basis could postpone many of the putative benefits of a pure LVT, but could still come with feasibility issues.

In that light, the Scottish Local Government Finance Review published in 2007 that “although land value taxation meets a number of our criteria, we question whether the public would accept the upheaval involved in radical reform of this nature, unless they could clearly understand the nature of the change and the benefits involved….”.

Goodhart and colleagues, recognising that, argued that:  the overarching issue is that the bridging the gap between economic efficiency and political acceptability requires extensive public consultation, education and communication…to include short, accessible and realistic examples of the effect of the reform on different types of taxpayers, which for the vast majority will show that the gains from lower taxes elsewhere will far outweigh the losses from higher land taxes.”

That tends to gloss over, however, the ‘rough-and tumble’ way that new proposals are examined by the media, especially during the heat and sound of an election campaign when voter perceptions are prone to be moulded by untrue or partly true selective slogans and soundbites.

Unfortunately, the current political environment is geared to garner electoral support based on attitudes and perceptions, not to expound sound policy development supported by painstaking preparation in a process more conducive to the education of the electorate of the long-term benefits of a LVT.

The failed attempt of Theresa May to explain her plan to reform adult social care financing during the 2017 General Election, forcing its ignominious withdrawal after a media onslaught provides a salutary lesson in that regard.

Politicians of the mature industrialised countries – with England an exemplar example –have also become increasingly beholden to the electoral clout of the greying homeowner vote.

They can be expected to be extremely wary that potentially affected voters will take with more than a pinch of salt any promise that income tax cuts (in any case less attractive for retired households with limited incomes) sometime in the future will more than offset the publicised here and now impact of a salient pure annual LVT; many are likely to perceive it simply as a bigger council tax bill.

Such voters, many of whom plan in the future to bequeath their home to their children, can also be expected to react negatively to media-magnified fears on the impact such a LVT will have on its future value.

Any prospect of a successor government reversing introduction of a LVT would add to uncertainty with attendant adverse consequences.

Threats to do so could undermine its prospects of success from the start, sowing doubt as to whether the gradual benefits – notwithstanding that they could, indeed, accumulate exponentially over time – justify the short-term political hassle and risks involved.

A new government is likely to be dogged by vocal campaigns from those that would lose from its introduction, by other contingent political squalls, and by other pressing priorities; all can be expected to intrude and quite likely to knock off course a smooth LVT transition or phasing-in.

A revenue raising LVT reform, on the other hand, can be expected to induce correspondingly stronger political opposition.

In the absence of both overriding commitment and an effective and sustainable political counter strategy, the likelihood remains that it risks remaining as stillborn as it was in the nineteenth century.

That said, the increased proportion of residential property value taken by the underlying land does also mean that alternative reforms of council tax that address directly its current regressive vertical and horizontal inequity and efficiency, could offer a proxy to a LVT.

A proportional tax on total property value, as proposed, for example, by the Fairer Share campaign at a 0.48% rate, which they estimate would be sufficient to allow the abolition of Land Stamp Duty tax, seems credible in that context.

6          LVT and Business rates: line of least resistance?

“The property tax is, economically speaking, a combination of one of the worst taxes — the part that is assessed on real estate improvements — and one of the best taxes — (the part based) on land”, William Vickrey, Nobel Prizewinning economist

“Taxing business property inefficiently discourages the development and use of business property. If possible, it would be better to tax the value of the land excluding the value of any buildings on it, which would have no such effect …. is such a powerful idea, and one that has been so comprehensively ignored by governments, that the case for a thorough official effort to design a workable system seems to us to be overwhelming…. and significant adjustment costs would be merited if the (current) inefficient and iniquitous system of business rates could be swept away entirely and replaced by an LVT”…and that “a much stronger case for having a separate land value tax in the case of land used for non-domestic purposes”.Institute of Fiscal Studies (IFS) Green Budget 2014

Business rate (BR) reform or abolition, at least at first glance, seems to provide a potential line of least resistance to the introduction of at least a partial LVT.

BR is a tax predominately on economic activity operating from fixed premises, assessed according to the assessed rental value (RV) of such premises rather than on turnover or profit.

Its deadweight impacts, acting as a fixed cost, thus potentially weigh down particularly heavily on the investment and employment decisions of small business owners, although the smallest do get relief (see below).

Although such rental (rateable) values in principle should revalued according to a five-year cycle, in recent years revaluations have been delayed due to the external shocks of the GFC and of Covid.

The relative infrequency of five-year valuations, even when they occur, mean that RVs tend to become outdated as the cycle progresses, while subsequent revaluation adjustments induce uncertainty and often volatile changes in BR liability with associated cash flow problems for many business owners, leading to further adverse deadweight impacts.

The last revaluation came into effect in April 2017, when April 2008 assessed values were replaced with April 2015 assessed values – a seven-year gap that straddled the 2008-10 GFC.

Significant change in relative valuations between locations occurred in the meantime, requiring transitional and dampening arrangements to mitigate consequent impacts on business budgets.

BR is also an unpopular tax for these reasons. As such, it attracts quite general attention – at least at the conceptual, if not at the detailed implementation level – providing some political head of steam favourable to reform.

The 2019 Labour Party manifesto retained the option of a land value tax on commercial landlords to replace the existing system of business rates.

In September 2021, Rachel Reeves, the shadow chancellor, announced that Labour “will cut and eventually scrap business rates” as part of wider plans to set up an Office for Value for Money with a remit “to tax fairly, spend wisely and get the economy firing on all cylinders”.

But she did not spell out, however, how the BR system would be reformed and what arrangements would replace it and whether they would include a LVT, or the timescales involved.

Liberal Democrat policy is for business rates to be replaced by site value taxation, as “a first step towards a wider system for taxing land value”.

The 2019 Conservative manifesto specifically committed to a ‘fundamental review’ of the business rates system.

The relevant findings of the HM Treasury Review published in October 2021 are considered later in this section.

The current system

Business property comprises the building structure (which can be altered, used more intensively, or extended) and the land (which is fixed) that it sits on: business rates constitute a tax on both composite elements.

They are charged on all non-domestic properties, subject to reliefs or exemptions for the smallest businesses (those with a RV less than £12,000 are exempt and those with a RV above that but below £15,000 receive tapered relief), and are collected by local authorities. Agricultural land and outbuildings are exempt.

BR raised during 2019-20 approximately £30bn across the UK (£25bn in England), about 3.6% of total current public receipts (TBC).

The liability of each business premise is its rateable value (RV) – based on its notional annual rental indexed for inflation – multiplied by a government prescribed multiplier, which in 2021-22 was 0.51 (in England) for most business properties.

The National Valuation Office (NVO), using a set of economic and locational assumptions, assesses the RV of each business premise for each successive valuation cycle.

It does not currently assess the proportion of the assessed combined value of each business premise (land and premises) that is taken by the land underlying the business premises (excluding the depreciated value of the premises).

That land or site value can vary sharply, as it does for residential land, with its location and connectivity.

RVs are generally much higher in London and across other economically buoyant urban areas, although regional variations in business land values tend to be more muted than they are for residential land.

What might take its place

A potential window of opportunity might exist therefore to design a LVT that could redistribute the burden/incidence to richer landowners and away from productive businesses, so generating associated static and cumulative macro-economic gains and/or increased public revenues.

The IFS in its 2014 Green Budget review of business rate taxation concluded that because the demand for business premises is much more responsive to price than is its supply that over the long run, the incidence of such a LVT in practice will be mostly passed on to the owners of properties via lower rental income.

An annual LVT could also extend the tax base by taxing empty sites, encouraging their development.

The review did, however, also caution that over the short run, downward rigidities in property rents linked to contracts and leases could result in its incidence falling on the occupiers and users of business premises.

This is because BRs are currently generally paid by the business occupier in accordance with their lease or other contractual arrangement with their landlord that often include five year no downward movement rent review clauses.

Such a LVT could be levied on the freehold landowner of business premises rather than its occupiers, although this would presumably require some statutory redrawing of the that contractual framework.

This incidence impact issue is likewise relevant to residential tenants; the ability of landlords to pass on the tax should be limited – at least in the longer-term – if, as theory predicts, house prices fell because of the tax; but, on the other hand, especially in the short term, a shortage of suitable alternative rented accommodation and the costs of moving, as well as tenancy contractual arrangements, could well allow the landlord to pass on at least some of the cost of the tax onto current or new tenants.

The IFS went on to note that a periodic four per cent LVT on land value could replace business rates on a revenue-neutral basis, phased-in over several years.

Other commentators have proposed variations, such as a two per cent LVT tax while retaining half of business rates, allowing a shorter phasing-in period.

A June 2022 ONS methodological paper concerning the valuation of land underlying other buildings and structures advised that such land was estimated to be worth £869bn in 2021, accounting for 12% of the total c£7trillion value of UK land. Just over half (51%) of that £869bn value was estimated to come from property subject to business rates.

Using those estimates, a pure LVT levied on the value of land underlying business premises would need to be set at seven per cent to raise c£30bn of revenue – approximating to the recent BR total yield across the UK (869*0.51*0.07=c30).

Any phasing-in period would likely need to be accompanied by mitigations shielding businesses – likely to be concentrated in London and other high value urban centres –from suddenly facing higher bills.

Such arrangements, however, could risk undermining the effectiveness and efficiency of any reform.

As in the case for residential land, the same trade-off between softening potential and actual opposition and reducing the need for transition arrangements while maximising net public revenue and economic efficiency gains, remains.

A revenue-neutral scheme while still helping to reduce deadweight loss and to increase efficiency in relation to the use of business premises, is still likely to throw up gainers and losers.

Gainers may well outnumber the losers in numbers, but the latter often tend to be most vocal and possessed of greater lobbying and media influence powers.

Any significant reform involving a business premise LVT is also likely to require a Parliament or more at least to implement.

Even that timescale assumes that reform is implemented early in the life of a government elected with a secure majority that was prepared to treat the reform a core legislative priority, had already a scheme up its sleeve to give to civil servants to work up into well drafted legislation, and it was implemented in parallel with the necessary supporting valuation arrangements.

The HM Treasury  Review  of Business Rates, published in October 2021, however, recommended that the current system is retained, explicitly rejecting the adoption of an alternative LVT, as advanced by the IFS above and others, concluding that the arguments made in its support: “are outweighed by a lack of evidence (concerning its) benefits, the significant practical challenges of introducing (it), and the probable adverse impacts in relatively high-value areas such as city centres”.

It did, however, announce the government’s intention to move towards more frequent three yearly valuations of business premises, starting in 2023, as well as to “carefully consider the case for an annual revaluations cycle, in the longer-term” based on capital values.

Incremental tinkering of the existing arrangements rather than radical BR reform accordingly appears on the cards as currently laid.

That could change with the arrival of a new Prime Minister in September 2022, given that commitments during the leadership contest to reduce taxes, at least in the absence of cuts to public service funding, appear to be built on very shaky public finance foundations.

In that light, a BR reform that could be presented as furthering the Levelling-up agenda in a way that is economically efficient and friendlier to smaller businesses as well as provide a potential to secure more net public revenue, could become an increasingly attractive political proposition.

In any case, any move to a regular one-year revaluation cycle should help to underpin an emerging overlapping technical consensus more favourable to the future rolling out a wider partial or pure business rate LVT underpinned by regular and accurate valuations.

These would need involve the ONS and NVO working in closer partnership to allow these to include separate valuation of business premises and the land underlying them.

The Labour Party and Rachel Reeves may likewise find it politically expedient to frame up their stated ambition to abolish BR to include a partial BR LVT.

Even a limited transitional business rate reform involving at least a partial LVT (which seems the most promising line of political least, but still possibly significant, resistance) aiming to redistribute from landowners to business owners and ultimately to consumers – a process that over time should raise more net revenue – needs to be clearly explained and justified, however, and be driven by clear and understood objectives.

6          Concluding comments

 The Real Crisis of the Fiscal State is the mismatch between the public expenditure requirements of the UK and the political and electoral willingness for them to be met through forms of taxation that are efficient, sufficient, and transparent.

Honest and deep debate on public funding requirements matched to sources is accordingly avoided, invariably subverted instead to short-term political presentational purposes. The recent Conservative Party leadership contest recently showed that in spades.

The impoverishment of public services and an almost default governmental resort to hidden stealth or inefficient forms of taxation is the inevitable end-result.

The public deficit overhang left by the government’s response to the Covid pandemic combined with continually rising real demands for social expenditures generated by an aging society, and quite likely in the future by post-Ukrainian invasion defence expenditure increases (Liz Truss committed to raise it to 3percent of GDP), underscores the impending fiscal imperative to develop forms of taxation that are efficient and equitable, as well as sufficient and sustainable.

An accelerating secular trend for land values to account for ever-rising shares of national wealth across many high-income countries and the UK in particular and its relationship to tardy investment, productivity and growth outcomes has helped to interest re-awaken in a modern Georgist LVT (phased-in gradually) across informed economic circles.

The analysis of Henry George in terms of its translation into practical policy may have suffered from its over-simplification and lack of engagement with the institutional environment.

Nevertheless, based on the pioneering work of the founders of economics as an academic discipline, it has been supported and even vindicated by such recent trends, as well as by modern modelling that a switch from direct and indirect taxes on labour, goods and services, and firms in favour of a LVT would generate substantial direct economic gains in a cumulative self-sustaining manner, as well as dampen speculative activity and wider cyclical instability.

The experience of Singapore has shown that long-standing economic and social returns can be achieved by suppressing private land speculation and the capture of rising land values for public benefit.

Yet obstacles to the effective implementation of even a gradual modern LVT, notwithstanding its huge potential latent benefit, remain formidable within current political environments.

The main ones can be headline summarised as follows:

  1. Its benefits are potential and uncertain and will be sensitive to the contingent wider macro-economic and political environments that it is rolled-out into, subject to unforeseen shocks and events that could well blow a gradual LVT off course, given that future certainty concerning its retention and future progression is necessary for its benefits to be realised;
  2. Its introduction as a planned flagship programme in the first place would carry substantial short-term electoral political and electoral risks linked to its perceived immediate incidence impact on homeowners; these are likely to deter its political adoption;
  3. Measures– including revenue-neutrality – designed to mitigate above are likely to blunt some of the beneficial impacts of a LVT, introduce new complexities and uncertainties, and underscore concern as to whether its potential long-term benefits would justify the political risks and upheaval costs incurred in the short-term.
  4. Comprehensive and accurate valuation arrangements that need to be put in prior place presuppose at least a nascent political commitment to introduce a gradual LVT that is currently lacking.

Perhaps, most seriously, for a LVT to raise enough revenue to significantly reduce the need for economically more harmful taxes in a UK context, it would need to be levied on residential land and at rates that would increase bills for many households above what they currently pay in council tax – a very problematic political proposition.

Yes, such a tax would allow other net taxes to be reduced to the point that the net tax burden of most such households would be reduced. But that, indeed, would be in the future (unless the any short-term transitional shortfalls in public revenue were met by borrowing) not at the time of initial implementation: in short, possible jam tomorrow, but pain today.

Given that, politicians, even of a reforming bent, might well conclude that an incremental non-revenue raising reform of the current council tax system, focused on relieving some of its most pressing regressive inequities, such as its regional incidence (the occupier of a  lower-value dwelling in the North or Midlands, for instance, can pay as much as a much higher value dwelling in London), presents a more appealing and realistic option, with its potential to chime, for instance, with a wider ‘Levelling-Up’ agenda.

A combination of such a reform – as was noted in Section Five, the increased proportion of residential dwelling value taken by the underlying land means that a proportional property tax has become a closer proxy to a LVT – with the business rate reforms discussed in Section Six, is probably the best that can be hoped for and would be greatly beneficial in their own rights, and consistent with possible LVT progression over the medium term.

Any move to more frequent and accurate valuations, facilitating the separate valuation of land from buildings and structures, would offer a supporting step in the that direction.

Wider progress will ultimately depend however on both government and opposition politicians recognising and addressing honestly the Real Crisis of the Fiscal State.

That at present must be considered a hope rather than an expectation.

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Filed Under: Economic policy, Housing, Time for a Social Democratic Surge

Starmer’s Story Must Be Labour’s Story

29th March 2021 by newtjoh

Christened by working class parents to commemorate the Labour founder, Keir Hardie, the young Starmer trod an upward mobile professional journey through grammar school, redbrick university, and Oxbridge into select Bar Chambers. Becoming a doughty legal defender of organised strikers, anti-capitalist campaigners and death row inmates, he then ‘took silk’ as a QC, providing a pathway to his appointment Director of Public Prosecutions in 2008 – an establishment role he excelled in, exhibiting rationality and competence tinged with radicalism.

Succeeding Frank Dobson – a former Health Secretary but unsuccessful first Labour London Mayoralty candidate – to the inner city, and still largely working class, safe seat of St.Pancras, Starmer quickly but quietly learnt his Westminster ropes. In October 2016, Jeremy Corbyn appointed him Shadow Brexit Secretary – an appointment based not on political affinity, but on a recognition that his skill profile best matched the requirements of the post, surmounting concerns within Corbyn’s inner circle that it would simply provide Starmer with a stage for a continuing audition for the top job.

Which it did. By far the most effective Shadow performer in the Commons, Starmer effectively critiqued the Brexit position of both May and Johnson governments. Elected Labour leader in April 2020 at the height of the first Covid wave, he soon established himself as a measured but effective leader of the opposition, whose gravitas contrasted sharply and favourably with both a Prime Minister almost habitually reliant on bluster and boosterism and with a predecessor invariably out of his depth at the dispatch box.

But doubts began to surface that Labour’s new leader, while brilliant at discharging a brief and in forensically unpicking an opponent’s case, lacked the ability to create and personify a political counter narrative that could resonate within, yet alone beyond, Westminster. It was also noted that his six Brexit tests and espousal of a ‘People’s Vote’ had proved counter-productive in political and economic outcome terms. After a honeymoon period, apart from taking the whip away from Corbyn, his leadership style was characterised by caution and indecision with a proclivity to tack to the prevailing wind of the day in a way that often smacked more of tactical opportunism than strategic vision.

Since 1945 only three Labour leaders, Clement Attlee, Harold Wilson, and Tony Blair have won electoral power at Westminster – all following a long hiatus for Labour in Opposition. The first two did so not by dint of their personalities but rather by their ability to manage and to link a desire for change within the population, the last by a more presidential project that personified ‘New’ Labour’s colonisation of the centreground.

The December 2019 Tory capture of ‘Red Wall’ seats won with an enlarged working-class support base, along with the party’s practical collapse in Scotland, means that to become the fourth, Starmer  – discounting a return of a substantial number of SNP seats in Scotland back to Labour – must secure the largest ever electoral swing that Labour has ever achieved in England of over 12% compared to 10.7% in 1945.

Has Starmer really got what it must take to overcome not only that unprecedented electoral challenge – likely to be compounded by boundary changes favouring the Conservatives – but also concurrently the immense structural social democratic wider political challenge of reconciling necessary fiscal and political responsibility with the accommodation of ever-rising rising demand and need for increased health, social care, and education social expenditure, on top of equitable social security reform – the true underlying fiscal crisis of the state – as well as the secular tendency for education and age rather than social class associational factors to determine voting behaviour, requiring the cultural and the economic to be ever finely balanced in political calculation.

In the short term, policy reviews and prescriptions can wait. Starmer must first build a sustainable value base that can support and illuminate a coherent overarching political strategy chiming with majority concerns covering affordable housing, quality neighbourhood schools, and the building safe and secure communities endowed with well-paid jobs, that some of the more thoughtful members of his Shadow Cabinet, like Rachel Reeves, have begun to build.

Starmer cannot recreate Blair’s presentational elan, but he can mesh such a strategic framework to his personal back story: the son of a disabled mother and toolmaker father who forged a successful career by hard work and application, subsequently marked by public service. He should dare the Mail and Telegraph to sneer at such an epitome of Middle England endeavour and aspiration for honest and in the scheme of things modest material reward.

Starmer as a person and Starmerism as a political project should be joined and projected, linking, by way of contrast, the entitlement and real elitism of the Prime Minister’s back story to his opportunistic and hollow ‘chancer’ policies.

A case in point is the Johnson’s government’s Levelling Up agenda. It relies upon a mix of big ticket and local bus depot-type infrastructural projects with thinly spread centrally determined funding-streams, themselves subject to manipulation for party political advantage.  Starmer must seize as Labour’s own, the emerging overlapping consensus, manifested recently by Bank of England’s chief economist Andy Haldane speaking on behalf of the soon to be defunct Industrial strategy council, that sustained local growth needs to be rooted in local strategies, covering not only infrastructure, but skills, sectors, education and culture, measured by defined understandable transformational outcomes: improved educational attainment and opportunity, the generation of new and well-paying jobs, and the spread and mainstreaming of affordable housing.

He will also need to tap an enlarged fiscal space for government borrowing, evidenced by Biden’s Stimulus and Climate Change Package, taking the opportunity to be both bold and lucky, as Johnson did to combine ‘ getting Brexit done’ with electoral success.  Unlike Johnson, he also must be honest and straight-talking about linking future social benefit and justice to contribution. It is not just about the economy, but also about values and vision. The policies will follow.

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Filed Under: Economic policy, Welfare State and social policy Tagged With: Starmer

Winning the Final Straight

7th December 2019 by newtjoh

The polls, although tightening with the squeezing of  the Liberal Democrat and Brexit party vote share, continue to project a comfortable working majority for Boris Johnson on 12 December.

Labour itself seems resigned to limiting losses of seats in Brexit-voting areas in the Midlands and North, the same areas, as Brexit and Lies that Matter pointed out,  which will suffer the most from a bad-Johnson Brexit.

The 2017 Corbyn effect has not materialized this time round. His lamentable  failure to lance the anti-semitism boil, and his similar – but different – inability or unwillingness to relate to ‘Middle England’ in a way that his electorally successful predecessors – Attlee, Wilson, and Blair – did in varying ways, continues to dog his party’s prospects.

The actual result on Thursday, of course, cannot be predicted precisely in today’s uncertain political environment.

The young and undecided could still tilt towards Labour on the day.

Local circumstances and issues could intervene and disrupt the national pattern given the vagaries of our current electoral system.

The parties’ respective manifesto commitments, or, rather, lack of substantive ones that can be trusted, could still induce an unexpected decisive and late electoral effect.

Significant electoral shifts, however, invariably follow a wider groundswell of the popular mood. Yet that remains stubbornly stuck in muted cynical mode.

The Conservative’s resurrection of their ‘triple-lock’ commitment not to increase income, national insurance, and VAT rates compares with Labour’s to fund additional expenditure from increased taxes on companies and income-tax payers earning over 80k.

Although clear blue water, accordingly, has opened-up between Labour and Conservative on tax and spending, neither party have articulated a future economic and social vision that engages and resonates with the wider electorate.

It will be tragic if the lies of an entitlement-laden and amoral former Etonian prime minister allows him to win the day because Labour neglected to engage and enthuse Middle England voters, at a time when the intellectual tide has turned in favour of, and national need calls out for, a radical but feasible socialist or social democratic – call it what you will – programme in government.

To deny Johnson a working majority Labour must continue re-orient and its Prioritise its message, but with much more Focus, Consistency and Honesty.

It should mesh its vision and Brexit policy much more clearly, highlighting how a bad-Johnson Brexit will sunder the UK, undermine peace in Northern Ireland (NI), and generate unnecessary economic costs, acting as a deadweight drag or worse on growth and  hence the public finances across the UK.

This when the maintenance, let alone the improvement, of public services to an aging population in reality, will require increased borrowing to fund rising real current expenditures and/or higher taxes, which, if not direct, will be of the less transparent stealth variety, difficult to limit in incidence to higher income groups, even when intended. Funding social care is a case in point; honesty on that score is needed.

To be successful, both in electoral and sustainable strategic policy template terms, ‘Goody-bag’ giveaways and unattainable maximalist gestures should to be downplayed. Measures that interlock economic justice and efficiency should instead be prioritised.

Institutional reform to secure demonstrable efficiency in the selection, planning and delivery of infrastructural investment must be integral, and not subsidiary, to the design and operation of fiscal rule reform: greater fiscal latitude for productive public investment must go hand-in-hand with greater demonstrable efficiency in its selection and execution, as set out in  Making Public Investment Smart.

Individuals are empowered, in practice, to take control over their future by having pathways to suitable, available, and improved education, housing and job opportunities, forged and opened-up across the country, pushing up productivity and expanding economic opportunity to lower income households.

That, in turn, will depend upon high quality transport, digital, and social infrastructure in housing, education, and, to a degree, cultural services within existing high-productivity cities and areas – the London-Oxford-Cambridge triangle is a case in point – to maximise their potential to generate more growth through the further complementary agglomeration of productive firms and people.

At the same time, coastal and smaller cities and towns, especially in sub-regions located north of a line drawn between the Humber and Wash and in Cornwall, that have borne the brunt of decades of de-industrialisation, losing jobs not replaced by relatively stagnant or declining service sectors – the same areas that tend to the most exposed to the loss of EU Structural Funds – will also rely upon targeted and efficient productive investment in economic and social infrastructure.

Is the answer then, growth-friendly general or ‘place-blind’ policies to improve education, healthcare, infrastructure, and affordable housing?

Or more place-based policies to tackle regional inequality, where subsidies, grants, and public infrastructural investment are targeted to individuals and firms, according to location?

Both, according to International Monetary Fund (IMF) researchers in a recent world-wide survey of regional inequality, pointing out that the high cost of housing in high income regions and cities restricts domestic migration, while the rejuvenation of declining areas requires an expanded supply of locally available better paid jobs, supported both by an improved local skills base on the supply side and by rising demand for locally-produced goods and services.

A conclusion echoed in another recent paper on innovation policy, endorsed no less by Dominic Cummings, Johnson’s  human lodestar: an example of  the flow of the intellectual tide mentioned above, but all much more in accord with the Labour manifesto than the Conservative one .

In the UK context, that means partnerships between Whitehall, devolved, and local government to attract and sustain private investment to lagging sub-regions and areas com, where possible linked to university and other sources of expertise that can lead best to the cluster development of productive enterprises, combined with targeted and efficient productive public investment in site preparation, affordable housing, education and skills, and above all in improved connectivity allowing people to access quality employment opportunities within reach of their existing homes.

Reducing the friction of travel Trans-Pennine and within the West Midlands are two of the more obvious examples of productive public infrastructural investment contributing to long-term prosperity.

Another practical example of the potential of public investment to raise productivity and growth in a balanced and equitable way is a sustained increased in investment on affordable housing to a broad steady-state level, meshed with the planned expansion of apprentice and training opportunities targeted to indigenous young people.

Besides its social impacts that should help to mitigate and avoid existing and future labour bottlenecks within the industry, while enhancing human capital and productivity outcomes and making them more balanced in income and spatial distributional terms, thus interlocking economic justice and efficiency in practice.

The costs of providing infrastructural investment should be reduced by directly tackling market failure and rent-capture. Speculation in land largely explains the escalating cost of buying a home,  as is increasingly recognized across the political spectrum, most recently by the Conservative-leaning Financial Times journalist,Liam Halligan, in his recent book, ‘Home Truths’.  Another example of the current flow of that tide that Labour is not harnessing.

The land root of the current crisis of housing affordability, indeed, must be overcome for real progress to be made in a way that impacts on the majority of those wishing to buy and rent affordable housing, not just those most likely to qualify for social housing.

It is quite likely that a Johnson Conservative Brexit government will pivot towards variations of such measures – at least in early rhetoric before the inevitable capture and perversion of ends and process by the same vested interests that fund the party, choke them.

Labour should occupy that ground during the last week of the campaign.

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Filed Under: Brexit, Economic policy, Time for a Social Democratic Surge

A Way Out of the Brexit Impasse

17th August 2018 by newtjoh

The prime minister clearly hoped that her Chequers package could at least be sold to the warring factions in her own party. The swift resignations of her Foreign and Brexit secretaries soon put paid to that. The European Research Group (ERC) of hard-Brexiteers, led by Jacob Rees Mogg (JCM), were emboldened to openly rebel. The government then went on to accept amendments from him that seemingly contradicted the principles on which its and her own package was based.

That, in turn, prompted 12 Conservative Remainer MP’s to table an amendment of their own requiring the government to consider staying in the customs union if no EU agreement had not been reached by the end of January 2019 – their initial promise to give ‘a fair wind’ to the new approach blown away by May’s apparent craven capitulation.  It was defeated by a mere three votes, and then only after four Labour MP’s, including Frank Field, defied their own party’s three-line whip to vote with the government.

May’s decision, on the surface, puzzling.  She had earlier – at least according to some reports – advised Conservative Remainers to hold fire on their amendment and to wait for the EU to knock-back her then-forthcoming Chequers offer. She could have then told Parliament that the only way that to avoid either NI/Ireland border infrastructure or an Irish Sea border, as well as the maximum economic disruption of a disorderly exit, would be to accept, in effect, the UK staying in a CU equivalent to the existing one beyond the already-agreed two-year transition or implementation period slated to end in December 2020, where no tariffs or quotas or intrusive border ‘rules of origin’ checks would be needed, or levied, or conducted on goods travelling between the EU and UK. The UK would continue to levy, collect, and remit the EU’s applicable Common External Tariff (CET) on all goods imported into the UK from the rest of the world (ROW).

Such a position with government support could have been expected to pass Parliament given Labour Party support for the UK to remain a customs union.

Although Mrs. May had previously provided the Trade Secretary, Liam Fox, with personal assurances about his ability to sign independent trade deals with the ROW, that does not explain why the prime minister felt that it was necessary to capitulate to JRM and his ERG band of fundamentalist Brexiteers. Their two ‘wrecking’ amendments, covering VAT and the EU collection of tariffs on behalf of the UK, would have almost certainly been rejected by the Commons, had her government not accepted them.

Most likely, her motivation was to persuade potential rebels to desist from depositing enough letters of no confidence in her to trigger a summer leadership contest. Yet, by accepting JRM’s amendments, she served to strengthen their position and stiffen their intransigence against the Chequers package. Such appeasement has and will continue to undermine her future political negotiating positions, both internally with her party and externally with the EU, making her ouster as Conservative party leader and prime minister more likely than less.

Putting that political misstep aside, the yawning core contradiction at the heart of the entire Brexit process was inescapably and openly laid bare by Chequers: the economic damage that it entails can only be mitigated by the UK retaining as much of the tangible benefits of EU customs union and single market membership that it can. But that in return requires the UK to accept some of the obligations of EU membership along with an accompanying loss of domestic UK control over their content and of their future development: making the UK a rule-taker without representation.

If the point of leaving was to wrest wholly in practice and effect any EU direct control of ‘our money, laws, and borders’ back to Westminister, such a Brexit-in-Name only (BINO), as it is called by its detractors, seems, in logic at least, pointless: the UK might as well not leave. But that would be contrary to the June 2016 referendum result. On the other hand, exiting with no deal to trade on World trade Organisation (WTO) rules, as extolled by the ERG, would result in the most economically most damaging, and politically (and quite possibly socially) calamitous consequences: a conclusion disputed, or brushed away, only by most fervent Brexiteers.

As Parliament went into its summer recess, individual members of the ERC group – that could number between 60 and 100 MP’s in total – swore that they will vote against any future withdrawal deal aligned to the July Brexit White Paper, which fleshed out the Chequers package. The Labour party, on its part, confirmed that it will continue to oppose such a deal because it would not meet the – albeit unrealizable (short of continuing de facto CU and SM membership) – six ‘Starmer’ tests. And, the Conservative Remainers, alienated by May accepting the ERC amendments, were once again cast outside the government tent.

If the Labour Party and the ERG stick to their existing guns, any deal based on the white paper package will be rejected by Parliament later this autumn, thus shortening the political odds on a UK ‘no deal’ exit, occurring by default. That outcome is far from certain, however: a season is a very, very, long time in politics.

Neither a responsible government nor opposition could engineer, or even countenance, a no deal exit; that is unless they simply washed their hands of its known anticipated consequences on the national interest. Even if they did, many of the potential political ramifications or fall-out from such an outcome, either by design or default, are too unappealing, or too uncertain, for both main parties to stake their future electoral prospects on.

The looming prospect of ‘no deal’ itself could cause the EU, however, to modify or fudge its own previously declared red lines to accommodate a compromise deal with the May government that could then possibly garner the grudging acquiescence of Parliament. It is to that prospect, we turn.

The european dimension

The facilitated customs arrangement (FCA) provides the cornerstone of the UK negotiating position. It is designed to avoid the need for the NI backstop included in the draft withdrawal treaty. The other main pillar on which May’s package rests is UK regulatory alignment with the EU, but only to the extent necessary for the UK to continue to benefit from frictionless trade in goods with the EU27 and with no border infrastructure to be placed between the two Irelands.

That pitch jars with the mood-music coming from, not only from Barnier and the European Commission, but also from key political leaders, that has hitherto maintained the steady tune that the four freedoms of the single market – goods, services, capital, and people – are both inviolable and indivisible.

But as summer simmered in early August, some suggestions of a possible softening of the EU’s absolute position began to emerge. Thee separate treatment of goods and services could perhaps be countenanced, subject to the adoption of interpretation and enforcement mechanisms that would give the final say to its own institutions, most particularly the ECJ.

The EU and UK red-lines could both be blurred or fudged, by, for example, providing the European Free Trade Association (EFTA) court a similar role in deciding disputes that it currently  commands in the existing European Economic Association (EEA) governance structure.  That arrangement already involves Norway, for example, opting out of membership of the customs union, and the acceptance of some associated frictions in the free movement of goods.

Freedom of movement is the main elephant in the room for the UK, and some tweaking of its application could be creatively presented by both parties as part of a movement to a negotiated and  comprehensive replacement arrangements.

That the EU might be prepared to row back on its own stated negotiation red lines should not come as that much of a surprise. A no deal exit would cause one of its members, the Republic of Ireland, almost as much – or even – greater economic harm than it would wreck on the departing UK, whose domestic manufacturing and farming sectors would bear the brunt of the pain both immediately and longer-term. The EU’s other 26 members would also suffer some economic loss, most marked for the Benelux countries geographically closest to the UK.

A chaotic UK exit would put in jeopardy both the £40bn divorce payment and the residence rights of EU nationals working in the UK. At its most existential, the diplomatic credentials and reputation of the EU with the ROW would be soiled, perhaps permanently. The UK exit is a particular situation; at the end of the day: needs must.

Yet it is difficult to discern why the EU should allow the UK – a state that has chosen to leave its ‘club’ and become a non-member third-party –  the benefit of the  special customs arrangement represented by the FCA, while allowing the UK also to continue to benefit from FTA’s agreed between the EU and the ROW.

In particular, the proposed dual tariff structure of the FCA provides an inherent incentive to fraud and smuggling that along with its other added complexities and inefficiencies makes the prospect of its 27 remaining members suffering consequential trading and revenue, almost inevitable. That makes its adoption most unlikely as, https://www.asocialdemocraticfuture.org/2018-brexit-white-paper/, pointed out.

In that light, the EU should also do itself, as well as the UK, a favour by putting the FCA out of its misery as soon it can, without precipitating Mrs May out of office, although that might mean waiting until after the Conservative Party conference in October.

Brussels could then push the UK to maintain an equivalent CU with the EU until such time that a replacement FTA can be mutually agreed and put in place, as a ‘price’ for offering the UK some measure of flexibility on FOM. Of course, no real economic price would be paid by the UK by accepting de facto continuing membership of the CU. Its manufacturing businesses would benefit from the greater certainty of the maintenance of frictionless trade for a longer period; it is only the illusionary prospect of securing substantive new trade deals in goods outside the EU in the short-term that would be lost.

The real issue is whether the resulting political price for the government – and for Mrs May in particular – would be too high.

The domestic political dimension.

Any variant of the Chequers package is sure to be rejected by a sizeable segment of Conservative ERG members. But they set their face against the Brexit White Paper even in its July pristine published state. They, therefore, have already shot their bolt:  no deal is their unshakeable article of almost religious faith, whatever happens.

Mrs May can be expected to stand firm behind her Chequers banner and now face down their messianic zeal for a disorderly exit, relying on the silent majority of her more Brexit-agnostic MP’s to carry her through.

But if she does, could the ERG unseat her in the autumn? Possible but unlikely. Not only are the majority of Conservative MP’s not wedded to a hard-Brexit outcome, which even if they were, would not pass Parliament, but a new hard-Brexiteer Conservative leader would face another general election.   That precise same prospect is likely to deter Conservative MP’s from exposing both their party’s Brexit record and their divisions to a leadership contest and then to a volatile electorate.

That electorate could well vote in a ‘hard-left’ Labour government led by the populist Jeremy Corbyn, and trust it to negotiate a vague soft-Brexit aligned to Starmer’s six principles under a jobs and prosperity banner. A new Labour  government can be expected to seek an extended Article 50 timetable – a need that Labour would make clear during the election had been generated  by Tory incompetence and extremism.

Even if the Conservatives won, the ensuing chaos and economic damage caused by a disorderly exit would quite likely render it a short-lived victory that then made the party subsequently unelectable for a generation.

It is possible that the Conservatives,  if a leadership contest was forced onto Mrs May, would elect a compromise candidate, such as Jeremy Hunt or Sajid Javid, promising a harder line with Brussels in the negotiation,  but with no deal as the backstop rather than the desired destination. This assumes that the constituency members, who would decide such an election, would be amenable to any whiff of Brexit compromise. The deep Tory divisions would still be exposed by such a contest.

Some suggestion has been made that such a ‘compromise’ leader could oversee a UK exit according to a vague and skeleton withdrawal agreement and its accompanying political declaration minimally acceptable to the EU, before exiting in March, but then backtrack to a more hard-Brexit arrangement, presented as ‘what the people voted for in 2016’.

The EU, however, can be expected to include provisions within the withdrawal divorce treaty that would make that difficult. Nor could it be expected that Parliament would be fooled by such duplicity.

Turning to the Labour party, it might hope that a parliamentary vote rejecting any final package based on Chequers would also precipitate an election bringing it then to power. An election fought ‘on what happens next for Brexit’, however, is just as likely to expose Labour’s own Brexit fault-lines.  Its outcome could well prove to be another stalemate that second time around could also induce a splintering of existing party alignments. Its current leadership could well decide, in that light, that betting on the altar of Brexit the once-in the-lifetime opportunity to implement the socialist transformative programme, which is its main preoccupation, was not justified by the odds.

Some on the left, most notably Paul Mason, How Labour could unite the country have argued that Labour should complement its opposition to the Chequers package by publishing the single market and migration approach that, after getting the Article 50 exit date extended beyond March 2019,  as the new elected government it would progress with Brussels.  Labour should also promise the electorate  a second referendum on the final deal that it was then able to secure with the EU27.

This presupposes, of course, that Labour voting against the variant of Chequers package that is offered to Parliament would result in a general election and that sufficient time was left to extend Article 50. It is questionable whether a Corbyn-led government would wish to be distracted from its domestic transformative programme by such a second referendum and its connected complexities and uncertainties.

It is certainly unlikely that either the May government or the present Parliament will concede a second referendum.  Indeed, the cross-cutting complexities of the Brexit permutations are not amenable to a vote between binary alternatives, underscoring that the 2016 referendum was inappropriate in the first place: there was no precipitating new overarching ‘new destiny’ issue; party political management reasons rather led to it.

A second referendum offering Brexit multiple-options would be problematic in content – for example, see the permutations offered in https://infacts.org/theres-more-than-one-way-to-count-a-three-way-peoples-vote/  – and could well be indeterminate  in result, notwithstanding that this time round it would be billed the ‘People’s vote’. There is no simple solution to the complex problem of Brexit. Pretending otherwise is likely to cause more problems than solution.

Anything short of an astounding vote to Remain, would simply lay the ground for Leaver demands for yet another and a third vote, compounding divisions within and between the constituent countries of the UK to an even more dangerous tipping point.

A second referendum only really makes sense when framed between leaving with no deal, and extending Article 50 and staying in: leaving with no deal with its resulting economic and social damage, in that case could well come into ‘new destiny’ territory.  If the majority voted for no deal at least they would be doing so with their eyes wide open, taking, perhaps, the heroic assumption that the consequences of the choices are communicated clearly and transparently the second time round.

But, as argued above, defaulting to ‘no deal’ option should be avoided by a responsible government and opposition.

Can Parliament agree on a ‘least bad’ option?

It is both possible and mutually desirable for both the EU and UK  to negotiate a withdrawal treaty and accompanying political declaration exit that could be conceivably be accepted by the UK Parliament.

The UK would accept an equivalent CU and connected continuing harmonization to EU rules concerning goods infinitely after its formal exit from the EU, at least until alternative trading arrangements are thrashed out and finalised.

Such a Mark 2 Chequers agreement would resolve the NI backstop for the foreseeable future and preserve the continuing vital not-to-be-lost benefit of frictionless trade in goods to both parties.

From the EU standpoint, it would provide comfort that the UK would continue to align and conform to EU rules.  In return for the UK jettisoning the unworkable FCA, the EU could offer some wriggle space to the UK on FOM.  It could also allow the UK’s to progress FTAs concerning goods to the point where they could come into operation when the UK finally leaves the interim equivalent but still bespoke CU. In the meantime the UK could negotiate and enter into new service agreements with the ROW.

The prime minister could thus offer this the as the ‘pragmatic’ and ‘principled’ best available deal that will allow the UK to actually leave the EU at minimum net economic cost, while providing scope within a realistic timescale for Britain to progressively to identify and to reap the most advantage from its altered future relationship with Europe.

The ERG and other hard-Brexiteers, of course, would indict that to stay in the CU and SM indefinitely would make the UK a ‘vassal-state’ that will prevent it venturing out onto a world stage again as a buccaneering and proud free trading nation winning new trade deals on its own account. Their bawl that this would constitute a grass betrayal of the June 2016 democratic decision to leave the EU can already be heard.  They are going to continue to shout that whatever happens, short of securing their desired no deal exit. That outcome – like the continuing CU and partial SM membership arrangement proposed here, was not on the 2016 ballot paper, when 52% of those who voted, simply expressed to leave the EU in preference to remaining.

The sensible majority in Parliament – across the parties –  should simply rely on the facts to demolish the deluded and national interest-damaging hard-Brexit position. The actual prospect of independent deals – at least of the  significance and scale needed to offset the loss of frictionless trade with our nearest and main partner, the EU, is to put it kindly, dim and distant, whose horizon has always extended way beyond January 2021.

Paul Krugman analysis on why existing customs union is better than relying on alternative free trade deals, provides a concise expert summary of that common-sense reality. It already is reflected in the government’s own economic analyses of the expected impact of different Brexit alternatives. Other studies have highlighted the particular adverse impact on jobs and incomes across areas most dependent on manufacturing industry, often located in either Labour-voting or marginal constituencies,  most notably in the North-east, as described in more detail in previous posts, such as https://www.asocialdemocraticfuture.org/time-labour-protect-national-interest-voting-cu/.

Of course, for Parliament to exercise its collective wisdom, the Labour leadership would need to be prepared at least to refrain from impose a three-line whip against such a Chequers Mark 2 withdrawal deal.

This it might do insofar that the government will have saved them the trouble of negotiating a deal with the EU that could and would not differ materially very much from what Labour could negotiate with Brussels. Voting it down to precipitate an election that would inevitably be dominated  by ‘what next for Brexit’ would very likely come across as self-serving; and rejecting a CU that would accord with current Labour party policy, which the majority of Labour MP’s are united in supporting – a unity that could shatter if attention shifted to the single market.

Other similar political calculations could also come into play.  Tory hard-Brexiteers  might well be joined by some ‘Lexiteer’ Labour MP’s; perhaps  some hard-Remain Labour MP’s committed to nothing short of a cancellation of Brexit or at least a second referendum could even join them in the ‘noes’ lobby, providing a potential silver lining to both Mrs May and Jeremy Corbyn, by isolating their respective hard-Brexit and Remainer detractors and plotters.

The prime minister could claim that she had delivered Brexit in accordance with the referendum mandate, while Labour could claim that they have secured a result far more worker and jobs-friendly than otherwise would have been the case.  Both leaderships would be served the national interest, while avoiding an election that risked the future break-up of their respective parties.

The balance of political risk would remain with Mrs May and her party. She would still have to withstand the venomous and destabilising attacks of the thwarted hard-Brexiteers who no doubt would strive to incite a rightwards-drifting rump membership to exert pressure on their MPs to ditch the prime minister.

If, on the other hand, she allowed the negotiations to drift to a point where a ‘no deal’ exit beckoned, the pressure for a second referendum to be called in time for such an outcome to be avoided, could become unstoppable.

 

 

 

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Filed Under: Brexit, Economic policy Tagged With: brexit, Customs union, Mrs May

The process and impact of Quantitative Easing (QE).

18th June 2018 by newtjoh

The Bank of England (BoE) statutory monetary policy remit or mandate since 1998 has been to secure price stability in a way that supports the government’s economic policy objectives. The Chancellor’s November 2017 annual letter to BoE Governor  defined that as the achievement of ‘strong, sustainable and balanced growth’. The same letter, however, underscored the government’s ‘absolute’ continuing commitment to price stability. That BoE mandate is operationalized by a forward-looking ‘medium-term’ inflation target of two per cent, as measured by the Consumer Price Index (CPI).

The primary monetary policy instrument open to the BoE to achieve that target is through influencing short-term interest rates by changing the rate – the Bank Base Rate (BR) –  that it levies for the near-term use of its own funds. But, BR, has been close or at its effective lower bound (ELB) – where reducing it further is expected to have little or insufficient impact on domestic real economic activity – for nearly ten years.

BR was reduced to a historic low of 0.5% in March 2009. It was then that the introduction of QE was also announced, in effect, to give a second string to the BoE monetary policy bow, in recognition that conventional monetary policy – changing BR – in the wake of the Great Financial Crash (GFC) had been rendered too weak to be effective on its own.

QE involves the BoE creating new money electronically and expanding its balance sheet massively in order to purchase financial assets, predominately longer-dated (5-25 years) government bonds (gilts), mainly from insurance and asset management companies, pension funds, and other non-bank institutions, https://www.bankofengland.co.uk/monetary-policy/quantitative-easing.  £375bn of such assets were purchased between March 2009 and July 2012, across three phases:

  1. £200bn between March 2009 and January 2010 (QE1);
  2. £125bn between October 2011 and May 2012 (QE2);
  3. £50bn extension announced in July 2012 (QE3).

There was then a lull until August 2016, when in response to Brexit uncertainty, the MPC announced, on top of a further cut in Bank Rate to 0.25%, another £70bn of asset purchases including a limited tranche of £10bn corporate debt (QE4).

For purposes of simplicity, post-GFC UK monetary policy (MP) can be defined as MP = BR+QE, with both acting in concert.  The acronym, MP, in this post, is used in accord with that meaning. References to monetary policy relate to its more general non-time-bound meaning.

The impacts of MP, in practice, over time, have been and are affected by the complementing or offsetting impact(s) of fiscal policy (FP), as well by a raft of other macro-economic factors, some endogenous (internal) to the economy, such as productivity, others exogenous, such as changes in internationally-set energy prices impacting upon the domestic inflation rate.

Since 2010, with interest rates remaining at their ELB, and with discretionary fiscal policy contractionary in impact, and thus acting in an opposite direction to that of MP, QE has provided the primary, if not the sole, active policy mechanism or instrument to inject additional discretionary demand into the economy to sustain output and employment.

The Chancellor’s November 2017 letter confirmed that the QE asset purchase facility would remain in place during 2018-19. The BoE had still not sold back into the financial system any of the £435bn worth of the bonds that it has purchased under QE since March 2009. Maturing bonds are replaced or rolled-over. Such sales would take liquidity out of the financial system, tending to push up short-term interest rates, thus acting as a drag on expansion within the economy, all other things being equal.

The BoE jealously protects, however, its flexibility to reverse QE in the future, if its Monetary Policy Committee (MPC) considers that would be consistent with its primary price stability remit. The post-GDC QE programme remains very much unfinished business.

How QE works in theory 

The honest answer is that even the central bankers don’t really know for certain (see Table 1, https://www.bankofengland.co.uk/working-paper/2016/qe-the-story-so-far ). The main identified transmission mechanism assumes that asset-holders, following changes in longer-term interest rates induced by QE, switch from lower-yielding and safe assets into higher risk  asset classes more associated with increased real economic activity: the ‘portfolio re-balancing’ effect.

In that light, a Speech by Deputy Governor of BoE in 2012 suggested that as an immediate effect, QE1 had lowered long-term gilt yields by around 1% (100 basis points) between March 2009 and January 2010, and a 20% increase in their price. Investment-grade corporate bond yields, in turn, were lowered by about 0.7% (70 basis points), and high-yield corporate bonds somewhat more, by 150 basis points. Later QE rounds appeared to have been more muted in their impact on gilt yields, but this may have been due to other influences within the wider macro-economic environment, such as the intensification of the Eurozone crisis.

BoE-financed asset purchases increase the demand for longer-dated government gilts and other securities (5-25years); other things being equal, this should push up their price and reduce their yields (interest as proportion of price). The financial institutions selling such bonds to the BoE can then use the resulting receipts to acquire equities and corporate bonds. That they should do so rests upon impact of the QE process suppressing safe-haven bond yields, thus improving the relative the risk-adjusted returns of equities and corporate bonds, as an asset class.  Such portfolio rebalancing should lower the cost of capital for firms issuing new equity or bonds by increasing their price or value while lowering their prospective yield (increasing potential receipts at point of sale and reducing their interest cost over time), so encouraging business investment. The BoE back in 2012 noted that given that both UK new equity and bond corporate net issuance rose sharply in 2009 compared to the preceding 2003-2008 period, that this provided some evidence that this may have happened, not only as response to the cuts in BR (which made equities relatively attractive as an income-earning asset), but also because of the immediate effect of QE1 on raising the demand for equities relative to gilts through the portfolio balancing effect.

Rising equity and property asset values that makes their holders, whether they are Middle England homeowners, or owners of substantial equity holdings, or firms with such assets, feel richer and ‘confident’ than they would otherwise be, and so more inclined to borrow, to invest, and to consume more, can provide a related but indirect ‘wealth effect’ transmission mechanism into real economic activity.

The injection of liquidity into the financial system by QE should also increase commercial bank deposits. Financial institutions selling bonds under QE will tend to deposit their receipts with their banks and/or use them to purchase higher risk assets that, in turn, generate receipts for the selling counterparty to deposit with their banks. This increase in the short-dated liabilities of the banks should encourage them to expand their direct lending to firms and to individuals to secure a return exceeding the interest payable to depositors –  the ‘bank lending channel’.  Little evidence is reported, however, that this happened, or was even expected. Banks preferred in the wake of the GFC to increase their reserves to cushion future anticipated asset write-downs of bad debts, even if that impacted adversely on their profitability.

Bank lending to households and firms can, of course, in any case, be used to fund the purchase of existing assets for speculative capital appreciation purposes, rather than on new productive assets that can generate future additional output and income.  As noted above, rising asset values can impact on real economic activity, largely indirectly, through the wealth effect.

The aggregate and distributional impact(s) of monetary policy (MP), as reported by the BoE

That very tendency of post-GFC MP generally, and of QE especially, to increase the prices of equities and property assets, has given rise to concerns about its distributional consequences and their possible impacts) on widening both class and generational inequality, with Conservative Cabinet Ministers expressing concerns about MP policy decisions made by unelected technocrats that reward the already-rich.

A growing sensitivity of the BoE to such claims is clearly discernible in recent speeches by senior staff and within its research output. A, March 2018, Staff Working Paper No. 270,  modelled both the aggregate macro-economic and the distributional household income and age cumulative impacts of the reduction of BR from 5.5% to 0.5% between February 2008 and March 2009 with the introduction of QE1-3, claiming to be the first UK study to investigate the impact of monetary policy in such detail at the household level.

The methodology it applied, involved, first, modelling the aggregate impacts of MP on gdp, employment, wages, consumer prices, house and equity prices, using the main BoE macro-economic forecasting model. The counterfactual of what would happened if monetary policy had remained unchanged in response to the GFC was applied.   Then the estimated macro aggregate impacts it generated were then mapped to the micro balance sheets of individual households. This was done comparing data from the government’s Wealth and Asset Survey (WAS) for 2012-2014 and the Family Resources Survey for household incomes to earlier surveys, covering household:

  • interest payments and receipts;
  • employment income;
  • financial, housing and pension wealth; and on the:
  • effect of prices induced by MP on household real savings and debt levels, fixed in nominal terms.

The impact of MP on different households was then further mapped, according to:

  • tenure status;
  • whether members were in or out of work;
  • age cohort.

Andy Haldane, the BoE’s current Chief Economist, summarised in his April 2018 speech, How Monetary Policy Affects your GDP,  the results of that cumulatively across the 2008-14 period, graphically displayed across 24 charts.  The headline results reported included that without MP, the:

  • unemployment rate would have been four per cent higher, gdp eight per cent lower, and consumer prices 20% lower;
  • overall impacts of MP income and wealth terms on different cohorts of society since the GFC proved positive and significant in overall; the average mean income household benefited by an estimated £1,500 a year, and £9,000, (charts 7, 8 and 9);
  • overall distribution of income and of wealth, as reported by the 2012-2014 WAS, between the end of 2007 and 2014 remained broadly the same: in a nutshell, the UK’s unequal income and wealth distribution appeared to have remained largely unchanged by the combined impact of MP (see Charts 5 and 6).

Drilling-down on the distributional impact of MP:

  • half of the total income gains in real cash terms was concentrated to the benefit of the top two income deciles; but, in percentage gain terms, Haldane advised, they were ‘reasonably evenly spread out, despite being slightly lower for lower-income households and negative for the lowest income decile’ (see chart 10 and 11, respectively);
  • the young gained proportionately more from the positive modelled impact of MP on inducing lower unemployment and higher wages – an outcome related to the relative greater pro-cyclical propensity of the young to participate in the labour market compared to older age groups if provided with the opportunity, (see charts 14 and 15);
  • households around retirement age, however, gained the most from the modelled impacts of MP on their total wealth (see chart 16);
  • higher income decile households secured higher additions to their utility (welfare) than did lower-income deciles (chart 22), but the welfare benefits of having a job, and its associated job-satisfaction and self-esteem benefits, were concentrated in favour of the young (chart 23).

Haldane offered some additions. Notably, the social welfare benefit of enjoying improved levels of subjective satisfaction or happiness (utility) as result of having a job and/or improved job security, as well as from higher levels of income and wealth, was computed. Regression analysis was used to translate WAS-reported changes levels in household happiness into a notional-income equivalent. Reduced unemployment and arrears were found to have an especially statistically significant impact in explaining survey-reported changes in household happiness. Strikingly, a reduced probability of being unemployed was associated with a notionally deduced income-equivalent effect on household well-being of £7,300, compared to an actual reported average household income of £32,500.

Disentangling and quantifying the particular effects of QE must have presented an even more challenging task to the researchers.  Charlie Bean, the deputy governor of the BoE the time, in the speech referenced above, noted that equity prices did rise substantially during both the periods covered by QE1 and 2. This was no doubt related to multiple reasons, including the continuing impact(s) of BR being cut to 0.5% that by reducing bond yields tended to make financial investment in equities relatively more attractive.  His tentative conclusion was that equity prices probably rose by about 20% and 10%, as a direct consequence (my italics) of QE and Q2, respectively. This was on the back of the broad empirical fact that the introduction of Q1 and Q2 coincided with equity prices switching from a decline to growth trend, as well as on more analytic BoE econometric studies conducted at the time. The 2018-reported findings also stated that QE had the most modelled wealth impact on equities. Instructionally, lower income or younger households tend not to own equities  (as they don’t tend to own housing wealth): the Bank of England quarterly-bulletin,2012, Q3, noted the richest 5% of households owned 40% of financial wealth held outside pension funds.

Only one chart (21) out of 24 in the latest 2018 BoE published research, reported QE-specific results. That painted a rather rosy picture, denoting that the overall impact of QE across the income distribution was positive, with all ten decile household cohorts enjoying an estimated c.20% average cumulative rise since 2007 in average real net income. There was some variation; the second to fourth deciles benefited from slightly under 20% gains, while the top decile enjoyed 30%. In that regard, the health warning that the direction of a modelled impact, rather than its precise estimated quantification, is more instructive, remains relevant. The translation of higher levels of household income and wealth attributable to MP to additions to their social welfare was appropriately captured by the near-logarithmic (constant percentage increase) across the distribution deciles that the survey reported, Haldane concluded,  in preference to average cash increases per decile, invoking the diminishing the classical marginal utility of income principle that a unit increase in income is worth less to a rich person in marginal utility or social welfare terms than a poor one.

WAS is collected only from private households, excluding people living in publicly provided housing.  As the authors of the working paper recognised, using the household as the unit of measurement hides inequalities within households; for example, young adults living with their parents while saving to purchase their own home were not be separately identified in the results. This is relevant as although MP does appear – according to the research –  to have particularly benefited some groups, such as the established homeowners; other groups, including, tenants, or, indeed, the increased number of young people having to still live in the parental home (and not separately recorded) due to unaffordable housing entry costs, were likely to be disbenefited by the impact of MP on the house prices and rents.   For members of Generation Rent, such effects, could be very significant, indeed.

Putting on one side survey sampling issues and the sensitivity of the regression results to different assumptions and specifications, the specifications and assumptions of the BoE model, or any other model for that matter, may or may not have captured the interaction of MP with other macro-economic and other quite possibly unidentified influence and their (temporal) distribution over time. As the FT economics editor, Chris Giles, has pointed out with respect to the economic modelling of different Brexit options, economic modelling depends on a lot on things that we don’t know. The BoE model patently failed, to take a notable example, to forecast the GFC as its specification failed to capture the actual behavior and impact of the financial sector.

Nor should sight be lost that the BoE is evaluating its own conduct of MP. Take one possible instance of that: its Chief Economist chose to introduce (no doubt an important and welcome dimension to macro-economic analysis) the impact on individual social welfare of MP in his analysis of the distributional impact of MP, highlighting that these were positive, as reported above; but these welfare gains only partially offset and compensated for what must have been much larger losses in welfare that followed the GFC that could have, in part, been made worse by the prior pursuit of monetary policy combined with failings in financial system regulation.

That said, all policies will involve winners and losers, who, in theory at least, could be compensated. And, after all, the remit of the BoE is not to secure some desired abstract distributional result, but, rather, to secure a medium-term inflation target consistent with future sustainable non-inflationary growth.

When measured against that benchmark, how effective has MP been?

Understanding the wider picture

It is important not to lose sight that any modelled positive changes in aggregate macro-economic outcomes and in micro household circumstances that may be attributable to QE, at best helped to ameliorate – and not to reverse or to overcome – the deflating cumulative impacts of the GFC and the following Great Recession. A state of stagnation now shrouds the UK economy. Many individuals and households are worse-off than they were in 2007: an unprecedented post-war outcome.

That interest rates remain at their ELB nearly a decade later, reflects the empirical reality that the UK has still not had a proper recovery yet, nearly 10 years on from the GFC. Its muted,  uneven, and incomplete nature was spelt out in Speech by Andy Haldane, May 2016, Whose Recovery?  in some evidential detail. He catalogued that actual real per capita gdp has barely moved since 2007, while net national income (after taking account of remittances of income and profits to foreign countries) fell, and net disposable household income flat-lined. Real earnings remained five per cent below their 2009 peak in 2016, and, although the incomes of the poorest income deciles did rise, this was largely because of the redistributive impact of pensions and benefits.

Increases in income and in wealth over the course of the decade have been largely captured by higher income and older households; while the real disposable incomes of pensioner households rose by 9%, the incomes of working age adult households fell by 3%. The median income household enjoyed little benefit, mirroring a similar long-term trend in the US. Consistent with that, Haldane postulates that half of all UK households have seen no recovery in their real inflation-adjusted income since 2005 (although he was reporting in 2016 using BoE analysis of data available then, the economy subsequently has not showed signs of a material recovery, rather, if anything regressing further). Regional inequality – measured by gdp per head – also widened.

The real actual income of younger people fell further and recovered more slowly from the GFC than did older age groups. Although MP impacts on their employment income especially, as was reported and considered in the preceding section, may have helped them, in the sense that their economic position in its absence would have been even worse otherwise, that countervailing influence was not enough to prevent the economic position of that group worsening, when considered and measured over the course of the last decade.  The growth of self-employment, part-time-working, and zero hours contracts within the labour market, no doubt, was connected to that outcome. Total employment levels recovering to record new levels conjoined with downward pressure on wages and job security.

The different presentational slants of these two speeches by the BoE Chief Economist are marked, no doubt related to the different purpose and target audience of both. They are not necessarily contradictory, but it takes quite an effort to reconcile them. The connecting thread between them is that MP served to prevent the economic fall-out of the GFC from being substantively worse than it proved, on ‘an umbrella doesn’t stop but protects from the rain’ basis.  Economic conditions were maintained that allowed many to either return or to enter the labour market and so secure better incomes and enjoy welfare levels higher than would otherwise been the case in the absence of MP. What MP has not done is to put the economy on a recovered sustainable growth path.

Even more seriously that sin of omission is linked to one of commission or agency. Where liquidity created by QE flowed into the purchase of existing land, housing, and equity assets, combined with the impact of low interest rates, it will have tended to pushup such asset values, along with the corporate profits of companies in the property and financial sectors. Many middle-income deciles saw their wealth rise, even while their incomes stagnated. The entry of the young into owner-occupation became much more difficult – at least without a contribution from the Bank of Mum and Dad. The richest households benefited disproportionately from rises in equity values. Leaving aside the broad distributional tendency for MP in general and QE in particular to maintain the status-quo of the wealthy staying wealthy, the poor remaining poor, and those in the middle, and the young in particular, having to run faster to maintain their position, comes the rub.

The palliative process and effect of MP risks creating conditions conducive to another asset bubble-induced recession, which are particularly prolonged and damaging, rather than helping to build the foundations and providing the wellsprings of future sustainable and balanced growth in line with the stated macro-economic objective of the current government.

Conclusion: a problem of political economy

Intuitively it seems safe and fair to conclude that QE acting in concert within the wider MP response may well have helped to prevent the GFC from turning into another Great Depression.  Not an unimportant outcome, of course: at least, when taken on its own terms. On the other hand, its immediate effect in helping to stabilise an economy in systemic crisis may have initially served to obscure that BR+QE can be inherently inadequate to secure sustainable recovery when interest rates remain at their ELB for a prolonged period. The UK economy appears to be in a near-comatose state, where fitful recovery alternates with stagnation. MP appears to have become the economy’s ‘life-support’, which, if reversed, could tip it back into prolonged recession or worse.

This lends support to the growing body of informed opinion that the current macro-economic policy framework has been overtaken by events, and that it requires strategic reform if the economy is to provide the future growth, incomes and public resources that its population expects and will demand.

The centre-left leaning think-tank, the Institute of Public Policy Research (IPPR) in March published Just About Managing Demand.  This proposed comprehensive reform to the BoE mandate, including raising the inflation target by up to two per cent to allow the economy to ‘adjust permanently to a higher rate of inflation’, which would then allow interest rates to settle at a higher resting point, giving greater space for a rate cut to be made in response to a future recession. The fiscal rules would also be changed allowing fiscal policy to be used as primary activist policy lever in place of the ‘uncertain and unreliable QE’ to restore and protect levels of aggregate demand when interest rates are at their ELB, and where ‘government fiscal policy is believed to be overly restrictive’.  The independent remit of the BoE would be further extended to allow the MPC measured against its medium-term inflation mandate to decide when such a stimulus was necessary and its quantification. The BoE would also gain an added power to ‘delegate’ that economic stimulus to a new National Investment Bank (NIB) in effect, linking it the introduction of a more interventionist industrial policy.

Other more market-oriented economists, including ex-members of the Monetary Policy Committee (MPC), such as Andrew Sentance, argue that weaning the economy off the addictive, artificial and harmful prop of abnormal and ultra-low interest rates, requires that they should rise and QE be unwound. Capital could then gravitate and be allocated to where it could secure the best return; the historical process of ‘creative destruction’ could then re-exert itself. Zombie companies, such as many high street retailers, would exit the market, releasing resources to the growth sectors of the future, capable of  creating the new sustainable jobs that could replace the zombie ones extinquished.

The BoE faces a MP policy double bind, where interest rates need to rise to provide it with some reserve power to respond to a future recession or shock, but given the reliance of the UK economy on debt-financed consumption and high and rising house prices – at least in London and the South-East –  and the current context of Brexit uncertainty, such rises could risk precipitating a downturn turning stagnation into actual recession that may or may not be followed by either depression or by a new process of creative destruction and rejuvenation; or rather, by much the same. Who knows?

The macro-economic framework is in a state of limbo, therefore, where the BoE is unable to achieve its remit in an economically, socially, and, thus over time, a politically acceptable way, but alternatives are stillborn.  Something sooner or later will need to give.

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Filed Under: Economic policy, Time for a Social Democratic Surge Tagged With: Andy Haldane, Bank of England, Monetary Policy

Reforming the Current Macro-Economic Policy Framework

23rd May 2018 by newtjoh

Since the mid-nineties, the prevailing macro-economic policy framework – or ‘consignment’ as it sometimes called – has relied upon monetary policy to smooth the business cycle at a sustainable level of output and employment. In the UK, in 1997, it was given institutional backing, when the Bank of England (BoE) was given an independent mandate to achieve a medium-term set primary inflation target. The role of fiscal policy, in macro-economic terms, was relegated rather to the management of public deficits and debt.

This framework seemed to work during a period, often called the Great Moderation, when nearly all the advanced industrial economies, including the UK, enjoyed an unbroken period of steady sustained growth and low inflation. The business cycle appeared to have been all but neutered, if not banished.

That illusion was popped abruptly by the Great Financial Crash (GFC). The BoE in response reduced the base rate it charged for the use of its own funds from 5.5% in February 2008 to 0.5% in March 2009, when it also introduced the first phase of what has become known as the quantitative easing (QE) programme. £200bn of new money was electronically created and added to the BoE balance sheet to purchase long-dated government debt (gilts). This was in recognition that its main conventional monetary policy lever of base rate management had been rendered ineffective by short-term interest rates reaching their effective lower bound (ELB) – the point where reducing them further has little or no, and insufficient, effect on economic activity.

Rates remain at their ELB, reflecting the empirical reality that the UK has not had a proper recovery yet, nearly a decade on. Real gdp per head and average household income are barely above the level that they reached in 2007. The needed recovery in both growth and productivity is not currently on the horizon.

The macro-economic framework conceived during the Great Moderation – its application based on economic models that ignored the potential of liberalised financial markets to leverage debt – contributed to the GFC. It has been beached by the subsequent stagnation. In short, in its existing form, whether in design or operation, or both, it appears to be incapable of shifting the UK economy out of stagnation. It is thus unsurprising that policy attention is rotating back to the definition and ordering of the first-order principles of macro-economic policy, and to whether the BoE’s independent mandate should change.

The IPPR reform framework
A spring 2018 paper by Alfie Stirling, Just About Managing Demand, takes up that challenge. Produced as part of the centre-left Institute of Public Policy and Research (IPPR), Commission on Economic Justice , it reflects the view of the author, but follows the research and policy tramlines furrowed by the Commission; and no doubt will inform its final report.

Since 2010 monetary and fiscal policy has effectively pulled in opposite directions; monetary interventions injected demand into, while fiscal policy took it out of, the economy. The tendency of governments, with their short-term electoral horizons, to exhibit deficit bias, Stirling argues, has been supplemented by surplus bias: discretionary fiscal contraction or consolidation (fiscal austerity) is ostensibly used to reduce the deficit as a matter of economic necessity, but is effectively applied as a smokescreen to ‘shrink the state’ largely for ideological and political reasons.

The paper’s centrepiece proposal to overcome surplus bias, when interest rates are at their ELB, is to provide the BoE’s Monetary Policy Committee (MPC) with added independent powers to decide whether fiscal policy is ‘overly restrictive’ and in that event to set and quantify a rectification stimulus sufficient to substitute for the cut(s) in base rate cuts that the MPC would have otherwise made.

The operational implementation of that surrogate stimulus would then be delegated to National Investment Bank (NIB) – an institution presumably based on Labour Party proposals to establish a new National Investment Bank . The MPC to achieve its primary inflation target (as may be amended, as discussed below) would, in effect, align monetary and fiscal policy in default of the government.

A reformed and comprehensive set of fiscal rules, echoing and extending Labour’s Fiscal Credibility Rule, is also set out. The separation of current and investment public expenditure for control purposes (as New Labour’s Golden Rule did) would be reinstated. Five year rolling targets would be set for a zero-current balance, and for an operational debt target linked to a longer-term target level for debt.

Public investment (which supports long-term growth) would also be provided with a separate dedicated target, expressed as a minimum percentage of gdp over the same five-year rolling period. This minimum investment rule, however, would be subject to the proposed debt target; however when interest rates reach and remain at their ELB the zero-current balance and debt rules would be suspended, leaving the investment rule in place and operative.

The long-term debt target (which could be higher, lower, or the same, compared to a set baseline level) would no longer require the debt/gdp ratio to be lower at the end of each five-year Parliament. Rather it would be based on an assessment of the UK’s fiscal space – that is the scope available for increased public spending and/or lower taxes without threatening long-term fiscal sustainability and market confidence.

That assessment would be undertaken by the Office of Budget Responsibility (OBR) as a complement to its existing UK’s Fiscal Council (independent bodies set up by governments to evaluate fiscal policy),  remit. It would involve, a macro-economic ‘cost benefit analysis (comparing) lower levels of debt against higher taxes or lower levels of spending’. The OBR would also be given the independent authority to assess the long-term impacts of different investment projects on gdp in line with methodologies agreed with government and independent economists at different levels of debt.

It would also be mandated to conduct a review of accountancy classifications of investment, identifying areas where revenue spend on human capital, on software, or other sources of innovation and growth, in addition to capital expenditure on physical assets, should be counted as investment for expenditure control purposes. Borrowing that adds to future productive capacity of the economy or provides a revenue stream would not be subject to the zero-current balance rule. Borrowing by ‘independent’ public corporations – as defined internationally – for investment purposes would no longer be scored as government borrowing or debt.

Stirling highlights that recessions tend to recur on average every 10-15 years, with the next one expected before long. To prepare for that inevitable – although time-uncertain – eventuality, Stirling moots some more radical revisions to the BoE independent mandate.

The BoE’s primary inflation target could be increased by up to two per cent. This would be to allow the economy to ‘adjust permanently to a higher rate of inflation consistent with interest rates settling at a higher resting point above their ELB’. Unemployment and nominal (money) gdp targets, acting alongside, or as intermediate guides to, that target, could also be put in place.
These revisions would serve dual but related aims: pushing up interest rates above their ELB would enable the MPC once again to use interest rates management as an effective policy instrument to prevent or forestall a future recession; they could also prevent monetary policy being prematurely over-tightened during a period of above-target inflation, driven, say, by an external price shock, such as an oil price hike induced by international political instability.

In sum, changes to the BoE mandate could involve the toleration of higher future actual and expected inflation levels to get interest rates above their ELB and hence to provide reserve monetary firepower to counteract the next recession; but if they remain or reach their ELB, an activist fiscal policy of a path and magnitude determined by the MPC could then be deployed to overcome government surplus bias, as a more effective fiscal alternative to QE. Changes to the fiscal rule framework and to the classification of expenditures for deficit accounting and control purposes, if implemented in their entirety, could institutionally prevent the cutting of economically productive expenditures during a recession, while providing a target for their expansion across the economic cycle, subject to a long-term debt target, which, however would only apply when interest rates are above their ELB. Borrowing for investment by public corporations defined as independent in any case would not count against the deficit or debt total.

Political timing and feasibility
The package covers a lot of policy reform ground. It does come across a bit as a future strategic policy primer for the Shadow Chancellor, John McDonnell and his team; providing, perhaps, both its strength and weakness.

The next government would need to wrestle with the impact of Brexit on the economy and the public finances. Where not already ceded by the May government, fiscal demands on the current budget on ever-rising health and social care demands, local education quality and effectiveness, on training and apprenticeships, and manifesto commitments would have to be faced.
An incoming Corbyn administration would raise borrowing to finance its re-nationalisation, affordable housing, and industrial policy programmes, including the establishment of the NIB, where not shuffled off-balance-sheet. The political context can only be expected to be febrile in the first place – whether related to a Brexit-related hiatus and/or a media-hyping of the first ‘marxist’ Labour government – however unfair and politically-motivated that charge may be.

Making substantive changes to the BoE inflation, to the OBR fiscal mandates, and to the fiscal rules, all in parallel, could risk political over-load. And, to work and to stick, substantive changes to certainly the BoE and OBR remits could not simply be foisted on, but rather would require extensive consultation with, and the support of, the key institutional stakeholders involved. That would take time; as would the establishment of the NIB.

Although a Brexit-hiatus could precipitate a general election before 2022, it remains the due date. A freestanding NIB that relied upon the election of a Labour government in 2022 would be hard pressed to be operationally ready to expand lending on a scale sufficient to counteract any future recession much before 2025; that is unless the present Conservative minority administration decided to develop its own prototype, which it should, but probably won’t.

Changing the fiscal rules – and changing the BoE mandate even more so, as discussed below – would in themselves be political acts. The 1997 new Labour reforms to the fiscal rules and its establishment of BoE independence and were made on back of an already emerging strong technocratic and political consensus in their favour and were introduced within a supporting economic environment. The new economic settlement it represented – along with Gordon Brown’s self- denying ordinance to keep within Conservative spending limits – a tilt towards the centre ground and the assumption of the mantle of economic competence.

This time round, one can almost already hear the crescendo din already that would envelop the new government; that it only wants to change the fiscal rules to pass on the consequent debt burden to its successors for its own political purposes etc. Although is unlikely that Labour would be elected in the first place without a compelling economic and political narrative that underscored the necessity and desirability of substantially increased levels of public productive investment to spearhead the economy’s escape from stagnation, it is far from certain, however, that narrative would be sufficient to persuade the OBR to sign-off the government’s spending plans, whether in terms of the ‘fiscal space’ available for increased investment or their long-term fiscal sustainability.

Economically beneficial public investment also not only needs to be sufficient in volume, but efficient in selection, in composition, and in execution. Varying public investment levels for counter-cyclical stabilisation purposes could, however, risk a return to fluctuating famine and feast conditions, unconducive to such efficiency. https://www.asocialdemocraticfuture.org/investing-productive-infrastructure/ in that regard it proposes remedial reforms to the public expenditure and planning system that are designed to better reflect the long-term economic benefit of efficiently selected and executed infrastructural investment.

They include providing the National Infrastructure Commission (NIC) with a statutory remit to assist each government department to publish an annual Departmental Investment Plan (DIP). Each DIP should prioritise projects, according to their estimated economic and social return, incorporating auditable information on the methodology that it has applied to rank projects with reference to their expected economic return.

Such reforms could tie-in with changes to the fiscal rule framework that provide the OBR an added remit to assess the fiscal space available for increased public borrowing and debt. Splitting the function of assessing the micro-efficiency of individual projects from the more macro-task of assessing the overall fiscal space available for increased borrowing appears to align better with the respective roles and remits of the NIC and the OBR.

The point and sequencing of the proposed fiscal reforms referenced to likely future political and economic scenarios is not wholly clear. If Labour came to power in the aftermath of a Brexit hiatus it is almost certain that the economy would be in such a state that interest rates remained at their ELB. In that case, the new government could simply rescind the existing rules, and proceed to inject a fiscal stimulus financed by borrowing and begin to implement its industrial policy, including the establishment of the NIB. The OBR-brokered interaction between the investment and long-term debt rule in terms of assessing available fiscal space would come into play only when interest rates escape their ELB again.

The government would be able to call upon some substantive technocratic support to use fiscal policy as its primary instrument to escape recession. Prominent New Keynesian economists, such as Paul Krugman in the US, and Simon Wren Lewis in the UK, consistently made the case that monetary policy (MP) should have been complemented post-GFC, at the very least, by a fiscal stimulus, not contraction – a position that many mainstream other economists and organisations, including the IMF and the OECD have subsequently endorsed.

It could also point to empirical experience: the results of the Coalition’s conjoint reliance upon QE and fiscal austerity support the case that QE should have been, at the very least, combined instead with a conventional Keynesian fiscal expansion in public investment. Such an expansion where it utilised and safeguarded unused capacity within the economy could have protected and extended its future productive capacity, helping to lift the economic drag of falling and stagnant productivity.

A new Chancellor could also loosen fiscal policy in tune with the government’s own assessment of economic circumstances and requirements, without recourse to the MPC, as he could change the fiscal rules. In any case it would be unlikely that a newly-established NIB would be ready to spearhead the counter-cyclical response through expanding its ‘lending for business growth, housing, innovation, and social and physical infrastructure’ on sufficient scale to bring the economy back to a sustainable growth path.

For a new Labour Chancellor to press for a change in the BoE mandate, providing the MPC a power to initiate a fiscal stimulus, even though the BoE on number of occasions has disclaimed any wish to intervene in the direction and composition of fiscal policy, appears superfluous, save that it could provide an obstacle to future surplus bias if exhibited by a future government; that same government could then change the mandate again, however. Such a yo-ho would do little to bolster the credibility and purpose of an independent mandate.

Designing policy architecture to better prepare for the ‘next recession’ rather than escaping systemic stagnation now or, even worse, the prospect a Brexit-induced recession could therefore possibly put the cart before the horse. Without a period of economic expansion accompanied by rising pressure on wages and competition for loanable fund, neither interest rates nor inflation are likely to rise above their ELB to a point where rate reductions could be made to respond to a recession. The immediate policy reform priority is to escape stagnation in a sustainable way.

How necessary is (are) a BoE mandate change(s)?
A 2022 election could offer at least a time window for macro-economic framework reform to be considered and anchored to some semblance of a supporting cross-cutting and over-lapping political and technical consensus. On that score, the proposed reforms to the BoE’s mandate appear a rather tentative shopping list or one of possibilities. Many of the issues attached to raising the inflation target rate and/or providing it with a greater output and employment focus are not evidentially justified or explored – more attention is given to the proposal to empower the MPC to specify and delegate a fiscal stimulus to a newly-established NIB, as discussed above. The references, however, do provide a starting point.

With respect to raising the inflation target, the MPC has so far has recoiled from raising base bate above 0.5% This is despite headline inflation even exceeding three per cent – more than one per cent above its medium-term target – thus triggering the requirement for the BoE Governor to write an explanatory letter to the Chancellor. The majority assessment of its members has been that above target-inflation is mainly owed to conditions or factors external or outside (exogenous) to the domestic labour market, including rising oil prices and sterling depreciation linked to Brexit.

The BoE’s May 2017 Inflation report, in line with that, highlighted that the post-2015 fall in sterling was likely to keep domestic inflation above the two per cent target throughout the next three years, (author italics), further noting that where inflation settles once that upward pressure fades will depend on domestic (wage-related) price pressures, concluding that these were expected to build by 2020.

The MPC hitherto has been careful to apply its constrained policy discretion in accordance with its current mandate, focused on the medium-term not the short-term headline CPI inflation figure, so as not to chock-off any nascent or uncertain recovery, at least while spare capacity exists within the economy.

Given that institutional monetary policy context, what would be the economic point of modifying the primary inflation target to accommodate higher inflation and/or giving employment and output a greater weight within the BoE mandate? A slightly different answer to that of simply an interest rate buffer to counteract the next recession, which Stirling emphasises.

The underlying key problem is that the UK economy has failed to recover its pre-GFC secular real productivity and growth trend of annual average c2.3%-2.5% growth. The result: an unrecoverable massive 15-20% loss of potential GDP calibrated to the level it would have reached if that historic trend had been interrupted and thrown off-course by the GFC, the Great Recession, and then counter-cyclical fiscal austerity.

That lost stock of output and income foregone will rise further inexorably, if growth and productivity remain stuck in stagnation mode. In technical economic jargon the economy has suffered hysteresis (a change – in this case on UK gdp, whose initial effects persist, even when its proximate causes or source no longer exist).

A fiscal expansion combined with falling immigration that causing the labour market to further tighten and thus trigger wage inflation, but without it accelerating, could usher-in a new expansionary economic environment that could allow the economy to break out of that circle. How and by what mechanism(s)?

As labour inputs become relatively more expensive, investment in the upskilling of the indigenous labour force, as well as on additional and improved physical capital stock, should be encouraged, in turn, inducing an associated shift in the employment structure towards the formal and away from the insecure gig economy, pushing-up both overall (total factor) and labour (per unit period) productivity.

Infrastructural investment should also increase both the capacity of the economy and its total factor productivity; for example, improved connectivity should lower costs and expand the pool of labour that is available to work in higher productivity and thus higher paid jobs.

But if the MPC references the likelihood of rising domestic wage pressure to the current supply side-capacity of the economy, it risks taking the current compressed productive potential of the economy (for the purposes of MP) as an immutable given. The associated output gap (the difference between aggregate demand and the capacity of the domestic economy to meet it without inducing above-target inflation), has been significantly revised downwards since the GFC by the OBR.

The latest May 2018 BoE Inflation report appears to fall into that stagnation trap. Striking a more hawkish tone than its predecessor a year earlier, it notes that ‘labour demand growth remains robust with a very limited degree of slack left in the economy’ with productivity growth remaining muted, limiting ‘the pace at which output can grow without generating inflationary pressures is likely to be modest’, before diagnosing that ‘ongoing tightening of monetary policy (up to 2020-21) would be appropriate’ albeit that any future increases in Bank Rate are likely to be ‘at a gradual pace and to a limited extent’.

It is not altogether clear what that could mean in practice. It does suggest, on one hand, however, that the BoE does not intend to raise interest rates at a speed and magnitude sufficient for the MPC to draw upon a four to five per cent interest rate buffer to counteract the next recession, assuming that a Brexit-related one is avoided. On the other hand, even modest and slow rate increases could impede or even reverse the productivity-enhancing economic expansion outlined above.

In that case desired increases in personal and household income and improvements in public services will not be possible. Given the existing linkage between consumption and confidence to house prices in the UK, if rates were raised more substantively, such increases could even precipitate a home-grown recession, especially in a post-Brexit environment, which can only be anticipated to be uncertain at best.

Is increasing the inflation target to, say, four per cent, the answer, then? Raising the inflation target by up to two per cent could allow the economy in Paul Krugman’s words to ‘adjust permanently to a higher rate of inflation’, offering space for rate cuts to be made in response to a future recession. The ghost of accelerating inflation continues to lurk in the background, however. Economic actors might well take a supposedly one-off increase in the medium-term inflation target to be the thin end of a wedge that they should grab while they have the chance, resulting in insufficient passage of time for any productivity-enhancing adjustments to take root before pressures to tighten to retard insipient accelerating inflation become difficult to resist. It would also entail a quite marked discontinuity in the BoE mandate that could suggest instability and further changes, undermining its credibility.

What is not open to doubt is that allowing inflation to rest at a higher level would require – if international competitiveness is to be maintained – a commensurate increase in productivity across the tradeable sections of the UK economy; relying on sterling to depreciate in compensation instead, itself would add to domestic inflationary pressures.

Also, the Chancellor, facing higher public-sector nominal wage claims from health and other public-sector workers could well be forced to resort to fiscal drag and/or additional taxes to protect the current budget balance, dampening the translation of real wage into real disposable income growth in the process. Such dampening might well be desirable in terms of securing a shift in resources within the economy towards investment, but such suppression of real wage growth by stealth taxes cannot be expected to hold for any extended period.

An alternative might be to suspend inflation target temporarily while the economy escapes stagnation. It cannot be expected that the BoE would instigate such a change itself. But if imposed by the Chancellor, the effect would be nearly akin to abolishing the independent mandate of the BoE altogether.

Yet another variant could include raising the inflation target explicitly only for a temporary or time-limited period, on the basis that the retention of two per cent medium term target would conserve continuity. The aim would be to influence wage-bargaining behaviour so that real wage inflation tracks productivity, rather than inducing beggar-my-neighbour escalating, rises. That desirable outcome would tend to depend on, however, not only on the credibility of the new temporary, and necessarily, contingent target rule, but also on other emergent factors that may affect the labour market and wider economy. Perfect alignment of real wage inflation and productivity remains a heroic assumption.

Besides the existing inflation target is a medium-term one, although its precise time-span can be open to definition. The same desired end-result of a productivity-enhancing expansion could therefore possibly be engineered by more informal and less disruptive institutional means. The annual Chancellor’s letter to the Governor could be used to adjust the weight balance accorded to price stability and real economic activity, for instance. The MPC could continue to operate within its existing 1997-set medium-term two per cent target but with reference to a political tilt for it to be administered it in future with greater regard to employment and output considerations, as new economic conditions and times require.

An imperfect analogy might be a judge instructing the jury to decide a case on the balance of probabilities rather than beyond reasonable doubt. The underlying and overarching importance accorded to price stability would necessarily be diluted, however, with attendant possible implications for the credibility and certainty of the target. That said, a case can be made that the advantages of price stability was overstated within the existing framework and that events have tended to suggest that in some conditions its strict adoption can retard rather than induce strong and sustainable growth.

In that regard, tilting the MPC mandate towards output and employment considerations could also be achieved by moving to a nominal annual gdp target of, say, five per cent. This would combine or mix real output and inflation into a single target; it could be achieved by various permutations of both: for example, two per cent real growth and three per cent inflation, and vice versa. Such variability could gnaw at its overall credibility and certainty, however.

Or the target could be split equally, 2.5% for each; reducing uncertainty but at the same time also the flexibility that may be needed to allow the economy to recover its historic secular growth and productivity path. When taken in the round, as a 2013 Deputy Governor Speech on nominal income targets, pointed out, insofar that the existing mandate does take cognizance of output and employment objectives, many proposed alternatives can appear more different than they are actually are.

The issue really boils down to the relative weight that should be accorded to employment and output relative to medium-term price stability, for what period, and in what circumstances. Incremental evidence-driven change in emphasis subject to continual review might ultimately prove the best friend of radical reform.

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Filed Under: 2018 Housing Policy, Economic policy, Macro-economic policy, Time for a Social Democratic Surge Tagged With: Alfie Stirling, economic policy, fiscal rules, IPPR

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