No economic growth means no underlying increase in tax revenues. In today’s flat-lining economy Julian Chisholm FRSA argues that fiscal policy should assume no growth in tax revenues and only supply-side boosting public expenditure should be financed by borrowing.
Historically, economic growth has delivered continuous improvements in living standards around world, although their distribution varies. In democracies politicians woo the voters with promises to increase economic growth. Indeed, the survival of governments is often seen as depending on whether or not satisfactory growth occurs during their time in office.
Apart from boosting living standards, economic growth is attractive to politicians because it boosts tax revenues and provides resources to boost government spending without raising tax rates. This allows politicians to sell expenditure increasing policies to the voters on the basis that they will not require increases in tax rates and coverage, and/or to maintain existing spending levels while promising tax cuts. Economic growth is therefore a panacea for politicians. However, if the narrative changes and growth is no longer the norm, policy options are more constrained, choices more acute, and living standards stagnant. Only, if public expectations match will the results be politically acceptable.
Official and private forecasts of UK economic growth since the 2008 crash share one thing in common. Consistently, they have been too optimistic. There are two reasons for this. The first is that it is taking time for forecasters to understand the consequences of the 2008 crash, and to incorporate them into the econometric models on which their forecasts depend. The second is the impact on UK economic growth of unforeseen events, shocks, like changes in oil prices, and the Euro crisis.
The salient consequences of the 2008 crash can be summarised as a material reduction in confidence amongst consumers and investors, a large and financially risky increase in the budget deficit and public debt, and a severely weakened financial sector, which was a major contributor to pre-crash growth and tax revenues. This has produced discontinuities in economic behaviour that econometric models are not equipped or designed to take account of. Only if, by a miracle, the economy was to return rapidly to pre-crash conditions, and there were no shocks, would the reliability of forecasts based on econometric models likely improve.
So, rather than basing fiscal policy and government rhetoric on unreliable forecasts of an imminent return to growth, experience since the 2008 crash points to the need for an intrinsically more cautious approach. Failure to do so risks growing cynicism and disillusionment with politicians and political processes, growing demands for populist solutions, and further economic damage.
Whilst labour market data shows some improvement, the economy is flat-lining with little or no economic growth. Driven by the policy objective of regaining control over the public finances, the Government is not prepared to rein back its growth sapping austerity policy by using a fiscal stimulus to kick-start growth. Indeed in the Comprehensive Spending Review currently underway it is seeking further cuts in public expenditure. Further, until consumer and investor confidence improves, monetary policy, whether conventional or novel, is likely to be pretty ineffectual. Despite a material devaluation of sterling since 2008, there has need no sign of export led growth, no doubt because of the depressed conditions in the Euro Zone, and intense competition elsewhere.
In summary, a prudent and realistic assessment points to very subdued growth of say, 0-1.5 per cent per annum for the medium term compared the UK historic trend rate of 2.75 per cent per annum. For the long term, technology and investment will continue to be the driver of progress, but before this is again shown up in UK economic growth and social improvement, further adjustment is necessary.
Realism, prudence and responsibility dictate that what is needed now is a zero growth fiscal policy. That is one based explicitly on no real growth in underlying tax revenues, and underlying public expenditure only being paid for by them. The only exception to this would be spending needed for an urgently needed fiscal stimulus aimed at supply-side measures to improve long term growth prospects. To reassure the global financial markets over a fiscal stimulus, new legislation would require that any extra tax revenues that arose subsequently through growth would be used to reduce the ratio of public debt to GDP to, say, 60 per cent.
A zero growth fiscal policy brings important opportunities to make further cuts in some elements public expenditure, to re-order spending to support sustainable growth, to change the structure and culture of government to radically improve its performance and cost effectiveness; and, as a precursor, to redefine the economic purpose of the state as the Canadian government did in 1994 in response to an ever growing budget deficit. In this age of affluence, the only part of public expenditure which should be ring-fenced, and indeed increased, is that part of social spending aimed at the prevention of destitution at home.