A quick look at the problems for fiscal policy when interest rates are tackling inflation

 

Higher interest rates make government debt unviable as an economic solution

Kenneth Rogoff

Big economies such as the US must change fiscal policy as the realities of debt and inflation bite

Thu 2 May 2024 07.00 BST

For more than a decade, numerous economists – primarily but not exclusively on the left – have argued that the potential benefits of using debt to finance government spending far outweigh any associated costs. The notion that advanced economies could suffer from debt overhang was widely dismissed, and dissenting voices were often ridiculed. Even the International Monetary Fund, traditionally a stalwart advocate of fiscal prudence, began to support high levels of debt-financed stimulus.

The tide has turned over the past two years, as this type of magical thinking collided with the harsh realities of high inflation and the return to normal long-term real interest rates. A recent reassessment by three senior IMF economists underscores this remarkable shift. The authors project that the advanced economies’ average debt-to-income ratio will rise to 120% of GDP by 2028, owing to their declining long-term growth prospects. They also note that with elevated borrowing costs becoming the “new normal”, developed countries must “gradually and credibly rebuild fiscal buffers and ensure the sustainability of their sovereign debt”.

This balanced and measured assessment is far from alarmist. Yet, not too long ago, any suggestion of fiscal prudence was quickly dismissed as “austerity” by many on the left. For example, Adam Tooze’s 2018 book on the 2008-09 global financial crisis and its consequences uses the word 102 times.

Not too long ago, any suggestion of fiscal prudence was quickly dismissed as ‘austerity’ by many on the left

Until very recently, in fact, the notion that a high public debt burden could be problematic was almost taboo. Just this past August, Barry Eichengreen and Serkan Arslanalp presented an excellent paper on global debt at the annual gathering of central bankers in Jackson Hole, Wyoming, documenting the extraordinary levels of government debt accumulated in the aftermath of the global financial crisis and the Covid-19 pandemic. Curiously, however, the authors refrained from clearly explaining why this might pose a problem for advanced economies.

This is not merely an accounting issue. While developed countries rarely formally default on their domestic debt – often resorting to other tactics such as surprise inflation and financial repression to manage their liabilities – a high debt burden is generally detrimental to economic growth. This was the argument Carmen M Reinhart and I presented in a brief article for a conference in 2010 and in a more comprehensive analysis we co-authored with Vincent Reinhart in 2012.

These papers sparked a heated debate, frequently marred by gross misrepresentation. It did not help that much of the public struggled to differentiate between deficit financing, which can temporarily boost growth, and high debt, which tends to have negative long-term consequences. Academic economists largely agree that very high debt levels can impede economic growth, by crowding out private investment and by narrowing the scope for fiscal stimulus during deep recessions or financial crises.

To be sure, in the pre-pandemic era of ultra-low real interest rates, debt really did seem to be cost-free, enabling countries to spend now without having to pay later. But this spending spree rested on two assumptions. The first was that interest rates on government debt would remain low indefinitely, or at least rise so gradually that countries would have decades to adjust. The second assumption was that sudden, massive spending needs – for example, a military buildup in response to foreign aggression – could be funded by taking on more debt.

While some might argue that countries can simply grow their way out of high debt, citing the US postwar boom as an example, a recent paper by the economists Julien Acalin and Laurence M Ball refutes this notion. Their research shows that without the strict interest rate controls the US imposed after the end of the second world war and periodic inflationary surges, the US debt-to-GDP ratio would have been 74% in 1974, instead of 23%. The bad news is that in today’s economic environment, characterised by inflation targeting and more open global financial markets, these tactics may no longer be viable, necessitating major adjustments in US fiscal policy.

 Kenneth Rogoff is professor of economics and public policy at Harvard University. He was the IMF’s chief economist from 2001-03.

Innovation (potentially) - made in the UK:

 Why the world’s fifth-richest man is taking a $1bn ‘bet on Britain’

Oracle founder taps Tony Blair to help lead efforts to create UK companies worth billions

Szu Ping Chan1 May 2024 • 10:38am

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Larry Ellison, who founded American software giant Oracle, has a net worth of $146bn CREDIT: TORU YAMANAKA/AFP via Getty Images

One of the world’s richest men will create tens of thousands of UK jobs as part of a $1bn “bet on Britain” that will see cash poured into creating batteries and fighting superbugs.

Larry Ellison, the founder of American software giant Oracle, announced last year that he was building a new research institute in Oxford to “help solve the world’s great problems”.

The Ellison Institute of Technology (EIT) in Oxford, which is being headed by Sir John Bell, is working with former Labour prime minister Sir Tony Blair to create homegrown companies worth billions of pounds.

“It’s absolutely a bet on Britain,” said Sir John, who is known for his role in steering the Covid vaccine rollout. “He could have placed this anywhere in the world and he’s chosen to place it here for a couple of reasons.

“One is that we have some great universities and great scientists. And on the whole, the output of that science has not been very effectively exploited in the UK.

“It’s a real opportunity to round some of that excellent science up and make it deliver at scale against the big global problems.”

Oxford's $1bn Ellison Institute of Technology promises to 'help solve the world's great problems' CREDIT: Foster + Partners

Sir John explained that the world’s fifth-richest man has been drawn to Britain because he believes the country is not fulfilling its potential.

The former Oxford Regius professor, who gave up a position he held for more than two decades to take the role, said Ellison would create “tens of thousands” of UK jobs in the coming years in areas such as medicine, food security, clean energy and government policy.

The idea driving the $1bn (£800m) Oxford campus, which opens next year, is that the US mogul will do more than just invest millions of pounds into existing companies.

Instead, Ellison, Sir John and Sir Tony want to build companies in the UK from scratch.

Sir John, a 71-year-old Canadian immunologist, said the Institute’s priorities included trying to create a new superfuel that replicates the energy that powers the sun.

If successful, nuclear fusion could provide almost limitless clean and affordable energy to meet the world’s demand.

He also wants to invest in battery technology to power drones and other large vehicles.

“We not only want to produce green energy, but we want to store it as well,” said Sir John, who was formerly an adviser to the Government on its life sciences strategy. “Batteries for airplanes, batteries for ships, batteries for everything.”

Part of the motivation is to break China’s dominance in a sector that has so far focused on electric vehicles. But Sir John insists the EIT’s mission is bigger.

“Of course, there is a geopolitical argument. Obviously, we’ve got Tony Blair involved, and he’s there for good reason. But we’re not picking a fight with China. We just think we can do things just as good as them.”

Sir John is also planning to play to his strengths and create a database of infectious diseases that could be used to identify and fight superbugs, as well as combat the growing problem of antimicrobial resistance.

All these endeavours are designed to help arrest the slow decline of British companies that have been forced to look to overseas investors for cash.

Sir John, who has previously branded London a “bad place” to raise money, said this bet on Britain was designed to retain some of the country’s success stories.

“We don’t really have the productive capital in this country to allow us to scale and to take bets on some of this technology as it evolves,” he said. “That is the big problem.

“And I think if there was more access to that capital, I think we would have more successful companies that would have gone on and commercialised products and ultimately sold them and paid more tax.

“There have been massive subsidies for science research and development. And the trouble is if no companies ever pay that tax [back when they make a profit], you can imagine that the Treasury starts to get a bit grumpy. So we really need to turn that corner and make that happen. But it is the lack of capital which is holding us back.”

However, he concedes that moving the dial won’t be easy.

“I think this [money] gives us an opportunity to demonstrate that it can be done,” he said. “We’ll train people to be able to do it. We will have a cohort of people growing companies here, which can expand and help grow other companies. And it’ll perhaps be proved to other people, other investors, that this may not be such a bad place to invest.”

Ellison stepped down as Oracle chief in 2014 but remains its biggest shareholder and has a net worth of roughly $146bn.

The US billionaire, who races yachts and collects samurai swords, is reportedly pushing Donald Trump to pick senator Tim Scott as his running mate in the 2024 presidential election.

Although Ellison is an unorthodox character, his money and ambitions are very real.

Public filings show he has donated $44m to Tony Blair’s think tank and earmarked a further $272m for future donations to “support effective governance work in Africa”.

Larry Ellison (left) is set to hand Tony Blair's think tank donations totalling more than $300m

The EIT could also soon be involved in shaping government policy. It is no secret that Sir Tony is a fan of digital ID cards that proponents say will make it easier for people to access public services and for policymakers to target support.

Critics argue they involve too much state intrusion.

Darren Jones, shadow chief secretary to the Treasury, is also understood to be very interested in digital IDs.

A Labour victory in this year’s general election could see Blair’s think tank team up with the EIT to deliver such a scheme.

Sir John said it’s early days, and stressed that his institute is apolitical.

He said: “We’re not an arm of the Labour Party. The ideas and the innovations that we’re going to generate should be of interest to any party. If we get another Conservative government, I think they will be very enthusiastic about what we’re doing as well.”

Sir John is confident the Oxford site will be home to a new generation of fast-growing companies, though he admits there are challenges ahead.

“We just don’t have a lot of really good examples in life sciences at least where we’ve grown companies, kept them in the UK and grown them to be global leaders,” he said.

“And as a result, I think people are sceptical. I think this gives us an opportunity to demonstrate that it can be done.”

Another one on tax - the bad effects from stamp duty

 

The ridiculous tax that has doomed a generation to financial ruin

Tories’ extraordinarily harsh levy continues to suck every saver and supportive parent dry

NEIL RECORD27 April 2024 • 9:05am

Related Topics

• Tax rises, 
• Stamp duty, 
• Housing crisis

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The Government is reported to be considering a tax break on stamp duty in the 2024 Autumn Statement.  

According to reports, consideration is being given to raising the starting price at which stamp duty kicks in from £250,000 to £300,000.  

This is thought to be part of a pre-election tax “giveaway” to encourage voters to stick with the Conservatives.

Stamp duty is a strange tax. It is voluntary (you are not compelled to buy a home – you could rent instead); it is generally levied at the very moment when the person who pays it has the least money in their entire lives; its taxpayers are much younger than average (the young move more than the elderly); and it has no offsets or allowances. 

You pay it – it’s done – and you never get the money back, whatever you do in the future.

The largest three sources of tax revenue for the Government are (in order) income tax (£250bn), National Insurance contributions (£179bn) and VAT (£162bn). Taxpayers may not like these taxes, but they understand that the Government must supply itself with a core base of revenue that takes a slice out of the heart of the economy. These taxes do that.

But there are many more taxes, and many of these attempt to modify behaviour – taxing “bad” behaviour more heavily than “good” behaviour.  

The reader will have his or her own idea of “good” and “bad”, but it is commonly agreed that duties on tobacco and alcohol (“sin” taxes) do align, at least in principle, with this idea.  

Economist call taxes like this “Pigouvian”, after a British economist Arthur Pigou (1877-1959), who argued that where consumption or production has negative effects on people not involved (say like causing ill health which uses public health resources), an additional tax is justified to compensate society and discourage the behaviour.

The same argument is being applied at the moment to carbon and pollution. You may not agree with the calculus but at least the principle is logical.

But back to stamp duty, or residential SDLT, as it is officially called.  

Stamp duty is levied on the purchase of a property to live in. Under no conceivable world could this behaviour be successfully claimed to be causing harm to the general population.

You could certainly argue that building houses on greenfield sites can have negative consequences to non-participants (like neighbours), but stamp duty applies to every home transaction, not just purchases of new homes.  

We are also facing a house price crisis in the UK, driven by two factors – strict planning law which prevents large-scale new development – and a very strongly rising UK population.

Stamp duty (specifically SDLT) is not a new tax, but the rates are – they are much, much higher than in recent history. 

Until 1997, the top marginal rate was 1pc (on properties over £60,000). As recently as 2011, the top rate was 4pc (on properties over £500,000). Today, the top rate is 12pc (on properties over £1.5m).

For an economically very important group – young professionals working in London and the Home Counties – these extraordinarily high rates will have changed an important perspective on life for them, and also changed their behaviour.  

The perspective change is that I suspect they believe that the Government is not remotely interested in their financial wellbeing.

A couple (say late 20s/early 30s) buys a flat in London five years ago for £600,000. Let’s suppose today that they both earn really well – £100,000 p.a. (including bonuses, etc) each. They would have paid some £20,000 in stamp duty on their flat purchase (about 1/3rd of one of the couple’s annual after-tax income in the year they bought).

Then today they find a house that will accommodate their growing family, but in London this could easily be £1.5m. They are offered a mortgage large enough to make the jump, probably with the help of family as well, but the stamp duty bill will be £91,000, or about 18 months after-tax income for one of the couple.

No logic has been offered by Government for this extraordinarily harsh tax – there are no offsets (like an allowance for the £20,000 already paid), and to get this £1.5m house (by the way, not a mansion in London by any means) they will likely have sucked every savings account, supportive parent and mortgage-provider dry. 

It will feel to them a ridiculous tax, targeted specifically at their desire to live and work in the best jobs in an expensive city. I suspect many will think about where else in the world they could get a better life.

But people are also adaptable, and the adaptation that this “ridiculous” tax engenders is to strongly discourage people climbing up the ladder from moving too often.  

When I was moving up the ladder (in the 1970s-1990s), I moved four times in 10 years. Buy; do up; earn and save; move. This formula was brilliant for a generation now just retiring, but stamp duty has completely robbed the generation now moving up from doing this. 

Moving now has to be in the largest leaps possible. This compromises the liquidity of the property market, and it runs the risk of forcing upwardly-mobile young people to take financial risks (like huge mortgages) that they may find come back to bite them. It exposes them to larger property market risk and larger interest rate risk than they would otherwise choose to take.  

So far from being a “Pigouvian” tax, stamp duty encourages, rather than discourages, behaviour which is likely to have negative consequences for society. Society does not want a vulnerable, over-financed housing sector – the lessons of 2007-09 should have taught us that.

So why does this, or any Government, continue with this terrible tax? The answer, of course, is money. In 2022-23, residential SDLT in England raised £11.7bn, or just over 1pc of Government revenue. 

This Government, desperate for cash, just cannot find within itself the will to abandon such a nice little earner – easy to administer with the money mainly coming from the apparently well-heeled.

A tax which impinges on young people trying to buy their first home – trying to better their living circumstances by moving from a flat to a house (perhaps to accommodate a growing family), and which has no basis in Pigouvian logic is a tax that should be abandoned, and indeed should never had been contemplated in the first place.

A small adjustment in the starting point for the tax is not going to change anything.