Public Attitudes to taxes and spending, and VAT zero rating

 

Does the recent and unprecedented increase in the minority wanting a smaller state reflect the non-indexation of tax thresholds? If it does, are social attitudes a problem for those economists arguing to end the zero-rating of many goods for VAT?

The National Centre for Social Research produces an annual survey about British Social Attitudes, and they have issued a preliminary look at the survey conducted in the Autumn of last year. One question that I have looked at a number of times in previous years has concerned attitudes to taxes and public spending. The latest results are both surprising and imteresting.

As I have regularly noted, over the 40+ years of the survey the number of people saying they wanted lower taxes and spending (a smaller state) has been remarkably low at less than 10%. Remarkable, that is, given the prominence that view gets in public discourse. But not any more. In the last few years this proportion has grown significantly, and is now at 19%.

Why is this? The most obvious explanation is that taxes are going up, which is true. But total taxes have risen before, and we haven’t seen this response in public attitudes. Here is the share of total taxes in GDP from the OBR’s database.

Taxes have risen substantially since the pandemic, but they rose by almost twice as much from 1993/4 to 2000/1, yet in the social attitudes survey there is no rise in those wanting a smaller state over that period comparable with recent movements..

One explanation for this recent rapid increase in those wanting a smaller state would be if people were much happier about the level of public services now compared to the late 1990s. This isn’t plausible because both the level of public service provision (measured by indicators like waiting times for hospital appointments) and the level of spending on public services is clearly inferior to the period at the end of the last Labour government, and is at least comparable if not worse than in the late 1990s. The impact of the austerity period from 2010 onwards has not been undone.

A more plausible story is that those answering the survey are not thinking about total taxes, but rather just taxes on income. Here is a chart from the Resolution Foundation:

The noteworthy fact this chart shows is that taxes on income have been falling for most earners since 1980. [1] This hasn’t been true for the total tax burden because taxes have been shifting from taxes on income to taxes on consumption (e.g. VAT) or taxes on profits.

Very few survey respondents will be aware of the total tax burden they face. What most will see is the amount of tax taken from their pay each month. So the recent increase in the number of people wanting a smaller state could simply reflect the recent rise in the amount of income tax they are paying, which in turn is mainly the result of the non-indexation of income tax thresholds, started under the previous government and continued by Rachel Reeves. [2]

If this interpretation of the survey is correct (and I’m sure there are other interpretations) then the main implication for me is that attitudes to the size of the state depend crucially on the type of taxes being raised. Public attitudes to the size of the state may depend on the mix of taxes, with in the longer term the public accepting higher taxes on consumption and profits more easily than taxes on income. (In the short term the latter will generate inflation which is unpopular, but that unpopularity does not seem to be translated into public attitudes about the size of the state.)

Of course politicians, particularly on the right, have long suspected this, which is one reason why there has been a shift away from taxes on income over the last few decades. To that extent recent public attitudes are consistent with this belief. Those on the political left have often favoured higher taxes on income rather than higher taxes on consumption because the former is thought to be more progressive. This is true, although VAT in particular is in itself mildly progressive because there are lower or zero tax rates on necessities like food, children’s clothing or domestic energy.

However the progressivity of consumption taxes has been challenged by economists, who argue there are better, more effective ways to help poorer people than zero-rating. They, and journalists, love to tell us about the time wasted on borderline cases involving Jaffa cakes and the like, and these compliance costs are real and waste resources. At least as important is that the better off also spend large amounts on zero rated items, so zero-rating is a relatively inefficient way of redistributing income.

In my view a perfectly legitimate counter argument is that this reasoning neglects how many people feel about helping the poor in other ways. The same National Centre for Social Research Social Attitudes survey shows more people now disagree than agree that more money should be spent on benefits for the poor. It is fine to argue that the poor can be helped more efficiently by replacing zero-rating with better benefits, but that will not happen if better benefits are impossible to achieve politically, or are gradually reduced in real terms because of public suspicion or even hostility. 

To take a more specific example, an economist would argue that benefits (like child benefit) are better than VAT zero-rating on essentials in part because benefits don’t distort the choices those receiving them make. But many socially conservative voters might argue that they are happy to subsidise children’s clothing for the poor because they know that money is well spent, whereas they will be more suspicious that money on benefits that the beneficiiary is free to spend as they like will be misspent. 

There are many reasons why people might favour higher taxes and public spending, but one may simply be that they are unaware of the taxes they pay indirectly through VAT and elsewhere. This in turn may encourage politicians to shift the tax burden from direct to indirect taxes. Economists argue quite rightly that VAT zero-rating on essential items is an inefficient means of redistribution, but making indirect taxes more regressive could end up making the overall tax and benefit system less progressive if socially conservative voters and the politicians that represent them squeeze benefits.

[1] The only exception is for high earners, but they are likely to make up a good proportion of those who always thought that their taxes should be lower.

[2] An interesting question is whether the impact of the non-indexation of thresholds has been more noticeable ex post by survey respondents than the same amount of revenue raised by raising tax rates would have been, because it has meant that some are now paying income tax for the first time.

Idiot Wind

 

What Trump’s war against Iran tells us about the US government, the UK political right and the mainstream media in both countries

What did over 150 children in Iran die for on the first day of this new war? Did the US attack that killed them have a purpose? When the answer to this question changes many times in a week, and none make sense, you are entitled to believe this is a war without a strategy. As Ian Dunt writes: “It is a war that is so insane its own perpetrators seemingly do not know why they started it.” At least no purpose for the nation as a whole. Trump and some of those around him might hope that the war and its repercussions might allow him to avoid the humiliation of mid-term elections this year, and Trump must know this war will help Russia.

The US Secretary of Defence Pete Hegseth, on the other hand, seems to regard the war as another crusade. (Trump has appropriately issued an Executive Order renamining him as the Secretary of War!) Hegseth holds monthly religious services at the Pentagon, and in 2020 wrote a book called the "American Crusade". Hegseth has praised the Crusades, claiming that people who enjoy the benefits of Western culture should "thank a crusader". He has supported Donald Trump's threat tp destroy Iranian cultural sites. About the current war he has said “"No stupid rules of engagement, no nation building quagmire, no democracy building exercise, no politically correct wars.” He has blocked U.S. military personnel from taking courses at the most elite American universities, and instead stresses the warrior ethos. Before becoming Trump’s Secretary of Defence he spent a decade as a presenter on Fox News.

The initial justification for war was the prospect of Iran becoming the second country with nuclear weapons in the region. (Israel has had them for decades.) President Obama negotiated a deal with Iran that could have prevented its development of nuclear weapons, but it was torn up by Trump in his first term as President. According to one of the negotiators, just before Trump attacked, the US was close to securing another nuclear deal with Iran, but Trump attacked anyway.

The idea that the US had to attack because Israel was going to regardless is ludicrous. The US has always had the power to stop Netanyahu using force because it supplies its weapons, and previous US Presidents were not afraid to use that power. Trump, on the other hand, is easily led and Netanyahu has been doing his best to lead him in the direction of using force in Iran, again (with a little help from Republican friends). The most likely explanation is that Israel and the US had intelligence about where the Iranian Supreme leader would be and saw their chance to assassinate him. If Trump’s actions in Venezuela had a logic it was to show the capability of the US to abduct or kill the head of state, and therefore scare other heads of state to do Trump’s bidding. But in Iran they seem to have killed the whole line of succession. If that was Trump’s strategy, the tactics were not clever, and Iran’s new leader is more hardline.

Was the idea to return democracy to Iran, after the US and UK helped overthrow it in 1953? Initially Trump seemed to suggest this was one motivation, but has since said he doesn’t care. As someone who has a rather fraught relationship to democracy in the US this is hardly surprising. Also it is difficult enough for a foreign power to impose democracy when they have troops on the ground, as Iraq showed. Doing so from the air is almost impossible.

In truth the Commander in Chief and those advising him are not capable of any strategy beyond enriching themselves (corruption has always existed in the US, but now it is off the scale), entrenching fascism at home and spreading it to the rest of the world. This includes encouraging regime change in the UK. There is no reason why fascism has to involve a fool being the all powerful leader, but with Trump that is the case. Unlike 2016, today Trump has surrounded himself with people who are either as foolish as he is or know when to keep quiet. Here is a video recently released by the White House. And these are the words of the President.

When the UK’s Labour government refused to allow the US to use its bases to attack Iran, the UK’s right wing politicians and media became apocalyptic. According to them, the UK should have joined Trump in fighting his pointless war. To do this without the appearance of a moment’s thought about the objective of this illegal war just shows how deep in Trump’s image the UK right has fallen. They are now as much fools as he is.

Have they considered what impact this war will have on the conflict between Russia and Ukraine, and Europe’s ability to support Ukraine? Does it not worry them that it was Trump who attacked President Zelensky in the Oval Office, who ended all US military aid for Ukraine, who has undermined Ukrainian air defense, who has tried to bully Ukraine in handing over territory, who has rolled out the red carpet for Putin, and reduced oil sanctions on Russia. Does it not worry them that despite all the help Trump has provided Putin it is now Putin who is providing intelligence to Iran on US military assets?! But perhaps asking for a moment's thought and any consistency from those who write for the right wing press is asking too much. Perhaps they are paid not to think, but just to have a modest talent for transcription.

Trump duly obliged by saying Starmer was no Chrurchill, and Hegseth complained that America’s traditional allies “wring their hands and clutch their pearls, hemming and hawing about the use of force.” Hegseth seems to believe that attacking a country for no lawful reason is one of the masculine values he is so keen to promote. Trump, despite being at war, seems to have plenty of time to meet right wing UK politicians or journalists to attack our government.

The claim that Starmer has now destroyed the ‘special relationship’ between the UK and US, conveniently forgets that Harold Wilson refused to send UK troops to support the US in Vietnam. It also forgets that it is Trump that has threatened to invade a NATO state, and who is imposing tariffs on UK goods. It should now be clear that in political terms the ‘special relationship’ is nothing more than a device used by the right in the UK to tie the UK to US foreign policy. [1] The US has always acted in its own interests, and the idea that Trump would do anything otherwise as a favour to the UK is simply ludicrous. When these papers declared they wanted to leave the EU to take back control, what it seems they really meant was to give control instead to a fascist in the United States. Patriotic they are not.

Does the UK populist right, that very much includes the leadership of the Conservative party, worry about the impact a prolonged attack on Iran will have on energy prices and the global economy more generally? I doubt it, as such difficulties can be reckoned to assist the chances of the right winning the next election. Just as Conservative politicians have in the recent past put party before country, so does the right wing press. If the war does bring long term harm to the UK economy, the right will blame Starmer who opposed the war and conveniently forget that they were the ones supporting it.

These newspapers claim to speak for the UK public in describing the government’s stance as humiliating, but the reality is very different. A large majority of Britons oppose US air strikes on Iran, and overwhelmingly do not want the UK to join the war (and even the minority support for the war is falling). Like Trump, the right wing press has learnt to lie without shame.

In any sane world the deadly foolishness of Trump and the dangerous nonsense coming from the right wing press would be regarded as some idiot wind that we needed to shelter from but at the same time we could laugh at. Unfortunately the right wing press, although slowly dying in terms of people who actually buy their papers, has an incredible influence on the mainstream broadcast media in the UK. The right wing press so often sets the agenda for the broadcast media.

There is a desperate desire in mainstream media in both the US and UK to pretend that Trump isn’t the fool he obviously is, but instead to treat Trump like just another US President. This media’s reaction to fascism in the US is to pretend it is not there, and invent strategy where there is none. To ‘sanewash’ where there is no sanity. In the UK Robert Peston provides a good example of this failure, although Chris Mason is more thoughtful here.

Much of the mainstream media in the US will very soon be in the control of those who support Trump, and that is true for a growing proportion of the UK media. For that which remains free to tell the truth, an obsession with balance rather than knowledge and a deference to power means this media also assists rather than resists the onset of fascism. The good news is that with a fool at the helm fascist overreach is a constant danger, and the UK government and US opposition may end up benefiting from Trump’s bombardment of Iran. Those that die in this pointless war will not get the chance to be lucky.

[1] There are of course close military and intelligence ties between the UK and US. However the idea that because of these the UK should always follow the wishes of the US President, and particularly a President like Trump, is just absurd. Should we support his pro Putin, anti Ukraine stance?! It is equivalent to saying that all NATO members should acquiesce to any demand from Trump, including selling him Greenland, because otherwise NATO might be weakened.

Why Gorton and Denton is still a good result for Reform

 

It was a great result for the Greens, and a terrible result for Labour. Although Reform didn’t win the Gorton and Denton by-election, by coming second with just under 30% of the vote they did pretty well. In 2024 the combined Reform and Tory vote was 22% of all votes cast, and this increased to 30.6% in this by-election.

The remaining vote was almost entirely distributed between Labour and the Green party. As a result Reform could not have won, however that remaining vote was distributed between Labour and the Greens. In the event the Labour vote in percentage terms was exactly halved compared to 2024. But Gorton and Denton is not a typical UK constituency. It is in a large city, and as a result is likely to be far less right wing than the average UK constituency. To say that Gorton and Denton shows how Reform can be defeated is simply wrong.

Only around 100 constituencies in Great Britain had a combination of Reform and Tory votes in 2024 as low or lower than in Gorton and Denton. In getting just over 30% of the vote in this by-election, the right improved their position considerably compared to 2024. But they still lost because they had a mountain to climb. In most other constituencies their task would be much easier, as I show below.

In a post I wrote two weeks ago I said

“Under FPTP, it is highly unlikely that a combination of socially liberal parties (the Greens, Liberal Democrats and nationalists) can win a majority of seats in the House of Commons, even if these parties could form a perfect pact between them to divide up seats before a General Election.”

One comment I received was that “highly unlikely” was too strong. I disagree, and in this post I want to say why, using the Gorton and Denton result as a kind of template. I will ask if social liberal parties do as well as they did in that by-election compared to Labour, what kind of general election result would that produce. I’m not a political scientist and I’ll just be using a spreadsheet in a very crude way, but I don’t think I need anything more sophisticated to make some key points:

1. With current national polling and including their result in Gorton and Denton, the right wing populist bloc (Reform + Conservatives) will be very hard to beat if their within bloc tactical voting is as or more efficient compared to tactical voting among socially liberal parties excluding Labour.
   
   

2. This is partly because our First Past The Post (FPTP) voting system is biased against social liberals.
   
   

3. The best way to prevent a right wing populist victory at the next election is for Labour to abandon its mimicking of Reform, so that social liberals can again vote tactically for Labour, and for Labour to modestly reduce the right bloc's vote share.
   
   

Gorton and Denton is a useful template because tactical voting within voting blocs worked so well. The Green party got nearly all of the anti-right and anti-Labour vote, and Reform got nearly all of the votes that had previously gone to the Conservatives. In that sense, tactical voting within blocs, where we treat Labour as its own unique bloc, was almost perfect.

Suppose that result was repeated nationally. Suppose Labour’s vote share in each constituency is half what it was in 2024. Assume that the combined Conservative and Reform vote share increases by 8.5% compared to 2024, which is both what happened in Gorton and Denton and how current polls compare with 2024. Finally suppose that the remaining vote all goes to socially liberal parties: Greens, Liberal Democrats, Welsh or Scottish Nationalists. This is an exaggeration because the very minor parties always pick up a few votes, so our results will be biased towards the socially liberal bloc.

Now suppose that in each bloc there is perfect tactical voting, either because parties actually cooperate or because voters work out which party in their bloc is likely to do best and all vote for that party. It’s obviously an extreme assumption, but it’s not far from what happened in Gorton and Denton.

If my spreadsheet calculations are right, this outcome would result in a Labour wipe-out. Halving their vote in every constituency, and with perfect tactical voting in each of the other two blocs, would mean Labour did not win a single seat. So we can immediately see that this is a very extreme assumption. Parties in government tend to do better in general elections than in mid-term by-elections. But under that unrealistic assumption how would the other two blocs do? [1]

The answer would be that the right wing block would win a majority of about 250 among Great British seats. The average vote share for the right wing bloc in each constituency is just over 47%, which is close to their current vote in the national polls. The remainder of the vote is split between Labour and the socially liberal bloc, and as a result the socially liberal parties get considerably fewer seats than the right wing bloc even though Labour do not win a single seat.

This calculation assumes no tactical voting between the Labour and the socially liberal bloc. But if Labour’s vote collapses to Gorton and Denton levels because socially liberal voters are voting Green, Liberal Democrat or nationalist, it is no longer obvious to social liberals who to vote tactically for. In the scenario above I looked at all the constituencies where the Labour vote was still above the vote of the socially liberal bloc. I could only find one where the result would change if all social liberals voted Labour. This is because the socially liberal party vote tends to be small in constituencies where the right wing vote is very strong, so giving all the socially liberal votes to Labour in those seats does not help.

What about tactical voting from Labour to other socially liberal parties? Take the most extreme and totally unrealistic example of that, where there is perfect tactical voting between Labour and other socially liberal parties. In that case the right wing bloc (also with perfect tactical voting) could be defeated, just. Labour and other socially liberal parties would have a majority over Reform+Tories of just 8, even though Labour and other socially liberal parties have an average vote share across constituencies of nearly 53%. [2]

These calculations, although very crude, do I believe show two things clearly. First FPTP is biased against social liberals, and second that on current polling the right wing bloc is very hard to beat if their within bloc tactical voting is good.

But what about if the Labour vote continues to fall. With the success of the Greens in Gorton and Denton, perhaps half their 2024 vote share is not a lower bound for Labour. Could the socially liberal parties win then? The answer is simply no. Take an extreme example, which is that in each constituency the Labour vote collapses to one tenth of its level in the 2024 general election, and all these votes go to the socially liberal bloc. Then the right wing bloc gets a majority of over 60 among seats in Great Britain.

If the Labour vote continues to decline relative to Gorton and Denton levels, with all these votes going to socially liberal parties, the only way socially liberal parties could win a general election is if their tactical voting is better than the tactical voting within the right wing bloc, or if they start taking votes away from the right wing bloc. The former is possible of course, but more difficult simply because there are more socially liberal parties than right wing parties. On the latter, it is conceivable that some of those currently saying they will vote Tory or Reform could fall in love with Zack Polanski, and ignore all the attacks that are bound to come from the media, but I’d put that possibility in the highly unlikely category.

Which means that to realistically stop the next UK government being right wing, we need the Labour vote to improve by taking some of the votes currently going to the Conservatives and Reform (or, more likely, by current Don’t Knows breaking for Labour), and for Labour to stop mimicking Reform so that social liberals can more easily vote tactically for Labour against the right wing bloc.

That is why the Green victory in Gorton and Denton was important, because it helps strengthen the hand of those within Labour that want to change its strategy. Starmer’s response to their defeat in Gorton and Denton also shows that Labour still has a long way to go in that direction. Those that tell me and others that this will never happen and that ‘Labour are finished’ are in effect saying that a right wing victory in the next general election is very likely.

The best way of stopping a Reform government is to make the next general election all about voting tactically to stop that outcome. I’ve read some people saying that the Gorton and Denton result shows how that can be done. It doesn’t. The right wing vote in that constituency improved significantly compared to 2024, and its tactical split was almost perfect. Reform lost because it is a very left wing seat.

The Green victory in Gorton and Denton is important because it adds to the pressure for Labour to stop trying to ape Reform. That needs to happen, because to avoid a right wing populist government, socially liberal voters need to be prepared to vote tactically between Labour and other socially liberal parties in a way that is at least as efficient as tactical voting between Conservatives and Reform. As long as Labour acts and sounds like Reform on social issues, that is just not going to happen. But equally the anti-right wing vote needs a strong Labour vote, because it is highly unlikely that socially liberal parties can defeat the right without it. [3]

[1] If Labour did better than in Gorton and Denton, and achieved 70% of their 2024 vote in each constituency (current polls have them on just less than 57% of that vote), and with no tactical voting between Labour and socially liberal parties and the right wing bloc support remaining unchanged, Labour would still only get just over 40 seats, but the right wing majority would be around 300 seats in Great Britain.

[2] How can this be the case, when right wing parties did so badly in 2024? The first answer is that the combined right wing vote is better today than it was in 2024. If we do a calculation where the right wing vote is the same as 2024, and there is perfect tactical voting in both blocs and Labour’s vote is equal to its 2024 level, then Labour get about 250 seats, the right wing bloc 280, with the remainder and the balance of power held by over a hundred socially liberal party seats. The second answer follows from that. In 2024 tactical voting within the right wing bloc was almost non-existent, and in contrast there was a lot of tactical voting between Labour and socially liberal parties, because most voters wanted the Tories out of government.

[3] Of course a strong Labour vote is still compatible with the Green party winning a number of safe Labour seats like Gorton and Denton and perhaps with other socially liberal parties holding the balance of power in any future parliament. Just as the Tory move towards Reform may have created a large number of seats for the Liberal Democrats, so Labour’s move to Reform is likely to create a large number of seats for the Green party at the next general election.

Budgets are about much more than fiscal sustainability

 

Ben Zaranko of the IFS has just published a paper on fiscal rules. It is well researched and well written, but I disagree with its conclusions. For those interested in the subject I strongly recommend reading the paper. Here I will restate his main argument, and say why I disagree with his solution. I will also add what I think is the main problem with the current fiscal debate, and it has nothing to do with fiscal rules.

Problems with the current system

For clarity, let me focus on the current situation where the golden rule (taxes match current spending) is binding, and ignore the other fiscal rule (falling debt to GDP) which is terrible and should be abolished. This also happens to be the fiscal set-up that I prefer. Ben has a section (“Why not focus solely on the current budget balance?”) where he notes two potential problems with this set-up. I will add a third, which he mentions in his introduction.

1. The golden rule does not ensure ‘sustainability’ because it excludes public investment.

2. Volatility in the forecast will lead to volatility in policy.

3. In practice this rule is supplemented with a variable amount of headroom which leads to various problems.

I will deal with each problem in turn.

The first disappears when you recognise that there is nothing magic about zero for a target for the current budget deficit. It could equally be a target for a 1% surplus or deficit. Which it should be is governed by the society’s long term goals. Suppose, for the sake of argument, that everyone agrees government debt should be around 50% of GDP in fifty years time in the absence of major shocks. [1] The target for the current balance should be consistent with that long term objective.

Working out what current balance target corresponds with achieving that longer term objective involves various assumptions, like what the average real interest rate will be over the next fifty years. It will also include what the average level of public investment will be. It really is irrelevant in this respect whether that investment is partially ‘self-financing’ or not. Once those assumptions are made, working out what the current balance target should be becomes a calculation that can be done on a spreadsheet, but it would be good if the government could periodically (every few years) show that calculation. [2]

The second problem sounds more serious. To quote Ben:

“the framework and the way it has come to be operated mean that when forecasts move around – as they inevitably do – policy has to respond, often in a rush and with a spurious degree of precision. This does not make for good policymaking ….”

A core principle of fiscal policy is that taxes and spending should be smooth, letting changes in borrowing absorb short term volatility. If forecast volatility is leading to spending or tax volatility, we have a problem.

However I’m not at all sure forecasts are volatile in the sense of moving randomly either side of an underlying trend, particularly if they relate to the medium term that excludes cyclical variation. (Which is one reason why targets should be for quantities five years ahead, not three.) My impression is that often forecasts respond gradually to real shifts in the economy (like changes in productivity, for example), leading to years where the fiscal corrections due to the forecast are of the same sign. For this reason, I think adjusting the public finances once a year to achieve a fiscal rule seems about right to me. (Doing this every six months was silly, as I said at the time.)

Which brings us to the third problem, which is headroom. Everyone seems to agree that it is sensible for the government to go beyond its fiscal rule and add a certain amount of headroom: a buffer to absorb shocks. But if medium term forecasts are not erratic, why do you need a buffer? Why not set policy to hit the fiscal rule exactly? The answer has to be that tax rates are round numbers, so it is never possible to hit a fiscal rule exactly, and trying to do so by adjusting minor tax rates or allowances would lead to distortions.

My own preferred solution to the problem of headroom is to have none, and treat the fiscal rule as symmetrical rather than as some upper limit. As I explained, headroom is a concept that makes sense at the individual or company level but makes no sense for a government. However the political reality is that although central banks are seen as being responsible even when they forecast inflation two years out a bit above their target, we seem to live in a media climate where a government occasionally allowing itself to have a bit less than 50% chance of meeting its fiscal rule is deemed unacceptable. As a result, governments will allow themselves headroom.

As Ben explains, headroom has only become a problem when it started to be set at persistently very small levels (his Figure 3.1), an ‘innovation’ introduced by Jeremy Hunt. (Hunt was a terrible Chancellor for many reasons.) As Ben also notes, Reeves has now gone back to something more like pre-Hunt headroom levels, so hopefully the problem of headroom has also now gone away.

A traffic lights approach

Ben’s solution to these perceived problems is to move from a single fiscal rule to a multi-indicator approach, where a number of measures would be looked at and they would be assessed with a traffic light system. It’s like having multiple fiscal rules, but where none is binding, so policy can fail on some as long as it meets others.

One problem with this is that it makes the problem of fiscal sustainability sound like a complex issue when it is not. I don’t need lots of indicators to work out whether my bank balance will go into the red in a few months’ time, and sustainability is really just a similar matter of arithmetic, albeit over a much longer time period and without a bank manager or overdraft. We have fiscal rules because politicians are not very good at raising taxes or cutting spending, leading to deficit bias, and one simple rule should be sufficient to correct this bias.

In addition, if you in effect have lots of targets, then how do we know when the government is avoiding ‘difficult decisions’ by spending too much or not taxing enough? You need an expert to interpret all the traffic lights. Traffic lights are great for people like me or the IFS, who will be called on to interpret all the red, yellow and green, but it is not good for public transparency.

With many targets you have a whole new set of problems. Are the targets consistent with one another, or are the assumptions that make them consistent plausible? In addition many indicators allow politicians to cherry pick the targets that happen to look OK even though sustainability is not being achieved, or alternatively it can allow the media to insist that most of the targets are hit, resulting in too tight a fiscal stance.

As I noted above, all you need to ensure governments are trying to ensure sustainability and avoiding deficit bias is one simple rule, and periodically the spreadsheet calculations that lie behind it. I think a good deal of the dissatisfaction that Ben and many others have about fiscal policy at present is that this issue of sustainability gets far too much focus, from the media and (therefore?) politicians. Ironically having a traffic light system rather than one simple rule will mean more, not less, focus on sustainability.

The real problem with fiscal policy is the focus on sustainability

But I do have some sympathy with Ben in that having a single target does make it appear as if the forecast is determining fiscal policy. But the fault here is with the media and politicians and not the target. Fiscal sustainability is just one aspect of fiscal policy, and in many senses the least interesting aspect. It may appear far more important than it really is because politicians have ignored or downplayed other key aspects of fiscal policy.

The most important microeconomic objective of fiscal policy changes is to achieve a coherent and fair system that provides appropriate incentives in the simplest possible way. We should be asking the Chancellor each budget what have they done to achieve this, rather than obsessing with how much headroom they are allowing for fiscal rules. Unfortunately the media typically only touches on the issue of fairness, by talking about winners and losers, and largely ignores issues of incentiives, efficiency and simplicity.

Just as there is a tendency for politicians to avoid difficult political decisions which then lead to deficit bias, there is also a tendency for them to go for tax changes that are popular in the short term but make the tax system both complex and inefficient and which provide the wrong incentives. For example Labour in opposition pledged to not raise taxes on working people, so it put up taxes on employment thereby reducing output. Not raising petrol duty gets favourable headlines, but as a result over the last decade the cost of driving a car has risen by less than the cost of rail travel and by much less than travelling by bus, which hardly provides an incentive for greener travel.

Creating fiscal rules and fiscal institutions like the OBR has helped reduce the problem of deficit bias. I don’t know how you incentivise politicians to focus on creating a more efficient tax system, but making achieving sustainability more complex is not the way to achieve that.

In addition, sustainability is not the only macroeconomic goal for fiscal policy. In the last budget the Chancellor had a clear aim to reduce short term inflation using various fiscal measures, with the goal of reducing both short and longer term interest rates. While the media picked this up, I saw very little discussion of the macroeconomic merits or otherwise of this strategy. Furthermore in a recession, of course, fiscal policy should be expansionary to support or replace monetary policy, and the fiscal rule should be suspended.

More generally, the stance of fiscal policy has implications for aggregate demand and therefore short term interest rates. While it is true that there is a broad relationship between financial fiscal rules and aggregate demand, it is not an exact equivalence. Hitting the golden fiscal rule will often imply a neutral medium term fiscal stance in aggregate demand terms, but not always. [3] In addition, there may be scope for influencing (in either direction) aggregate demand in the short run while keeping to fiscal rules in the medium term. By thinking about the impact of fiscal policy on aggregate demand the government is not trying to duplicate the Bank’s role in controlling inflation, but instead is trying to influence what short term interest rates the central bank will end up setting to control inflation over the forecast period.

Summary

The idea that the OBR forecast determines what a Chancellor does is understandable given much of the media’s coverage of this event. But it is also a big misunderstanding of what is going on. That the Chancellor has recently had to raise taxes to meet her spending plans and fiscal rule shows that the goal of ensuring fiscal sustainability is being achieved. In that sense it represents a success story. Replacing that fiscal rule with a set of traffic light indicators could put that success at risk by adding considerable confusion. However a Budget involves much moe important microeconomic and macroeconomic issues than fiscal sustainability, and if that doesn’t receive enough attention that is the fault of politicians and the media, not a simple fiscal rule.

[1] Whether that long term objective is reasonable would require far too much discussion for this post. Note, however, that a major justification for such a goal is that it allows space for debt to rise after major shocks, like a pandemic or a major recession.

Another point is if reducing debt over fifty years is a reasonable objective, what is wrong with the falling debt to GDP rule. The answer is simple, if you ask what this rule adds to the current deficit rule? What it adds is public investment, thereby undoing the good that is done by excluding it in the current balance rule. 

[2] Such a calculation is quite different from the 50 year projection done by the OBR. The OBR’s projection assumes current policies for spending and taxes, and calculates the implications for the government’s current balance. The calculation the government would do would assume the current balance target was met in each year beyond the five year forecast.

[3] In this sense there is no great contradiction between a focus on a medium term fiscal rule based on the government finances, and setting fiscal policy to eliminate inflationary pressure in the medium term. The financial reflects the real. MMT prefers setting fiscal policy to control inflation in the short term rather than using changes to interest rates to do this job.

How Labour makes fighting right wing populism harder

 

I must confess that this post will be very similar to one I wrote a fortnight ago. The big difference is that this is about this Labour government rather than the current Conservative party. Another difference is that while the trajectory of the Conservative party seems reasonably clear under its current leader, things are potentially more fluid with Labour. One commonality is that, up until now at least, the leadership of both parties have got their strategy seriously wrong.

You might think what right have I, a macroeconomist by trade who just dabbles in political economy, to make such a claim. [1] Well I could point out that many others who know much more about these things have been making broadly the same points as I have. I would also point out that over the past year or so what I and others predicted would happen has come to pass. Labour’s core socially liberal voter base has continued to either not vote Labour, or vote for the Green party, Liberal Democrats or nationalists. The argument that these voters will come back to Labour in a general election was flawed in part because it ignored what would happen before then. The events of the last two weeks alone have proved that criticism to be correct, with the architect of Labour’s strategy now out of his job. [2]

Another commonality with the Conservatives is the belief that if politicians sound, and in the case of this government act, like Nigel Farage on immigration and asylum seekers this will win them votes that are currently going to Reform. This is a colossal mistake. As I said two weeks ago, Farage owns these issues, and in Labour’s case there will always be enough asylum seekers crossing the Channel for Farage and the right wing press to suggest to social conservatives that the government isn’t doing enough. By sounding like Farage and acting as if what Farage says is true, all Labour is doing is giving Farage’s message additional airtime and credibility.

Furthermore there is an economic dimension that adds what Jonathan Portes describes as a doom loop. Restricting immigration has negative economic and fiscal consequences, which intensify not only dissatisfaction with the government but also adds to the anti-immigration views of many voters.

So Labour sounding and acting like Reform on immigration and asylum was likely to increase rather than decrease the Reform vote and reduce the Labour vote, which is what has happened. But it has been far worse for Labour, because sounding and acting like Farage is anathema to Labour’s core vote, which is socially liberal. This problem is particularly acute now because of the popularity of Reform.

The idea that Farage could become Prime Minister, and then start acting like his hero Donald Trump, is horrifying to Labour’s base. The elevated nature of the threat from socially conservative populism makes Labour’s base that much more sensitive to Labour behaving like Reform. In addition, Reform’s success means that ideas that were once seen as so inhumane as to be inconceivable are now on the agenda. In those circumstances, if instead of aggressively combating those policies the Labour government spends its time telling voters how problematic immigration is and asylum seekers are, and why cruelty is necessary to deal with these problems, then much of Labour’s base will not vote Labour. Continuing to supply some arms to a regime engaged in ethnic cleansing, and a failure to recognise that ethnic cleansing, does not help either.

Diagnosis of why Labour have lost their core base is crucial to understanding how to get it back. It is not just a matter of Labour ‘tilting left’, and sounding or acting more left wing on some economic issues (or bothering to promote the areas where they actually are left wing). The way to win their core base back is to start acting like a party that at least protects socially liberal ideals, even if it also recognises socially conservative concerns that are not imaginary. Another commonality with two weeks ago is that analysis that treats politics as one dimensional (left/right) misses this key point. Labour has lost much of its base not so much because it hasn’t been left wing enough in economic terms, but more because it has sounded and acted in an illiberal way.

Which brings us to Shabana Mahmood, Labour’s home secretary. Judging by both her rhetoric and actions, she is as committed as McSweeney was to the strategy that has been such a failure for Labour. Mahmood has recently asked for comments on proposed changes to settlement rules: how long immigrants have to live here, and under what conditions, before they would be granted indefinite leave to remain (ILR). A very good summary of the proposals is given by the Migration Observatory here. One noteworthy change is that refugees granted asylum in the UK would face a baseline waiting period of 20 years (!) before becoming eligible for settlement. Many have suggested that such measures, as well as being immensely cruel to those currently waiting for ILR, will also severely damage integration, which compared to some other countries has up until now been a UK success story.

These changes will undoubtedly find support from many Reform voters, but with the Conservatives and Reform bound to offer ‘tougher’ proposals it seems unlikely this will attract many Reform voters to vote Labour. As I suggested above, by keeping immigration and asylum seekers in the news as ‘a problem’ it will gain Reform votes. In contrast these proposals are pretty unpopular among Labour, Liberal Democrat or Green voters. Add to this Mahmood’s apparent wish to cut immigration numbers whatever their level, the Farage type rhetoric coming out of the Home Office, and Mahmood’s determination to keep proscribing Palestinian Action and therefore locking up grannies for holding placards, and there is plenty here to keep former Labour voters voting for socially liberal parties at least until the General Election.

It is a good sign that this Labour government is at last actively opposing extreme reactionary statements like those from Jim Radcliffe. But given the damage that has already been done, the occasional socially liberal statement will not be sufficient if the government’s actions continue to be illiberal and in some cases simply inhumane.

Many on the left may think that a continuing drift of Labour’s core vote to other parties is a good thing, because Labour under Starmer or either of the two leading contenders to succeed him is probably beyond repair. In a system where all elections are based on a proportional voting system this argument has some force, because then power reflects voting numbers and social liberals make up a powerful voting block. Broadly the Greens would take economically left leaning socially liberal votes, the Liberal Democrats right leaning socially liberal and some centre votes, Labour would take some left leaning socially conservative and many centre votes, and the Conservatives and Reform would fight over the right leaning socially conservative vote. Even in this case, however, social liberal parties are unlikely to be in the majority, with at best Labour holding the balance of power

Unfortunately under a First Past The Post (FPTP) voting system such an outcome is a recipe for the next UK government to be a Trump tribute act. Under FPTP, it is highly unlikely that a combination of socially liberal parties (the Greens, Liberal Democrats and nationalists) can win a majority of seats in the House of Commons, even if these parties could form a perfect pact between them to divide up seats before a General Election. According to current polls their combined vote total is around 30%, similar to Reform. But the FPTP system is biased towards social conservatives, because the social liberal vote is heavily concentrated in cities (partly because it is relatively young). [4]

Even if the Labour vote stayed at around 20%, it would still attract some voters in the political middle, allowing right wing social conservatives to win critical marginal seats. In addition we have a media environment that is heavily tilted towards right wing social conservatism. As a result, in any General Election many socially liberal voters will need to vote Labour to prevent socially conservative populists winning an outright majority.

To prevent a right wing, socially conservative party coming to power in the UK, many social liberals will not vote Labour in by-elections or council elections before the General Election to put pressure on the government to sound less like Farage on key social issues, but then many of them will need to vote Labour tactically in the General Election. That they will manage to do so is of course why the Labour government is highly unlikely to change FPTP for General Elections.

The important point to stress for this post is that Labour gains nothing by delaying this move to a more humane and liberal stance on social issues, but has a lot to lose. The more modest any change is, and the longer it takes, means it becomes more difficult for social liberals to convince themselves to vote tactically in a General Election. It also makes deciding who to vote for tactically more confusing. Imagine the problem many voters have in the forthcoming by-election multiplied by hundreds of seats without much media coverage on those seats. And finally the longer a government remains very unpopular in the polls the more difficult it is for it to generate the positive media coverage it needs to win votes from low information voters.

Unfortunately all the signs are that the Labour government under any likely leader will be too slow to recognise the depth of the strategic error they have made and are continuing to make. While those on the political right have generally understood the need to protect their core vote, Labour has a tradition of doing the opposite that goes back to the factional wars that began in the 1980s. This makes the battle against socially conservative populism in the UK that much more difficult.

[1] Most political journalists are too absorbed in the moment to ask these strategic questions. All too often it is like trying to ask a market trader what they think the medium term impact of a particular macro policy will be. Even the ability of some of them to do short term political analysis seems questionable. It seemed to me pretty obvious that both of Starmer’s main challengers for the leadership would prefer to take over after the party’s drubbing in the May elections rather than before those elections. (A third was not even in play.) As a result, there would be no attempt to remove Starmer right now. But if your incentive is clicks rather than being right, then I guess the fever of the last two weeks makes some sense.

[2] Of course the proximate cause was Mandleson, but Labour’s dire position in the polls colours everything. In addition, as the current and recent by-elections show, any general election will be all about keeping Reform out, and crucial to that assessment is which party is most likely to achieve that. If before a general election another party (e.g. Greens or nationalists) have had considerable success in local elections in many areas, those parties rather than Labour will have a strong claim to be the party that can keep Reform out. Many might consider that a good result, but as a strategy for the Labour party it is not clever.

[3] I don’t like the kind of voter grouping that seems popular among pollsters and which NatCen does here, but the latter does have some correspondence to these four categories of voters. Most of ‘Urban Progressives’ and ‘Soft-left Liberals’ will be left leaning social liberals, ‘Left-Behind Patriots’ are left wing social conservatives, ‘Well Off Traditionalists’ will be right wing social conservatives, with ‘Apolitical Centrists’ and ‘Middle Brittons’ forming a large group in the centre.

[4] This is one of the reasons why Johnson won a large majority in 2019 despite a majority voting for parties supporting a second referendum.