Where would you get the money from?

In the recent furore in the UK over tax credits, I do not recall any government minister being asked the following question by a journalist: why don’t you just borrow more? Yet to any economist that is the most sensible, and indeed obvious, question to ask.

I just do not think most journalists (and I’m tempted to write and therefore politicians) have yet realised this crucial difference between austerity in 2010 and austerity now. [1] In 2010 debt to GDP ratios were rising fast, everyone was talking about market panic, so people like me who thought deficits should be larger had some explaining to do (although, as Ben Bernanke recently said, we were right). But now austerity already enacted has stabilised debt to GDP ratios, not just in the UK but in the US and Euro area. Over the next five years debt to GDP ratios in the UK will be falling.

This means that further austerity is no longer about stabilising debt and an imagined market panic. Instead it is about an obsessive need to cut debt to GDP really fast, or more likely a desire to shrink the state. It isn’t primarily about Keynesian economics any more [2], but instead about any kind of economics. Remember there are no economists prepared to defend Osborne’s fiscal charter. In economic terms the fiscal charter itself is the real embarrassment. The issue is no longer do we increase the level of government debt for the sake of the economy, but do we need to raise tax credits or cut vital public services just in order to cut government debt quickly.

Perhaps the most charitable explanation for this failure of journalism is that most people do not understand some very basic points. Governments running surpluses are rare. Unlike individuals, nearly all governments have always had a large amount of debt. Unlike individuals, nation states live for a very long time. Because the amount they produce also grows over time (real growth and inflation) that means that the ratio of debt to GDP (which is what matters) can stay constant even if they run deficits. For example with debt at 80% of GDP, and a conservative estimate of average 4% nominal growth, the UK’s debt to GDP ratio would stay constant with a deficit of 3.2% of GDP.

3.2% of GDP is a lot of money. It means the government could run deficits of £60 billion today (£70 billion by 2020) and not raise the debt to GDP ratio. By comparison, the now derailed cuts to tax credits were worth less than £5 billion, and the spending review is trying to save £20 billion.

So here is a simple exam question for journalists. If any politician over the next 5 years proposes not to cut some item of expenditure, or not to raise some tax, and they are asked where is the money to do this coming from, which of the following answers is most convincing?

1. We would generate more tax receipts by making the economy stronger.

1/10. Every political party thinks their policies will raise growth and therefore bring in more revenue, but they should never rely on this happening. In some cases political parties (pretend to?) believe things that we know are untrue, like tax cuts will pay for themselves. Of course some policies, like cutting tax credits, could well damage the economy by reducing labour supply, but again it is highly unlikely that such damage would make tax credits self-funding. So any interviewer would be quite right to raise their eyebrows at this answer.

2. We would save money by making public spending more efficient.
   

1/10. Same problem as above.

3. We would print more money.
   

3/10. Not as silly as it may sound when central banks have already created a huge amount of money (QE) to buy government debt. So no raising of eyebrows (or worse) appropriate in this case. But in the current UK and US context (but not the Eurozone) where central banks are talking about when they might start reducing QE it looks like an answer which is out of its time.

4. We would cut the following expenditure instead, or raise the following taxes, or get rid of the following tax breaks.

8/10. A good answer, particularly if the funding measures are specified and the sums are realistic and not double counted. Works in all seasons. Right now opposition parties have plenty of scope here, as Jolyon Maugham spells out.

5. We would borrow more.

10/10. In the current UK context the best answer, although if you had given this answer in Ireland or Spain in 2004 you would get 0/10. It may seem too easy to be true, but in the rather peculiar circumstances where you have a Chancellor that is pursuing reckless austerity for extremely dubious reasons it would be utter foolishness to turn your back on this gift horse.

Yet most politicians are incredibly reluctant to give that answer, in large part because they think they will get the raised eyebrow treatment from journalists or worse. So we have the crazy situation that no single economist is prepared to endorse the fiscal charter, but pretty well every journalist treats any suggestion that we should depart from it as unacceptable. That just cannot be right.

[1] Andrew Rawnsley rightly points out that the political reaction to the tax credit cuts over the last five months shows how little most journalists know about ordinary people as well as economics (yes, that Westminster bubble), but he fails to note the critical role of the fiscal charter, and so treats the need to find some extra money as self-evident.

[2] There still is a Keynesian argument about risk, but take that away and the case for a more gradual pace of deficit reduction is still very strong.