The fiscal challenge

Reeves' problem isn't raising money: it's much more difficult than that.

Everybody agrees that the issue in the forthcoming Budget is how to raise money to pay for public services.

Everybody is wrong. Money is not the issue at all. It is not money that cures the ill, cares for the elderly, builds houses or installs solar panels. It is people that do this. What we need is more of them to do so.

But how to find them? The unemployment rate has risen recently and thanks to bad management there are some doctors who are out of work. Some can therefore come from the dole queues. But with unemployment still close to its lowest in decades, not many will. And nor can many come from the economically inactive: people cannot move quickly from having long Covid to working on building sites, or from being a neet to an orthopedic surgeon.

The government’s challenge isn’t to raise money. It’s a much tougher one than that. It’s about how to achieve a shift in real resources.

It is here that taxes enter the picture. The purpose of higher taxes is to reduce consumer spending and therefore jobs in retail and hospitality, thereby releasing workers to move into other sectors care work and construction.

We can put this another way. Imagine the government were to simply try to recruit more home insulators, housebuilders, care workers, weapons producers and so on. They would attract applicants. But these would come not so much from dole queues and the economically inactive as from workers in other jobs. In an attempt to retain their staff their employers would raise pay. The result would be inflation and thus higher interest rates. And if interest rates rise, you can say goodbye to any hope of increase housebuilding. Tax rises are a way of preventing this.

You might think this is bog-standard modern monetary theory. But it’s simply an old truth. Here’s Hugh Dalton, then Chancellor, in 1947:

I am not, this afternoon, going to put any precise figure upon the inflationary gap which we have to close. But the line of our counter-attack, in so far as this runs through budgetary policy, is very simple indeed. We must reduce the total expenditure, and we must increase the total revenue. If there is a heavier inflationary pressure, we need a larger Budget surplus than would otherwise have had to be provided; just as if there were a heavy deflationary pressure, we should require a large budgetary deficit to counter it.

But, but, but. Higher taxes only reduce inflation and therefore free up labour if they reduce spending. And not all taxes do this. If the mega-rich respond to wealth taxes merely by saving less rather than spending less, then there’ll be no cut in aggregate demand or inflation. The same is true of the LibDems’ proposal to tax banks. If this merely reduces retained profits, there’s no fall in inflation. That would only happen if banks respond to the tax by reducing lending.

This isn’t to oppose such taxes. Instead, their function would be to provide legitimacy for what we really need - higher taxes on those who would reduce their consumption, namely the middlingly well-off. As the IFS and FT have pointed out, middling earners in the UK are taxes less than in many other countries. If we are to have better public services, it is these who must pay - as they do in much of Europe.

There are, of course, enormous problems with this. One is that it is physically difficult to get people to move job: they need retraining and reassurance that they’re doing the right thing. What we have here is as much a problem of labour market policy as fiscal policy.

Another problem is that the government is scared to state the issue so baldly - that better public services require middle-earners to curb their spending.

Perhaps it is right to be scared. Recent years have taught people to be sceptical about state capacity, with the result that they don’t have the confidence that higher taxes will indeed lead to better public services.

Nevertheless, failing to frame the issue properly has a cost. It means the government cannot credibly oppose those like the Greens, trades unions and LibDems who think we can get somebody else to pay for public services.

Even if we could tax middling earners, however, there is still a massive problem. Reductions in private consumption would accelerate the closures of pubs and shops. And these - as Diane Bolet and Thiemo Fetzer have shown - would quite likely further fuel the rise of the far right.

So, what’s the answer?

One possibility is to raise the inflation target and ditch the fiscal rules. There is, however, no sign of the government being willing to do either, maybe rightly so.

Another possibility would be specific targeted taxes such as upon luxury consumption or on delivered takeaway food: healthy young men should be working on building sites rather than running over pedestrians in city centres.

Yet another possibility is to consider ways of reallocating labour without higher taxes. A simpler tax and benefit system would reduce the numbers of bureaucrats, lawyers and accountants. Higher carbon taxes would cut the number of workers in polluting industries (yes, such as steel!). And better financial regulation would shrink the numbers of risk polluters and genuinely unskilled fund managers. Such measures, however, mightn’t be sufficient to greatly reduce the amount of misallocated labour - leaving intact, for example, guard labour and bullshit jobs.

I say all this not so much to provide policy proposals - there’s no point writing recipes if you don’t have a kitchen - as to show the enormous scale of the problem. Fiscal policy isn’t merely a matter of money. It’s about deeper, tougher questions: what sort of economy do we want with what jobs? How, if at all, can we move away from private consumption without exacerbating the sense of decline that has fueled the far right? How, if at all, can we persuade people of the need to pay for better public services? How can we help people change jobs? It’s almost understandable that the response of much of the political class to these issues is to simply ignore them.