Monday, August 31, 2009

Tax Rises and Recovery

Between now and the general election, the government is planning tax rises of close to £10bn. Mostly these tax rises involve the ending of previous tax cuts.
  • The 2p rise in petrol tax, which was delayed when oil prices were high last year, will come into effect Sept 1st.
  • The car scrapage scheme will be phased out by Feb 28th 2010
  • The 2.5% reduction in VAT will Jan 1 2010.
  • 50% Income tax rate will be introduced April 1st
  • End of Stamp Duty on houses less than £175,000 Jan 1st
Given the size of the government's budget deficit it makes sense for tax cuts to be reversed, at some stage. These tax cuts were supposed to be temporary in order to boost spending in a depressed economy. Recently, we have seen signs of recovery and though the economy is still far below full capacity, at least some of the fiscal expansion can be reversed.

The danger is that if the recovery is more fragile than many hope, the tax rises could snuff out the nascent recovery and plunge the economy back into a double digit recession. In 1937, the US economy was plunged into a second period of economic downturn after the government increased tax and tightened monetary policy too early.

Nevertheless, despite this fear, I feel the economy should be able to weather these tax reversals. Recent evidence has shown some positive signs. Whilst higher taxes will reduce consumer spending, monetary policy will be able to remain loose to maintain economic expansion. - Interest rates are still close to zero and the Bank of England has shown willingness to continue quantitative easing.

The only problem for the taxpayer is that these tax increases (£10bn) are still a drop in the ocean for the underlying structural deficit. Unless we experience above trend growth, more fiscal tightening will be required after the general election.

1 comment:

Anonymous said...

I figure your posts are there to help students with their courses but I would really like your view on the American situation, how is it faring up to now, is it looking like they've made good choices? Where have they made bad choices?

Thanks!