Budget Statement

Lord Skidelsky Excerpts

Wednesday 23rd March 2016 Grand Committee

[Lord Skidelsky (CB)]

My Lords, I want to address three topics that have arisen from the Budget—the productivity collapse, the overreliance on OBR forecasts and the failure to distinguish between capital and current spending. I know that noble Lords have spoken on the first two but the third one is also important and was briefly alluded to by the noble Lord, Lord Desai.

Productivity is really a disaster. Before the crash, productivity growth was about 2% a year. In the last eight years it has been 0.2%. These figures should alarm the Chancellor. It means that he can expect no help to growth from productivity and that a lot of our present growth is bubble growth, which will subside when the balloon is pricked, together with the bubble revenues it brings him. The belated recognition of this fact has led the OBR to revise downwards its growth forecasts, leaving the hole in the Budget to which many noble Lords have already alluded. Near-zero productivity growth also means we can expect very little improvement in living standards over the next few years. The Iron Chancellor will have presided over Britain’s longest period of stagnation in a century.

No one has a completely convincing explanation of why productivity has been so poor, certainly not the Bank of England, which has written a couple of reports on the matter. In the most general sense it must be because of the way our labour markets and financial system have worked during the recovery from the recession. What new jobs have we created? In his Budget speech the Chancellor claimed that the economy created 2 million “good” jobs in the last Parliament,

“90% … in skilled occupations ... three quarters … full-time”.—[Official Report, Commons, 16/3/16; col. 953.]

The view from chez Corbyn was, understandably, very different. He referred to,

“nearly 1 million people on a zero-hours contract ... the highest levels of in-work poverty on record”.—[Official Report, Commons, 16/3/16; col. 971.]

This means that this has been a jobs-rich, skills-poor, recovery—in marked contrast to both the great depression of the 1930s and the recovery from the 1980s. The labour-intensive nature of the recovery has shown that Margaret Thatcher achieved her goal of creating the flexible workforce dreamt of by the Chicago economists, but only by drying up the springs of productivity and thus real wage growth. From 2008-14, the median real wage, which had been growing by about 2% a year in the 1980s and 1990s, fell by an average of 1% a year. Real weekly wages still have not reached their pre-crisis peak; this is not what a recovery should look like in a “high-wage” economy.

We can discern two trends from this: a further shift from manufacture to services; and within the service sector, a shift from higher paid to lower paid jobs—from local government to hospitality, personal services and retail. Our new service economy is starting to look like the Victorian servant economy, with the difference that the services are now outsourced rather than in-house. However, to explain the increase in the labour intensity of employment we also have to look at the financial sector. Capital investment has fallen off, with investment as a fraction of output having been consistently 1% or 2% lower than its pre-crash level. The effects of this continued underperformance of investment, accumulating over time, has left us with an anaemic capital-labour ratio that continues to drag on our productivity.

Why has investment been so sluggish? This, we must remember, has been despite all the efforts by the Bank of England to stimulate fresh investment by keeping interest rates at zero, and, of course, pouring a lot of money into the economy. Is it because we have a damaged banking system or because we have a banking system which is less interested in helping small and medium-sized enterprises than in churning money around itself? Is it because the demand for loans has fallen off? It is probably some combination of the three. Much of the new money has been hoarded. Some of it has gone into asset speculation. Two-thirds of bank lending goes into mortgages to buy existing houses—which is speculation in a fixed asset. All of which is a far cry from the textbook idea of banks as intermediaries which channel public savings into real investment. Therefore, on the one hand an increase in labour intensity and on the other hand an increase in what the noble Lord, Lord Turner of Ecchinswell, calls “financial intensity”—an increasing share of financial actions taking place within the financial sector itself. I argue that the interaction between the two explains our productivity collapse. The conclusion I draw is therefore pretty clear. If the private sector will not invest in the economy, the state has to do it.

My second topic, which has been referred to by the noble Lord, Lord Darling, is about the over-reliance of the Chancellor on OBR forecasts. We know the picture. In November the OBR gave the Chancellor a £27 billion bonus and more recently it discovered a £4.4 billion hole. Targeting deficit reduction over a medium-term period became fashionable in 2010 to give fiscal consolidation credibility. In 2010, the noble Lord, Lord Darling, announced that he would halve the budget deficit over four years. A few months later, the Chancellor said that he would eliminate the “cyclically-adjusted” current spending deficit by the end of the 2010 Parliament. Labour now follows the same path. John McDonnell says that a Labour Government will balance the books every five years. All these targets depend, as noble Lords know, on growth forecasts which are bound to be wrong at the time, bound to be wrong—as the noble Lord, Lord Desai, said—even about the past, and are bound to be even more wrong in the future. Today no one knows how much the economy will grow over the next five years, yet the Chancellor still has a target of an overall surplus in 2019-20. The combination of point targets and variable forecasts is a mad way to do budgeting. No wonder the Chancellor has revived his talk of headwinds. I can see that having these medium-term targets gives some assurance of fiscal discipline. However, it also means that policy is just shuffled around between the front and back of the sofa according to the latest OBR forecast. The one thing this vacillating method fails to provide is a credible policy of fiscal consolidation.

The larger problem underlying all this is that the Chancellor’s Administration has been trying to achieve a balanced budget for a given state of the economy rather than trying to use the budget to balance the economy. Unfortunately, this restricted view is shared by Labour. It means that the current debate largely revolves round the fairness of the cuts—the distribution of the sacrifice—rather than challenging the logic of the cuts in the first place. We therefore need a lot more thought about that.

My final point is about George Osborne’s failure to distinguish between capital and current spending. This goes back some way, and he is not the first to fail to do that. One of Gordon Brown’s achievements was to revive the distinction between debt incurred to finance capital formation and debt incurred to fund consumption. The basic idea is that the Government should cover all current spending by taxes, but can borrow for investment. Had that distinction taken root, the spending that needed to be balanced by taxes would have been much smaller and the budget deficit consequently less alarming than has been shown to be the case in public debate. The problem, of course, is the difficulty of defining investment. Building a new school or hospital is surely an investment, but because it does not produce a calculable prospective revenue to service and pay off the debt, it creates a lot of wiggle room to borrow for current spending.

In reaction, the Treasury now treats all public investment as current expenditure. When the Chancellor says that he aims for a surplus in 2019-20, he means a surplus on public sector net borrowing. Since any investment financed by borrowing increases the deficit, that is in effect a veto on government borrowing for investment in the foreseeable future. We need to do a lot more work on this.

I am reminded of something that Keynes wrote in 1942. He said:

“We need to extend, rather than curtail, the theory and practice of extra-budgetary funds for state operated or state-supported services … [It is important] to associate as closely as possible the cost of particular services with the sources out of which they are provided … This is the only way to preserve sound accounting, to measure efficiency, to maintain economy and to keep the public aware of what things cost”.

I do not deny for a moment that there are some thorny problems here, but unless we make a determined effort to relate the cost of particular services with the sources from which they are financed—I have been a long-standing advocate of a national investment bank—we will never escape from the deficit trap, at least except by destroying what is left of social cohesion. That is the course, I am afraid, on which the Chancellor has embarked. But as the resignation of his Work and Pensions Secretary shows, it will bring him little joy.

--- Later in debate ---

[Lord Lupton (Con)]

My Lords, I want to talk about two matters in the Budget, one of which has had little publicity to date but to my mind signals a significant and welcome policy development. Before doing so, I want to make one general observation and remind the Committee of my declared interest as chairman in Europe of a global corporate advisory firm, some of whose clients may well be affected by the Budget.

In my first few months sitting in your Lordships’ distinguished company in the House, I have come to the conclusion that the opposition parties have learned little from the depressing tale of recent economic history. Reckless mismanagement of the economy in 13 short years, most of those years in the boom period before the crash, brought this country almost to its knees in 2010, requiring the Conservative-led coalition in that year, now a Conservative majority Government, to take decisive action to reduce a double-digit deficit.

It is apparently perfectly acceptable, when we have a deficit still running at more than 3%, to table amendments costing the country literally billions while criticising in a knee-jerk way any tax cut, even when there is good evidence that such a cut may produce more revenue. I am sorry to say that there is something sickening about listening to the sheer hypocrisy of Labour Peers criticising a so-called “black hole” of £4 billion opening up over the next five years on PIP when they dug a 10% deficit cavern in 2010—a Wookey Hole compared to a PIP pothole.

[Lord Skidelsky]

My Lords, can we just get some accuracy on the figures? The deficit when George Osborne took office was 8.3%. Let us not talk about double digits.

[Lord Lupton]

As the noble Lord well knows, the economy is a supertanker that does not turn around in six months, as indeed the evidence over many economic cycles shows. None the less, just to recall, all of that generated in 2010 the famous billet doux from the Treasury: “Good luck. There’s no more money”.

I want to talk about the proposal to cut capital gains tax from 28% to 20% from next month. In 2010, the Adam Smith Institute produced a compelling report on the effect of capital gains tax rises on revenues using data from the USA dating from 1955 to 2006. I apologise in advance for bombarding noble Lords with numbers, but when the tax rate was raised four times between 1968 and 1976 from 20% to 35%, total capital gains tax revenues fell by 21%. When the 35% CGT rate in 1978 was then progressively cut to 20% by 1984, the CGT take rose by 46% to $41 billion. When the rate was increased again in 1986 to 28% from 20%, revenues fell by 13%, and when the rate was cut from 20% to 15% in 2003, CGT revenues almost exactly doubled to $110 billion. Noble Lords will get the drift: there is a clear pattern of inverse correlation between the two. Professor Paul Evans of Ohio State University found in an important piece of research carried out in 2009 that a 1% reduction in the marginal tax rates on CGT in the US might trigger a 10% increase in revenues.

There have been fewer changes to CGT rates in the United Kingdom so it is more difficult to draw evidence-based conclusions, but I note that the rate cut in this Budget is possibly the only cause for my being in agreement with the former Chancellor of the Exchequer, Gordon Brown. He reformed CGT in his first Budget in July 1997, cutting CGT on long-term investments from 40% to 24%, and again in 2003 he cut CGT on business assets to a rate of 10% for assets held for more than two years. Thereafter—guess what?—CGT revenues in the UK increased by 35% to £3.2 billion. Since much of capital gains tax is a voluntary tax in that you can often choose when to realise a profit, this feels intuitively right.

I applaud the cut in the rate of CGT, not least for basic rate taxpayers who will now pay only 10%. With entrepreneurs’ relief at 10% now extended to all long-term investors in unlisted shares—quite often start-ups—there is already anecdotal evidence of a further surge in entrepreneurialism which will, based on strong historical evidence, particularly in the United States, increase revenues from this tax to the Exchequer—and hence my reason for applauding it.

I would also like to say a few words about the introduction of the interest deductability cap which, perhaps unsurprisingly given its name, has had little coverage in the press. The Budget imposes what to my mind is a sensible cap on the amount of interest which can be deducted from taxable profits at 30% of those earnings in the UK with a de minimis threshold of £2 million of net interest expense to avoid harming smaller companies. This represents a very important policy shift. While a key driver of this measure seems to be restraint of tax shifting by international companies away from the UK, sections of the investment community, some of whom I represent in the UK, will no longer have such a powerful personal motive to leverage the companies their firms buy.

This provision will force a change on the private equity business model in the UK, requiring, I believe, greater prudence and greater concentration on genuine business improvement rather than overreliance on pure financial engineering. That is a good thing and I am sure that the private equity industry will rise to the challenge.

The great financial crisis was littered with carcases of companies where the so-called “tax shield” of carefully constructed legal structures with double dipping and excessive debt went wrong when the profits of the company stumbled. From talking this week to some of the major players in the private equity world, my feeling is that this OECD-wide initiative, which our Government are now pioneering, is regarded by them as an inevitability, with the result that lesser personal rewards will be available from what, in aggregate—that is the point: in aggregate—became the taking of major systemic risk through excessive leverage. Excessive, and even abusive, use of interest rate deductions incentivises the use of debt over equity, overleverages corporations, thereby increasing their risk, and increases systemic risk in the UK banking sector as a direct result. Change is long overdue—a fact the Chancellor recognised with prescience when he called for such change in opposition. I applaud this move, with the cautionary note to the Minister that when interest rates eventually rise, the Government may need to be flexible on whether 30% is then the right threshold for the cap.

This is not only a pro-business Budget but one which is pro-market, pro-new entrant, pro-small business and pro-entrepreneur too. Under the bonnet of this Budget, small businesses and entrepreneurs are being helped the most and large companies are being held better to account to behave responsibly and pay their fair share. Growing, successful businesses create jobs. Higher employment improves the economy, reduces the deficit and enables us to take care of the most needy in our country. We should trumpet the success of UK business in recent years. I am confident that this Budget will build an even more vibrant business economy.