The Fallacy of Expansionary Austerity

A few small signs of growth for the British economy here, some small uptick in numbers in work there, and dubious claims about the expansionary nature of austerity come marching back with a vengeance.  I had convinced myself that I was too long in the tooth to ever see anything new in these tired old arguments.  For the first time that I can remember, then, I found myself last week thinking ‘thank goodness for John Redwood’.

He did what I had thought was impossible.  He managed to put two and two together to come up with something that was well in excess of four when suggesting that the Treasury had been proved “utterly wrong” in its prediction that a five-percentage-point income tax cut for the richest 1% would lead to reduced overall tax revenues.  Here was proof, should there have been a need for it, that if the lens through which you view the world is sufficiently skew-whiff then you can make even the most basic of statistics say anything you please.

Redwood’s variant of the expansionary austerity thesis took the following form.  Ripping the heart out of the welfare system to fund top-end tax cuts, he seems to be saying, has reawakened a dormant entrepreneurial spirit to such an impressive degree that more rather than less tax has been paid overall in the first year of the new lower rate.  More people have been put into work through releasing society’s highest fliers from the burden of funding the welfare state, and they have paid the Government back for its courageous pursuit of austerity to the tune of a whopping extra £9 billion in tax.

OK, so perhaps he didn’t express himself in quite such grandiose terms.  However, this was still the gist of his comments.

Two points should be made in response.

1. Redwood managed to take one thing that was true – HM Revenue and Customs did indeed collect £9 billion of additional tax receipts in 2013/2014 compared with 2012/2013 – but he then proceeded to turn it into a series of claims for which he had no evidence.

The increase in tax receipts did not follow a proportionate increase in the number of people paying tax.  As the Office for National Statistics and even the Government’s own Office for Budget Responsibility have shown, the greatest difference has resulted from existing taxpayers paying more of what was due.  The pre-announced reduction of the top rate of income tax from 50% to 45% was accompanied by a loophole big enough for any competent accountant to drive a proverbial bus through it.

A large outbreak of tax-switching ensued.  Payment on tax that was due at 50% in 2012/2013 was delayed so it could be paid instead at the lower rate of 45% in 2013/2014.  The country’s highest earners, in other words, simply refused to look a gift horse in the mouth.  This tax-switching artificially depressed revenues two years ago and enhanced them last year, so there is no need to search too far for explanations of last year’s bumper crop of tax receipts and certainly no need to embrace Redwood’s particular brand of expansionary austerity alchemy.

2. Even if his argument could be made to stand up in its own terms, however, does it not reveal a startling lack of ambition at the heart of Government economic policy?  Redwood is, after all, a former Shadow Secretary of State for Trade and Industry and David Cameron’s specially selected appointee to head the Conservative Party’s Policy Review Group on Economic Competitiveness.  But the only thing he seems to be able to say having held those briefs is that innovation is incentivised by tax cuts.

Surely, though, there is more to the likelihood of having a marketable idea than whether or not you live in a low-tax environment.  Are we really likely to believe that entrepreneurs keep all their best ideas to themselves if personal tax rates are set above a certain threshold?

Austerity has not only placed a blanket of conformity over British economic policymaking.  It now also seems to be encroaching upon what politicians are willing to say about the nature of modern economic life more generally.

Redwood’s recent intervention was as instructive in this regard as it was unhelpful if a serious debate is finally to be had about the necessary supporting conditions for economic innovation.  Desperately needed debates of this nature would appear to be yet another victim of austerity politics.

Matthew WatsonMatthew Watson is a Professor of Political Economy in the Department of Politics and International Studies at the University of Warwick.  He is the author of The Political Economy of International Capital Mobility, Palgrave Macmillan, 2007 and Foundations of International Political Economy, Palgrave Macmillan, 2005.

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