New Star economist Simon Ward says the Prime Minister’s plan for tax cuts and further borrowing, as a means to increase spending, will not help the economy.
He says: “A larger deficit does not necessarily imply a ‘fiscal stimulus’. A standard economic principle is that most consumers base their level of spending on their income expectations over the long term rather than current earnings. Current income is a key factor only for those households with no savings or unable to obtain credit.
“It follows that a temporary tax cut applied across all households and to be paid for by higher future taxes is unlikely to have a significant impact on consumption. Measures targeted at savings-short, credit-constrained households would have a greater chance of success but even in this case the rise in spending of those benefiting would be partly offset by cutbacks by other consumers anticipating lower future post-tax income.”
Ward says actions financed by higher borrowing can never deliver a short-term stimulus, but they must be aimed at the longer term. He says this could include cuts in marginal tax rates and public investment in projects promising a high long-term return.
Ward adds: “Temporary cut in VAT fails the test of being targeted at households more likely to spend any windfall gain and has no positive impact on the economy’s long-term supply potential.
“Consumption of higher-value items will rise in the months before the lower rate is withdrawn but fall by exactly the same extent afterwards. The temporarily higher demand will be met either from imports or a rundown of stocks, with no impact on domestic production.
“The longer-term “multiplier effect” of this VAT jiggling is likely to be close to zero.”