The Long Run is Now
The 2008 Pre-Budget Report was a response to a combined demand-side and supply-side shock. The major discretionary changes were a temporary deficit-funded VAT cut (demand-side or supply-side stimulus, take your pick), bringing forward some planned capital spending (ditto), “efficiency saving”-type cuts planned for 2010 onwards, plus:
1. introducing a new 45% marginal tax band for high earners,
2. introducing two new 60% marginal tax bands for high earners (“for no obvious economic rationale” – Robert Chote),
3. raising employee and employer-side national insurance rates from 2011,
4. raising alcohol, tobacco and fuel duty.
Pop quiz. Would you expect those policy changes to (a) increase or (b) reduce potential aggregate supply? If you don’t like the framing of this obvious right-wing trap, let’s ask another question. In that PBR document the Treasury described the situation as follows (p161):
[…] the global credit shock has significantly increased the uncertainties surrounding trend productivity and it is therefore difficult to assess to what extent lower rates of productivity growth over the course of 2007 and 2008 are likely to reflect cyclical or structural developments. Challenges in decomposing recent developments into cyclical and structural elements are likely to persist for some time.
From the perspective of 2014, the last sentence in that quote is certainly astute; the challenge of decomposing cyclical and structural issues has arguably only got harder since 2008. My (slightly) less loaded question, then: would the aforementioned tax hikes reduce or increase your uncertainty around the future path of productivity?
I had a depressing conversation with a friend recently, a high-skilled high-ish-earner with two growing-up children and a partner looking to return to part-time work after a few years providing full-time childcare. The family had calculated that due to the insane schedule of child benefit withdrawal, they could raise their net household income by having the high-skilled parent take a day off per week, and have the lower-skilled parent take a part-time job working that day. (This happens because the increasingly generous personal allowance applies a 0% marginal rate to the lower hourly wage and the benefit withdrawal schedule imposes a 60+% reduction on the higher gross hourly wage.)
That’s only a dumb anecdote, and I hate policy-by-anecdote debates, but it seemed like a good reflection of what has happened to the UK labour market. Since 2007 the government has introduced policy after policy aimed at reducing labour supply from high-skilled workers, just a sample here:
- The top tax band, now back at 45%, remains higher than in 2007.
- Marginal tax rates due to various withdrawals have risen at 60% and above for some.
- “Fiscal drag” means an increasing proportion of the workforce is hit by higher marginal rates; the IEA claim that in 2013, one in six income tax payers face a 40% tax rate, up from one in sixteen in 1990.
- Immigration reform aimed at reducing the number of (future) high-skilled workers entering the country.
For many of the policies above, I would think we would see the “long run” effects pretty quickly. At the same time, we have benefit reform and a large increase in the personal allowance aimed at increasing labour supply from low-skilled workers. If you discourage labour supply from high-skilled workers at the same time as encouraging supply from low-skilled workers, what’s the expected effect on average productivity? I don’t want to overstate the case, but surely at least some of the reduction in productivity which we’ve seen is just not that hard to explain. (Post title stolen shamelessly from Sumner/Lucas.)
PS. Since I know some progressives believe raising tax rates causes people to work harder, I asked the Guardian’s personal finance writers for their advice to those facing higher marginal tax rates:
Taking an extra week’s unpaid holiday,
The first six words were enough.