Economics is simple, or should be

Lord Finkelstein’s great discovery: big public spending doesn’t mean big public debt

In today’s politics, if a man is disliked (or liked) for something, he’s disliked (or liked) for everything.

If, say, Donald Trump opined that the sky is blue, his detractors would cry foul simply because it was he who said it.

And if Mr Trump insisted that the Earth is flat after all, his admirers would hail that as the acme of wisdom.

Boris Johnson is becoming a similar love-him-or-hate-him figure in Britain. Nothing he says or does pleases some people; everything he says or does pleases some others.

This dichotomy is becoming even more pronounced now Mr Johnson is transparently angling for Tory leadership and consequently the keys to 10 Downing Street.

Daniel Finkelstein is clearly no Johnson partisan, a stance with which I’m in broad sympathy. But that doesn’t mean that everything coming out of Mr Johnson’s mouth must be savaged as a matter of course.

That, I’m afraid, is exactly what Lord Finklestein does in today’s Times. He takes issue with Mr Johnson’s economic programme based on cutting existing taxes and introducing no new ones.

In the process Lord Finkelstein takes a swipe at Arthur Laffer and his notorious curve. Now that curve – like all sound economics – was just plain common sense. Nothing more and nothing less.

Laffer made a blindingly obvious observation that high tax rates don’t necessarily produce high tax revenue. A tax rate of 100 per cent would deliver the same tax revenue as a tax rate of zero per cent: zero.

The optimum tax rate lies between those two extremes, although Laffer didn’t specify exactly at what point. Those economists who believe that an economy has functions other than just punishing the rich tend to place that cut-off point somewhere between 15 and 20 per cent.

Since our tax rates are considerably higher than that, we tax too much, thereby putting dampeners on the economy. Hence Mr Johnson’s promises to cut taxes.

Enter Lord Finkelstein: “These promises are foolish. And the more watertight they are… the more foolish they are.” Quite. Watertight is the new foolish.

Lord Finkelstein then cites the experience of the Reagan administration as proof that the Laffer curve isn’t a magic potion.

That much is true. But Lord Finkelstein proceeds to display the modern intellectual failing, an inability to take the next step in ratiocination.

Yes, the curve did impress Reagan’s virginal mind. And politically it worked. Reagan rose to power largely by promising to reduce taxes without necessarily reducing government spending.

Alas, initially neither the president nor his close economic advisers, such as David Stockton, understood in sufficient depth the problem at hand. Stockton was the first to reach such understanding by the simple expedient of crunching numbers.

He quickly found that the Laffer curve didn’t work by itself, without parallel reductions in government spending. He then went department-hopping door to door. Like a child at Halloween he’d beg to be treated to some cuts, only to be turned away.

Having butted their heads against the impossibility of curbing the government’s appetites, the Laffer enthusiasts were faced with an unsavoury choice. They either had to go back on their tax-cutting promise or else plug the inevitable holes in the budget by printing money.

Given the political impossibility of the first option, they went for the second and, by the end of Reagan’s tenure had increased the national debt 2.5 times – leaving the country structurally worse-off in the long term.

Here comes the aforementioned next step, which Lord Finkelstein is unable to take. He correctly confirms Stockton’s discovery that the Laffer curve doesn’t pay for itself. But he incorrectly concludes that it doesn’t pay tout court.

The Curve will work famously if accompanied by concomitant cuts in public spending. In fact the most spectacular modern successes, both in Europe and in Asia, have been achieved by economies with low marginal tax rates and reduced government spending.

Even tax cuts against the background of a slower growth in public spending have been known to work, as they did in Thatcher’s Britain and are doing in Trump’s America.

Yet Lord Finkelstein dismisses lower government spending out of hand. In his mind, runaway public spending is a third sure thing in life, after death and, well, taxes.

He correctly points at the on-going demographic shift towards an older and presumably more dependent population. But ‘presumably’ is the operative word.

If people didn’t have to pay to the state more than half of what they earn over a lifetime, if the top marginal tax rate were, say, 17 per cent, and if contributions into private pensions were encouraged, older wouldn’t necessarily mean more dependent.

(Just think what kind of pension fund you’d have if you never paid more than say 10 per cent of your income in tax, after legal deductions. You wouldn’t be dependent on the state, would you?)

But, as I keep repeating, making people, young or old, independent of the state goes against the grain of the entire modern political ethos. The modern state is solipsistic, wholly committed to looking after Number One, itself.

This desideratum, and the political means of reaching it, trumps economic considerations. A more dependent population may not make sense morally or economically, but it does make sense politically and, if you will, politico-psychologically.

“Tax cuts can be popular and they have been,” observes Lord Finkelstein, looking down from his intellectual Olympus. “But they can’t be all the Conservative Party has to say. Even if that has worked in the past, it won’t work in the future.”

But neither Mr Johnson nor the Conservative Party has ever come up with a single-plank platform. Tax cuts have never been all they have to say. But if the country is to prosper, that’s something the government must say.

People, concludes Lord Finkelstein, “want a robust economy that isn’t floated on debt. They want good public services that are properly financed and a welfare state that they can rely on.”

He evidently sees no contradiction between the two parts. But refusing to acknowledge it doesn’t mean it doesn’t exist.

A welfare state (as opposed to some sensible welfare) presupposes an economy floating on an ocean of debt. A robust economy able to afford good public services without ruinous indebtedness has to be one propped up by low taxation and a small public sector.

Lord Finkelstein doesn’t realise this and, though Mr Johnson probably does, he can’t say it for fear of committing political suicide. So he sends half the message, lower taxes, which sounds half-baked.

That gives Lord Finkelstein a chance to pounce, but his rebuke isn’t even half-baked. It’s not baked at all.

3 thoughts on “Economics is simple, or should be”

  1. “People, concludes Lord Finkelstein, ‘want a robust economy that isn’t floated on debt.'”

    Only until recently Norway and Australia the only nations have a budget surplus. Maybe not Australia any more. Even having an abundance of natural resources can go only so far.

    Government debt per se is not bad. Having to use a large percentage of tax revenues to service the debt is bad.

    1. £50 billion a year in Britain. Our debt costs us more than our military. If this continues, before long our budget will be entirely made up of two parts: debt servicing and the NHS. Plus a little extra for government salaries.

  2. The house controls spending in the US, and the then Speaker, Tip O’Neill, lied to Reagan about cutting spending, as well as financing a wall with Mexico!

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