Float my boat?

The image of a rising tide lifting all the boats is a picture politicians like to paint – a fair recession and recovery, the reality maybe that the posh yachts and the scruff dinghies may be okay but the smartly kept but modest day boats may be stuck in the mud for a while yet!

Who will float my boat?

Five years after the Great Recession there is a sense that the world’s economy no longer adheres to normal rules, the tide is moving in a mysterious way.  In a recession wages are meant to be sticky and as a result of this unemployment rises sharply as workesr price themselves out of the market.  Following a recession, typically, productivity and wages pick-up quickly and eventually unemployment should fall.  This time around rates of employment have remained quite high through the recession, wages and earnings have fallen sharply and productivity has not bounced back; so why?



One of the other major (and unexpected) differences in this recession has been that the pain has been greatest for the middle classes.  Normally a recession hurts those at the bottom of the pile not those stuck in the middle.  Wages for the middle classes have (contrary to Keynes’ General Theory) been proved to be un-sticky and middle incomes have fallen appreciably since 2007.  This may well be the first warning shots of a new age in automation the so called “second machine age”. Typical middle income jobs in both public and private sectors are supposed to be replaced by technology – out with the book keepers in with new accounting software and so on.  This explanation seems a bit thin to me and it’s more likely that pressure on the middle classes is a function of policy rather than technology innovation.

Initially, in developed countries the policy emphasis was on supporting the low paid and the owners of businesses – a kind of supply orientated approach.  It was thought that tax breaks for the poorest in society and business friendly tax cuts would be the best mechanism to get people into work and trigger recovery.  

In the UK the poor have done pretty well – the threshold below which no tax is paid has been raised by three thousand pounds since the Great Recession (from £6,475 in 2009 to £10,000 this year) and there is a school of thought that the government should raise this threshold again to £12,500.  It is estimated that these increases in the personal allowance will result in 2.2 million people not having to pay tax on their income, while the cost to the Exchequer will be around £10 billion in 2013/14.   The Coalition government feel that this approach supports their “tackling the deficit fairly” story.

The enormous cost of tax cuts for the poor has been met by the Coalition Government’s decision, in its first Budget, to increase the standard rate of VAT to 20% and to reduce the thresholds for basic and higher rates of tax.  After allowances the 40% tax rate was £37,400 in 2009 and it’s now £32,010 a drop of over £5,000 without adding the effects of inflation.  Whilst middle income earners have had some marginal benefits from higher allowances this has be out-weighed by the huge fall in the higher rate tax threshold.  This devastation of the middle classes is now complete as those paying income tax at the higher rate (40%) has reached 4.4 million in the current tax year, that one in six – It was one in twenty a few years ago!  So now middle income earners get taxed like the rich – the poor pay no tax and nor do the very wealthy!  Some democracy

The world has certainly gone mad, when all income over £42,010 attracts taxes (income tax and national insurance) of over 50%.  Middle income earners have also suffered from sales taxes, loss of child benefits, very high costs in transport and the loss of earning from saving (due to negative real interest rates).  This policy of resolving the financial crisis and subsequent recession by attacking one section of society (about 5 million middle income earners) has been a true spectacular mistake by the Tory led coalition as these very same people are their core vote.  Gordon Brown squandered £85bn of tax credits and welfare payments on his core vote between 2006 and 2010 (an electoral bribe more significant than anything Robert Mugabe has attempted).  In contrast the current government have taxed the same amount of money from their core vote over this parliament!

It is obvious that the approach of bailing-out the country with money from a small number of middle income earners has been a huge mistake politically for the Tories, but more worryingly is may also prove to be a very poor economics.  The average income in the “squeezed middle” fell from £37,900 to £32,600 between 2007 and 2012.  Average direct taxes paid by them fell from £8,700 to £6,800 while indirect tax payments dropped from £6,400 to £6,000 (indicating a fall in consumption of around £8,000 per middle income wage earner).  Imagine what rising interest rates (high mortgage payments) will do to this already squeezed middle and time is running out.  George Osborne, having been saved by large in-flows of foreign direct investment, has one budget left to ensure the rising tide of recovery floats all the boats in the harbour.