Why Chancellor Bashed Contractors
In our article, Why Chancellor Bashed Contractors, we will set out the reasons why we think he did that, even though he spared contractors the worst excesses in his Autumn Statement.
During the awful downturn of 2008 and beyond, the amount of taxation that the Government got in fell sharply while their spending remained the same.
Raise Spending or Cut Spending
There was two options.
Governments could either cut spending by an equivalent amount to the amount of tax they had lost or they could increase spending to give a Keynesian boost to the economy.
In the first solution, spending would be reduced to the new reality of tax income.
In the second solution the Government would borrow even more to boost the economy so that tax levels came back up to spending levels.
The UK used the first method and the US mainly used the second.
If Household Income falls, Cut Spending
Most people would automatically believe that the first way was best. After all, if your income falls, or you are out of work altogether, you would reduce the amount of what you are spending.
This makes complete sense in a household.
Say you are a contractor earning £100,000 a year and you spend £60,000 a year.
If there is a downturn and you have to take a permie job netting you £40,000 a year, after tax, then if you reduce your spending by £20,000 your income and spending are now in equilibrium.
So, it is easy for people to believe that, when a state’s income falls, if you reduce the amount of spending by the difference between income and spending then everything will be in equlibrium again.
Government Spending Works Differently
However, it doesn’t work like that.
That’s why it is proving so hard to get rid of this deficit. The Conservative Government said they would get rid of the defcit by the last eelction.
Now they say that they will be rid of it by the next election.
What’s the reason for that?
The Budget Deficit Equation
Let me quote ex EU Minister Christine Legarde.
She said, a few years ago, during the worst of the downturn, and the cutting, that they had to change their figures.
Perviously they had believed that the deficit fell by one Euro for every 1.5 Euros that a Government cutin spending.
Now, their latest figures, from the downturn, showed that you have to cut spending by €3 to get a fall in the deficit of €1.
There are several reasons for this.
Spending Cuts Increase Spending
Many Government cuts either cut the income that the Government gets or increases the payments that they give out.
The Government was cutting the headcount in Government departments.
They axed many Government IT projects sending permies and contractors out of work.
Less Taxes and More Unemployment Benefit
If people are out of work then they are no longer paying taxes – so that’s less income for the Government.
Also, many of them will claim unemployment benefit which will increase Government spending.
So, if you add the amount of unemployment benefit an IT worker laid off is getting to the income tax and NI contributions that the IT worker is no longer paying then you can see that Government savings are not the whole of the IT worker’s salary. It is considerably less than that.
However, that is not all. There is a secondary effect.
As they now have less money, IT workers laid off from a Government department in a town or city will have less money to spend.
They will not spend so much in local shops, restaurants and pubs.
As a result, the profits in local businesses wil plummet meaning they pay less tax to the Government.
Another knock on effect would be that they would have to pay staff off or give them fewer hours.
As a result, they woud pay less, or no tax, and they will receive unemployment benefit.
Chirstine Lagarde and the EU
You can see here why Christine Lagarde’s figures night just be right.
You can see why you might have to cut Government spending by £3 just to cut the deficit by £1.
That is why this deficit is very difficult to get down.
Every time the Government cuts spending it also decreases it’s income and increases its costs too.
Increasing Spending Rather than Cutting
So, what if the Government had decided to try and bring tax income back up to spending levels rather than cut spending to the new income tax levels by borrowing even more and using it stimulating the economy?
Because this wouldn’t work in a household situation, i.e. you wouldn’t borrow more if your income was hit, people automtaically react against this as a Government solution too.
However, as we have seen, the situations are very different.
John Maynard Keynes
Keynes was hired in the 1930s by the UK Government for his advice.
The advice he gave was for the Govrenment to pay men to dig holes and then to pay other men to fill them in.
He didn’t mean this literally as there would be better ways for Government to spend their mony but it was for illustrative effect to make a point.
When King George cancelled the buidling of his new royal yacht in sympathy with his subects, Keynes said that this was the wrong response.
He should have ordered an extra one so that the shipyard workers of Glasgow would have money in their pockets and would spend it in local shops, pubs and rstaurants whos owners would then spend the money elsewhere.
Circulation of Money
The reckon, in he Circulation of Money theory, that every pound spent in an area circulates an average of 6 times.
So, six people, and businesses, get the benefits of it -as does the Government when they pay tax.
To cope with the extra demand, businesses would take on more people, who would pay tax. The businesses would pay more tax.
In the US, in the 1930s, they were doing the opposite.
President Hoover and the Great Depression
President Hoover was cutting Govrenment spending and, when that didn’t work well emough, he cut again and again.
As a resut, the US followed the Wall Street Crash with the Great Depression.
The economy fell a massive 50% and unemployment was 30%.
In the UK, who took Keynes’s advice, the economy fell by 5.9% in one year but then started growing again the next year.
Britain had a minor recession while the US had the Great Depression.
Keynesian economics held sway for many decades after that, with Governments spending on infrastructure during downturns.
So, if you have to cut spending by £3 to get £1 off the deficit, what happens the other way around.
How many pounds of deficit reduction, through greater tax income and lower unemployment benefits, would you get for each £1 invested in the economy as a stimulus?
To a certain extent it depends on how you spend it.
Stimulating the Economy
However, as you are doing the complete opposite to cutting and saving £1 in the deficit for each £3 cut, I would say that it would be likely to be the complete opposite in terms of the money.
I would suggest that it wouldn’t be to far away if you said that a £1 increase in spending would result in £3 of extra income for the Government.
This would mean that the deficit would by fixed by getting increased tax income rather than by cutting spending down to income levels (which keep falling as the result of the cuts).
UK Policy v US Policy
It was an interesting experiment to see the UK Government and US Government taking different routes.
So, what was the result?
The US economy was back to growth more quickly than the UK economy.
The economy was also back to its pre-downturn levels much sooner in the USA.
So, why did the Chancellor choose to cut rather than stimulate?
Had he never heard of Keynes? Had he never heard of Herbert Hoover?
Why Did Chancellor Osborne Choose Cutting?
Did he not know that the Government budget was not like a household budget and that when he cut he would also cause government income to fall and their costs to go up?
Instead of attempting to bring income levels back up to spending levels by stimualtion of the economy, why did he choose to try to cure it by cutting spending to income levels (and not succeeding)?
Autumn Statement Giveaway
I think that he gave the game away in the Autumn Statement.
After announcing that the deficit would disappear at the end of this Parliament (when it was supposed to be the last one), the Chancellor made another announcement.
He said that in the 5.5 years of the current Government that the State’s part of the economy had fallen from 46% to 36% of the total UK economy.
Chancellor Osborne’s Real Reason
Is that the real reason why he decided to cut rather than invest when the figures show that it is smarter to stimulate than cut – as the US showed?
Was the downturn and the budget deficit just a smokescreen, or an excuse, to do what all Connservative Government’s aspire to, i.e. to cut the State’s share of the economy?
Some readers will see this as a good thing and others will see it as bad.
However, it may well be that the UK economy was damaged deliberately to acheive that objective.
It is a massive cut in the State’s percentage of the economy in such a small space of time.
Chancellor Osborne Pleased
Despite the refusal of the Budget deficit to fall, the Chancellor looked very pleased with himself when he announced this fall in the State’s share of the economy.
Indeed, it got huge cheers from the Conservative backbenches.
Was this what the Chacellor wanted to achive from the beginning?
Was cutting the deficit never his main objective?
Was cutting the state always his main objective from the beginning?
Is this why Chancellor bashed contractors, and others, during the downturn?
What do you think? Let’s hear your comments below.