Notwithstanding all the toxic travails of Westminster’s ‘Partygate’ reducing us to an international laughing-stock in front of President Putin, this has been, or should have been, a deeply uncomfortable week for Her Majesty’s Government for other reasons too. At its heart are issues of both profound governance failure and lack of operational competence, and fundamental differences of opinion of ideology in the Conservative Party.
Rishi’s Heffalump Trap
You’ll remember the chapter in Winnie-the-Pooh in which Piglet meets a Heffalump. As Pooh and Piglet talk by the Six Pine Trees in the Hundred Acre Wood, the story about how best to catch a Heffalump goes like this: “Where should they dig the Very Deep Pit? Piglet said that the best place would be somewhere where a Heffalump was, just before he fell into it, only about a foot further on”. Writing in today’s Sun newspaper, the Chancellor Rishi Sunak says that he is only interested in “sound money”. One assumes all Chancellors would say the same, surely it’s in the job description! However, if not himself ‘on manoeuvres’ for the top job, then certainly distancing himself from the Prime Minister as the guardian of financial probity, one fears his is a pious aspiration. His own Heffalump Trap awaits, about a foot further on.
At the end of January Lord Agnew, an honourable and principled man, resigned as a Treasury minister. Responsible for countering fraud, he said that thanks to insurmountable obstacles, being incapable of doing his job he could not in all conscience defend the government’s track record. He cited how “arrogance, indolence and ignorance freezes the government machine”. The root of his concern was the £47bn handed out during the pandemic under Sunak’s Bounce Back Loan Scheme (BBLS). While well-intentioned, the scheme’s execution was riddled with “schoolboy errors”, such that £17bn is likely to be irrecoverable of which, according to the National Audit Office, £4.7bn was awarded under fraudulent claims (one assumes that the remaining £12.3bn was simply good loans turned bad; the companies involved failed to survive, their debts effectively written off). Agnew said that were government doing its job properly and efficiently, a penny could be saved off Income Tax rates if such wastage were avoided. Taking the unusual step of resigning at the Dispatch Box, the noble Lord thereupon closed his file and announced, “that’s it, I’m off”, and walked out of the Chamber.
Endemic waste on a heroic scale
Before Christmas, Boris had already demanded action and announced the inception of another chamber, a Star Chamber no less, to tackle government waste. He is neither the first nor will he be the last Prime Minister to demand such an initiative, for waste is endemic and embedded in the system. The numbers are spectacular and frightening. A cursory analysis of major capital projects and other initiatives spanning only the period in which the Tories have been in office since 2010 reveals the cost of flawed policy, mispricing, make-believe accounting systems and extensive overruns through bungled execution.
Consider the excess costs over the original estimates of such projects as HS2 and Cross Rail; or the costs associated with the redesign of the two new aircraft carriers after the flip/flop decisions about ‘cat & trap’ or VSTOL landing and recovery systems; the failure to hedge the foreign exchange risk on the purchase cost of F35 Lighting II aircraft over Brexit; the MoD procurement scandals of Ajax and the dithering over upgrading or replacing Warrior, both armoured warfare systems: it’s not difficult to reach a figure of around £80bn.
Add to that the £4.7bn fraudulent claims under the BBLS above (important and sensitive because £4.7bn is almost the entire amount of £5bn earmarked as emergency funding for the NHS to stop it falling over this winter), plus the £37bn spent during Covid on the NHS Track & Trace programme which was never of any proven utility and is now redundant, and the total irrecoverable sunk or excess costs are beyond £120bn. The Tories are in equally bad company: the previous Labour government was forced to concede that on its watch £26bn was wasted on the installation of literally useless government IT systems alone.
Tax rises: the government is not for turning
It is against this backdrop that despite fierce argument to the contrary, the Prime Minister and his Chancellor have both determined publicly that there is no alternative to the rise in National Insurance rates, both for employers and employees, effective April 2022. The NI surcharges are badged as hypothecated taxes, designated as a new Health and Social Care Levy to raise £12bn a year for three years. Readers will have already done the obvious calculation in relation to the £120bn of government money flushed down the loo to zero benefit, as identified above, to see by more than a factor of three just how unnecessary those additional taxes being levied are simply because, to use Lord Agnew’s words, the government is not doing its job properly. We should not forget that corporate taxation rates are due to rise in 2023 too from 19% to 25%.
Energy: a second own-goal
This links directly with the row about energy costs, the regulated price cap and the quagmire of green levies attached to every household gas and electricity bill to fund the subsidies propping up the investment in unreliable ‘green’ energy.
As the innately socialist policy of regulated prices rapidly unravels in the face of international gas prices which are beyond the government’s control (‘socialist’ not just in principle but because the idea was directly pinched by Theresa May from Labour’s Ed Miliband), this week the government was forced to announce what amounts to emergency state aid for consumers to help alleviate the worst ravages of spiralling household costs in the face of inflation at 30-year highs and a not insignificant simultaneous tax hike in April.
As MP John Redwood suggested, the notion of a ring-fenced, fully hypothecated tax is for the birds: what in reality will happen is that part the new taxes being raised under the Health and Social Care Levy will immediately be diverted and recycled into relief payments to energy suppliers to help reduce bills for their customers in a classic case of ‘circular’ money.
The dividing lines of fundamental ideology: Monetarism vs Keynesianism
As we have discussed many times in these musings, virtually every government in the western world including ours, and whatever political colour they purport to be, is currently prosecuting a fiscal policy based on Keynesian economics, employing relatively high rates of taxation, then spending not just percentages but often multiples of national tax receipts on not just the essentials (e.g. defence, police, justice, education etc) and the safety-nets (benefits, state pensions, healthcare), but on areas such as infrastructure and climate change policies where the temptation to be seduced by politically attractive panacea projects is hard to resist.
Underpinning that thesis is the assumption that the State, rather than the private sector, is the most efficient allocator of capital in a homogenous, holistic economy. The State raises taxes for reinvestment to the benefit of all; the central tenet is that everyone is a stakeholder, the corollary of which is that everyone is also subservient and subsidiary to the State. Arguably it is a sustainable state of affairs under a Utopian, completely closed, self-contained and perfectly communist society in which there is no private ownership or capital; collectivism is all, individualism is forbidden.
But the risk in any other world is that in the absence of constructive competitive forces, capital allocation becomes slack, inefficient and, to Lord Agnew’s point, wasteful; instead of having a multiplying effect such ‘investment’ obeys the laws of diminishing returns.
Where outside capital is required, surely the private sector is far more efficient at pricing that capital than the public sector? Tensions inevitably arise in situations where public and private sector interests collide. Just such an example is entirely visible now in the energy sector in which investors providing private capital are being asked to take asymmetric risk in an industry in which the major input cost (e.g. gas) is uncontrolled and volatile subject to international market and geopolitical forces, but output prices (domestic electricity) are regulated and ultimately capped by decree to protect consumers. As has been seen all too clearly, the system works when in equilibrium but quickly collapses under duress, ultimately leading to significant corporate failures and unhappy consumers.
At its core is the ideological Grand Canyon-wide chasm dividing statist Keynesians and free-market Monetarists. Conservative Thatcherite monetarists, already believing in the economic efficacy of low rates of tax to deliver higher nominal tax income and productive employment underpinned by a lean, match-fit, vibrant, competitive and innovative economy, are demanding to know why the present social democrat-inclined administration is contemplating tax rises when so much of what the government already spends is wasted. Where is the commitment to reforms of all the major spending departments, including the totem that is the NHS (health and social care is now over 40% of all government spending, both insatiable in their demand for cash) as a condition of even thinking about higher tax rates, especially when the UK tax burden is its greatest for 70 years? Where is the commitment to less state intervention, the encouragement to choose how best to spend one’s own earnings? Similar arguments are raging about regulation; how is it possible to unlace the regulatory corset bequeathed by the EU in the aftermath of Brexit, if Boris’s obsession with the green economy (William Hague’s ‘Revolution by Coercion’) demands a new, even tighter-fitting and all-constraining regulatory straight-jacket in its place?
The state certainly has a role, indeed an obligation to look after its citizens. But it is the private sector which generates growth, economic wealth and prosperity and which keeps us competitive and moving forward. Of course it needs regulation to a degree to provide basic protections, but you shackle it and smother it at your peril.
Does it matter?
Does this matter to investors? Certainly, in that higher taxation and increased regulation leads to the likelihood of reduced disposable income (both personal and corporate) and the resulting frictional drag to the economy. And that is even before we consider the corrosive effect of inflation reducing the real purchasing power of money. But many arguing against rising National Insurance rates have no great argument against the concept of using other methods of taxation to achieve the same aim; it is of no surprise that some Tory MPs have been openly suggesting again that Capital Gains Tax rates should rise (it was this time last year that Chancellor Sunak was flying the kite, rapidly hauled down, that CGT rates should be harmonised with one’s marginal rate of income tax). Meanwhile Labour’s Shadow Chancellor, Rachel Reeves, is on record recently as saying that substantial revenue raising under a future Labour government could come from not only Capital Gains Tax increases, but also Income Tax surcharges on unearned income streams including from dividends and investment property rentals.
Whether Conservative or Labour, whatever your predilection, come polling day, it would be nice to know that we are at least being offered a real choice. As it stands, the pickings in prospect are thin.
Central banks on the run
Last week, we wrote about the central banks having to fight their way out of the tight corner into which all of them had painted themselves about future monetary policy. If the US Federal Reserve was previously in the spotlight, this week it was the turn of the Bank of England. UK base rates were raised by a quarter point to 0.5%, entirely as expected; more will follow. Forecasting a rocky ride for the next two years for the UK economy, nevertheless Governor Bailey’s political antennae were operating on low voltage when, on the very day the energy regulator announced that the average annual household energy bill would rise £700 from April, Bailey pleaded for employees not to march on the boss’s office demanding a pay rise. Having endured more than a decade of falling real earnings and negative real interest rates on cash savings, all to a large extent thanks to the insidious effect of ultra-loose monetary policy since the Global Financial Crisis, and now confronted with the corrosive effect of inflation at nearly three times the Bank of England’s mandated target, the average member of the public might feel entitled to tell the good Governor precisely what he can do with his sentiments.
But the Bank was not alone. Christine Lagarde at the ECB, long the most trenchant of the “don’t worry, it’s all under control” brigade, was forced to concede she might be wrong, but not so much that immediate action was necessary. Smelling blood, markets reacted swiftly: the yield on the German 10-year government bond, negative consistently since mid-2019, surged to +0.2%. The message to Lagarde is clear: “you’re well off-pace, get with the beat.”
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