The message recently delivered by Andrew Bailey, Governor of the Bank of England, was gloomy in the extreme. The Bank predicts inflation rising further before peaking at 13%. Moreover, the expectation is that the UK economy will move into recession next year, meaning not only falling output but unemployment rising to 6%.
Naturally employees, some of them in trade unions, would normally seek wage increases in order to preserve their real incomes, but wage increases could perpetuate inflation. We could be back to the 1970s with a wage/price spiral together with economic stagnation – ‘stagflation’ as it was dubbed then. A vicious cycle indeed!
Option for a windfall tax on energy companies
The good news is that taxable capacity exists in our economy. Both income and wealth exist in the UK, the taxation of which would have relatively few adverse side effects but would allow the government to compensate households for the rising prices they face.
The sharp rise in energy prices recently resulted in unexpectedly high profits for the energy companies. These may be termed ‘windfall gains’. The Guardian recently reported ‘Big oils quarterly profits hit £50 billion’. BP is one of the smaller firms but nevertheless reported quarterly profits had tripled and risen to almost £7bn. The company proposed distributing £4bn of that to shareholders in dividends – in other words, passing money to the already wealthy.
The energy companies each have their strategic business plans. Last year these plans did not incorporate any expectation of profits at these high levels. To repeat, these are windfall gains and taxing them will not impact on the strategy of the companies’ business plans.
Option for a wealth tax
A side effect of the Covid pandemic has been an increase in wealth of the wealthiest in the UK. According to a survey by the Resolution Foundation, wealth in the UK increased by £900bn during the pandemic (partly as a result of quantitative easing by the Bank of England resulting in higher asset prices). The number of billionaires in the UK rose from 147 to 171. In this time the distribution of wealth has become even more uneven than previously, with gains at the top outpacing gains – or losses – at the bottom of the distribution.
Here we have another instance of windfall gains or, in my parlance, a bit more taxable capacity. Given the windfall nature of the gains that have been made, the disincentive effect of those taxed should be minimal.
Time-limited financial measures
Current inflation is a worldwide phenomenon caused by the global hike in energy prices. If policy can isolate the phenomenon and sterilise it so that it passes through the economic system without setting off a wage/price spiral, then so much the better.
The policy I am advocating would be temporary, consisting of time-limited or one-off increases in taxation to finance transfer payments (hand-outs) that similarly will be time limited and terminated once price levels are back under control. The furlough scheme to deal with the employment and household income effects of Covid is an example of one successful temporary measure. This could be another.
Using the windfall to offset the cost-of-living and fund green growth
The significant lump of additional tax revenue to the government could be used in a mixture of two ways.
First, it could be used to provide the population with a time-limited social security benefit that would offset the impact on living standards of price increases. This takes away the need for wage demands in the workplace. The government would compensate households for price increases.
Second, a smaller portion of the pot could be used to finance green growth industries – including better insulation for housing to reduce future energy use. Along the way there could be a programme of improving the air ventilation system in all schools and colleges that would have a significant impact on reducing the spread of Covid.
The Bank of England is predicting an increase in unemployment. Green growth investment would create good jobs and help mitigate unemployment. On this area Simon Wren-Lewis (Emeritus Professor of Economics at Oxford University) points out that “additional government spending, which given lags, would impact demand when inflation is falling and we need to recover from recession, makes perfect sense”.
Also, assuming the above policy succeeds in killing off inflation, then we could avoid increases in interest rates which will adversely affect business investment as well as the cost to households of servicing mortgages.
What about tax cuts?
Both Liz Truss and Rishi Sunak have highlighted tax cutting as part of their appeal to Tory members. Wren-Lewis’s view on this was to the point:
“There is in my view no good case for tax cuts (income or indirect). I know Truss is proposing them, but a good rule nowadays is Tories always do the wrong thing”.
All households will suffer the impact of inflation, therefore there is a strong argument that all households should receive a basic payment from the government to help them with bills and to reduce the demand for pay increases that would further fuel inflation. However, the poorest sectors of the community are being hardest hit by inflation, therefore those families in receipt of universal credit should receive an enhanced amount. At a stroke, the policy would become yet more progressive.
Economics has been dubbed ‘the dismal science’ but I hope I have on this occasion outlined a practical, viable route out of the cost-of-living crisis. We must live in hope.