Tuesday, 15 September 2015

Corbynomics and the Current Budget Balance

One of the propositions put forward in the Corbynomics documents and subsequent discussions is the elderly Keynesian idea of balancing the current budget and letting the capital budget float. The suggestion is that it is more politically acceptable for the government to be seen investing in hard and solid Fixed Capital Formation rather than create money to undertake frivolous consumption activities such as education, training, R&D or elderly care.

The Keynes idea appears to come from a time before the Beveridge style welfare state was implemented and certainly before that evolved into a spending side auto-stabiliser system, but that 'fact change' doesn't appear to have dulled enthusiasm for the concept.

So I thought I'd dig into the numbers to show what it is all about and point out the issues.

The numbers come from the Public Sector Finance report from the UK's Office of National Statistics.

For the financial year 2014/15 the current budget deficit stood at £48,876mn. So that is the amount you have to generate from somewhere to get it to zero.

However before we do that it is useful to understand how you get that figure. What actually is the current budget deficit?

It is defined as:
Net Current Expenditure + Interest Paid + Depreciation - Current Receipts
so using the figures from 2014/15 (In £ mns) you get:
634,317 + 47,222 + 37,306 - 669,969 
To get the current budget deficit to zero you have to conduct extra investment spending - which then gets taxed away at the tax take percentage (which is 1 - the saving percentage) creating the extra tax receipts to cover the current budget deficit. Effectively you move the deficit from the current budget to the capital budget.

There are a couple of things to note from this calculation.

The first is that the depreciation figure is a transfer from the capital budget and adds to the current deficit. The more investment you do, the bigger the depreciation figure gets which then means you have to do ever more investment spending every year to cover the growing current deficit.

The second is the interest paid figure which similarly adds to the current deficit. The more investment spending you do at interest the bigger this figure gets. The higher interest rate you pay the bigger this figure gets. And the bigger the figure gets,  the more investment spending you have to do in subsequent years to clear the current deficit.

You can already see that there are two unfortunate positive feedback loops inherent within the calculations.

Net investment spending (Gross spending less depreciation) for 2014/15 was £30,328mn. If you express receipts as a percentage of total expenditure you find the tax take is 89.4%. So for every £100 spent, £89.40 came back as tax and £10.60 was held as financial savings.

The tax take percentage varies as the tax side auto stabilisers allow people to save. In the post crash era where people are generally saving it has been as low as 82%.

So to clear the current budget deficit at a conservative tax take of 80% you'd need to make £61,095mn of extra investment spending (i.e. the capital net spend needs to be three times what it currently is). That will vary up and down depending upon the actions of the automatic stabilisers. In 2009/2010 you would have needed £107,684mn of investment spending.

There is of course lots of talk within Corbynomics of closing tax gaps, changing rates and the like. All of that is largely distributional. If you take tax off one person, they can't then spend it with somebody else and you potentially deprive somebody of an income. Only where you defer or offset saving behaviour, somehow, is there an impact on the total tax take percentage. Really you're relying on the old balanced budget multiplier to work its magic - which likely isn't that effective in an open net importing economy like the UK.

There is, of course, no need to balance any budget, and doing so violates 'Lerner's Law'. The wisdom in Lerner's statement is already apparent given the brouhaha over People's QE. All that is down to the complexity of trying to present a simple overdraft or guarantee in flowery language. The mainstream have misinterpreted it and are now engaged in a campaign of misinformation. The lack of simplicity makes that difficult to counter.

Besides the complexity issues, balancing the current budget has clear issues.

  • you are limited to fixed capital formation and capital transfers. So you can build universities and hospitals, but you can't staff them.
  • eventually you run out of stuff to build. This leads to the old Labour problem of building roads to nowhere just to keep 'investment' going. 
  • you neglect items because of the current budget restriction. The only effective investment a government can make is in its people. But that is all current spend and is therefore difficult to do. 
  • you have to raise taxes to make the books balance. Nobody likes tax rises. Raising taxes is far more unpopular than explaining that budget balances are not really significant. It seems strange to take a political hit on taxation when you don't need to
  • Fixed capital investment targets a small section of the country's supply chain. Only a small section of the population is engaged in building things. The UK is 80% service based and people are trained for services. So you are quickly going to run into supply side capacity constraints, and potentially start to limit other capital development in the private economy.
  • the action of the auto-stabilisers pulls the current budget out of balance as a matter of design. If the economy contracts social security payments go up and tax take declines. You then have to do more investment spending to counter that. Yes there is more slack at that point, but is it the right sort of slack. Is the supply fungible enough?
  • the more investment, the more depreciation and interest paid. That leads to a positive feedback spiral between the current budget deficit and the level of required investment (and is another reason why Gilt Issues are harmful)

Overall it seems a strange political choice, when you can easily get away from adjusting taxes and allow yourself more freedom to improve direct services (the National Education Service for example) with a functional finance approach.  Simply explain that government is creating money so banks don't have to lend it. Government is stepping in so that ordinary people can save more and borrow less while at the same time ensuring everybody the private sector doesn't wish to hire has a job and an income. 

Surely the only people that would object to that are bankers and their economist lackeys.

Source: Office of National Statistics. Figures from Public Sector finance sequences: ANBT (Total Current Receipts), ANLO (Interest Paid), ANLT (Total Current Expenditure), ANNZ (Depreciation), ANMU (Current Budget Deficit), and ANNW (Net Investment). Data and calculations are available online