Thursday, 16 October 2008

Why cutting VAT could now be on the agenda

With the rise in unemployment figures released yesterday, and continuing long term downturn in consumer confidence affecting retail spending and small business, it may be that the time has come to consider cutting one of the most regressive tax schemes currently in place - VAT.

Calls have already been made this year for government to cut VAT on maintenance and home improvement work as a means to encourage homeowners to carry out energy efficiency measures and contribute to carbon reduction - see for details.

In his last speech as Chancellor, Gordon Brown also called on the EU to cut VAT on 'green goods' to 5%.

But a wider VAT cut may have advantages over tax rebate strategy that has been put in place by the Bush administation and which was echoed in comments made by the TUC's Brendan Barber in an interview with Channel 4 news last night.

As we highlighted earlier this year on this blog, one of the key theoretical advances made by the monetarist economist Milton Friedman was his exposition of the 'permanent income hypothesis' which dictates that households will not be encouraged to spend by income tax cuts whilst they are fearful for their jobs and long term position. As a consequence, VAT cuts have a distinct advantage - the benefits of them are only realised in the act of spending. To get the benefit of lower prices, you have to buy. They also have a real advantage in redistributing income to the poorest who spend a greater proportion of their income on VAT than higher income households, especially if the VAT regime is rebalanced in order to provide the largest cuts in the VAT rate on those goods which the poorest need and buy most.

If government is seeking to boost the economy and consumer spending then the measures we set out in our post earlier this week - an income based mortgage interest credit, central bank control over new long term mortgage and consumer lending rates, compulsion for banks to lend, discretion for courts to reschedule mortgages that are in arrears, and a cut in the VAT rate could form the basis of a solution.

Tuesday, 14 October 2008

Banking on Change - Can we build a sane future?

The action of governments and central banks across Europe and in the U.S to save the financial system from complete collapse is without a doubt one of the most significant economic and political events since the second world war. But it would be foolish to think that this crisis is anywhere near over. In fact, we may simply be entering a third phase in which we witness the impacts start to spill over into the real economy - resulting in more lost homes and rising unemployment.

The primary reason for continuing alarm? The causes of the credit crisis have not been addressed. We perhaps need to remind ourselves that neither the mass movement of bank deposits or the loss of liquidity in the banking system was the initial cause. Both of these were second order problems. They only arose because of falling values in the U.S - and by extension uncertainty in other national - housing markets. This 'trigger' remains in place, creating a prisoner's dilemma for banks.

Simply put the prisoner's dilemma is this - with so many people now in need of remortgaging at cheaper rates in the U.S, which one of the banks will be the first to take the risk on by offering them loans? The answer, clearly is none will do so for fear of attracting the most risky customers - after all just as the market knows that those banks accepting loans from government are in the worst problems, the banks know that those customers most desperate to reschedule home loans are likely to have the most problem repaying. This 'adverse selection' in credit markets was recognised long ago.

Two immediate actions need to be taken to resolve this. Firstly, households in the most difficulties need helping and fast. Secondly, central banks have to break the prisoner's dilemma by placing 'strings' on their assistance.

How can households be helped? - Debt on our Doorstep calls on government to consider introducing a 'housing interest credit' for low income families, which provides interest relief at source on mortgages and is paid on a sliding scale according to income. That will provide instant assistance to households struggling with increased fuel prices, and rising inflation but will ensure that it reaches mortgage repayments and reduces the risk of arrears. The Obama campaign has something similar in its economic proposals in the U.S at the moment.

Government should also legislate to amend S.36 of the Administration of Justice Act 1970 and S.8 of the Administration of Justice Act 1970 - the legislation which currently provides court's with powers to help borrowers facing repossession proceedings. The current law does not allow judges to reschedule mortgage agreements to ensure that people can retain their homes. They should be provided with the discretion to do so. Again, these measures are being supported by Democrats and community groups in the U.S.

But fundamentally the prisoner's dilemma in banking needs to be broken. To do this, banks must be forced to put out greater amounts of capital on loan to support mortgage and consumer credit restructuring for households over the next five years. Long term loans need to be made available to the banking industry from central banks to support this but banks must pass on this funding at fixed rates and terms established by the central banks to consumers. In effect the central bank will be setting the terms on which loans are to be provided to consumers, with banks simply acting as the intermediaries. Such is the lack of trust which can be afforded to Britain's banks.

Over time, such a direct mechanism can be relaxed provided the regulatory framework under which credit is provided in future is revamped and ensures that incentives are in place for responsible lending to take place and long term, ethical, relationships between consumers and lenders fostered.

That regulatory framework now needs to be constructed with the active participation of consumer agencies and representatives in partnership with banks and government. Our conference, which will take place on 13th and 14th November in London provides a seminal opportunity to begin those discussions. Further details can be found at
Please note that we have also secured up to 50 half price places for not for profit agencies to attend these discussions.