High Labour costs

Four weeks from today, the main UK political parties will go head-to-head in an election we do not really need to have. No prizes for guessing that Brexit will be the key battleground on which it will be fought. But with changes in the leadership of all main parties since 2015, this really should be an opportunity to address many of the key economic issues which have plagued the UK over the last seven years. The lack of investment; the over-reliance on austerity and a chance to reset the terms of the EU debate which David Cameron got so totally wrong and which Theresa May is not helping to improve. One might have thought that by now, the parties would have their economic plans ready to roll in order to give us time to assess the issues. Well, not exactly. The Conservatives are not planning to publish their manifesto until next week, and the best we have from Labour is a leaked draft which was splashed all over the press, framed as a socialist document worse than the longest suicide note in history, as their 1983 agenda was dubbed.

If you actually read through the leaked draft of the Labour Party manifesto, rather than rely in the headlines which tell us how very socialist it is, there are some rather interesting ideas in there. Jeremy Corbyn, for all his many faults, is trying to fight an election on issues of fairness and responsibility. The key message is that the vast majority of the electorate has been squeezed since the financial crisis-induced economic collapse, and Labour wants to do something about rectifying it. Thus the plans outlined so far indicate more spending on the NHS and the creation of a National Care Service; the building of more new houses; the scrapping of university tuition fees and the reintroduction of student maintenance grants. Add in the prospect of establishing a National Investment Bank to facilitate £250bn of spending on infrastructure over the next ten years (which is not a bad idea and I will deal with it another time), and you have what sounds like a classic fiscal stimulus. I would use the phrase “pump priming” but Donald Trump has apparently just invented it. (“Have you heard that expression used before? Because I haven’t heard it. I mean, I just…I came up with it a couple of days ago and I thought it was good”).

There is just one tiny problem: The plan sounds horrendously expensive – and that is before we even talk about the renationalisation of rail and energy. Let’s start with education. The Institute for Fiscal Studies reckons that Labour’s Higher Education policy would raise the deficit by over £8bn (about 0.5% of GDP at current prices). Investing £250bn in infrastructure over a ten year period implies a boost equivalent to 1.5% of GDP per year. To secure the financing, taxes must inevitably go up. Labour has suggested that it will raise income taxes on those earning over £80,000 per year (the top 5%), though has not said by how much, and “will ask large corporations to pay a little more.”

Some back-of-the-envelope calculations suggest that there are 1.1 million taxpayers earning between £80k and £150k per year paying higher rate tax at 40%, and 0.3 million earning above £150k paying a 45% rate. This means that only 25% of all higher rate taxpayers earn more than £80k. We can thus take the HMRC’s tax rate elasticity multiplier which calculates the full effect of raising higher rates taxes, and assume a 25% efficiency rate compared to the full impact. Running through the numbers, each 1% rise in tax on those earning above £80k per year will yield around £0.5bn in revenue per year. If the tax rate is whacked up by 4 to 5 percentage points, we could thus fund the education costs. The ready reckoner also suggests that each 1% on the corporate rate will reap around £2.4bn per annum. Thus, reversing the planned 3 percentage point cut in corporate taxes by 2020 yields another £7.2bn over three years. A Labour government could even raise corporate taxes back towards 25% over (say) five years, yielding an extra £12bn by 2022. Adding up these numbers (an effective 8 percentage point rise in corporate taxes and 5 points on taxes for higher earners), we thus start to get close to the £25bn needed for annual infrastructure spending.

But funding the reprivatisation would be enormously expensive. A brokerage report by Jefferies in 2015 put the cost of renationalising the energy sector at £185bn (~11% of GDP). They also pointed out that “if a future Labour government restricted itself to just acquiring the UK assets of the big six generators plus National Grid, the cost would be £124bn.” I have no idea what renationalising the rail sector would cost but let’s say £60bn for the sake of argument. An increase of £184bn in public outlays would raise the debt-to-GDP ratio by 11% at one stroke. Even assuming this is not a problem, the markets would almost certainly demand a higher risk premium on gilts, so debt servicing costs would rise. But here is the kicker: Labour has proposed a Fiscal Credibility Rule which plans to reduce the current balance to zero on a five year rolling timescale (which sounds to me like a never-never rule), but also that the debt-to-GDP ratio be lower at the end of the parliamentary term than at the beginning. Nationalising rail and energy would blow a hole in that, but fortunately Labour proposes to suspend the operation of the rule so long as monetary policy is operating at the lower bound. So that’s all right then!

All of these numbers are back of the envelope calculations and in no way constitute a detailed analysis of the costs.  Although many commentators liken this document to Labour’s 1983 election manifesto, its 1974 document which called for “more control over the powerful private forces that at present dominate our economic life” was at least as damaging because the party was actually in government. Labour’s main failure in the 1970s was to recognise that the poor performance of the British economy was not due simply to the failings of the capitalist system: It was largely due to an insular view of the economic problems. It feels very much like we are at that point again today.