There is a general acceptance of myths about government finances and economic management that comes from a lack of understanding of public spending and taxation. Lack of understanding turns into misunderstanding under the assault of propaganda, and provides fertile soil for converting myth into accepted wisdom. Knowledge provides the mechanism to dispel these myths, to reveal accepted wisdom as myth.

Informed citizens are the foundation of democratic society. By participating through democratic institutions citizens facilitate effective government, and understanding government finances is central to that participation. In both Europe and the US few public issues are as consistently misrepresented as how governments should manage the economy, and this facilitates policies that undermine rather than enhance public welfare. To defend special interests governments can use these misrepresentations to justify policies that weaken the ability of the public to participate as citizens.

Many of us hesitate from engaging in a discussion of government budgets because of an imagined lack of expertise in what are perceived as complex subjects – because ‘I am not an economist’ or ‘economics is too dull and difficult to try to understand’. Public sector economic management is about politics as well as economics, yet many politicians and much of the media discuss government economic policies as if constrained by economic imperatives. Those imperatives themselves are frequently treated as natural forces beyond the control of governments and citizens. Debates over political priorities are too frequently treated as if they were a technical matter for an expert elite.

This first part of this book takes the reader past surface rhetoric for a straightforward discussion of government economic management, ‘fiscal policy’ (public spending, taxation and the balance between the two), monetary policy and the Bank of England, and the functional role of public deficits and the public debt. Understanding the nine ‘policy ideas’ in this part of the book requires no prior knowledge of economics, only an inquiring and open mind.

The ideas that follow all challenge the prevailing orthodoxy on economic management and the role of the public sector. Mainstream ideology on economic management preaches that the main task of policy-makers is to balance the public budget and keep inflation low. That combination will allegedly stabilise the overall economy, automatically ensuring full utilisation of resources and employment for all.

What's the issue?

For four decades British governments have placed priority on maintaining low inflation. Under Conservative governments this functioned as a central macroeconomic policy goal. A progressive government will come under strong pressure to maintain this priority, although it is frequently in conflict with other objectives such as economic growth and full employment.

Analysis

Private sector price increases are simultaneously increases in private sector incomes:

By definition price increases do not themselves erode real wages. Real wages and more generally household real incomes fall as a result of the distributional effects of price increases on incomes (wages and profits) and expenditures (spending patterns across the income distribution). When private sector prices go up, private incomes go up by the same proportion. However, some incomes go up by more than other incomes. Distribution, and not the inflation rate, is the key issue.

The standard definition of inflation is ‘a general and continuous increase in prices implying a fall in the purchasing power of money’. Several empirical yardsticks exist to assess the degree of inflation, prices paid by households on final goods and services (‘consumer’ price indices, CPI), prices paid by producers, wholesale indices and aggregate output (GDP) deflators. Each of these measures can serve a different purpose. All have the same failing of treating an increase in the index as indicating inflation.

‘A general increase in prices’ need not imply ‘a fall in the purchasing power of money’. A price increase may indicate an improvement in the quality of a good or service. For example, from 2000 to 2016 in Britain the price of new motor vehicles rose by 20 per cent. Part of this increase represented quality change, not inflation. A closely related source of non-inflationary price increase is the introduction of new products, such as computer-regulated fuel injection in motor vehicles.

What's the issue?

During 2008–11 the Labour government successfully implemented counter-cyclical fiscal policy to moderate the impact of the global financial crisis. As a result of the fiscal deficits in those years, the outstanding net public debt by the generally accepted measure rose from £560 billion in mid-2007 to £1.1 trillion by the 2010 General Election. Despite the austerity rhetoric of the subsequent coalition and Conservative governments, by mid-2018 the debt reached £1.7 trillion.

Analysis

The UK government has the tools to prevent debt default and excessive interest rates. These are not and will not be problems. Britain has a national currency managed by a national central bank. As a result, the British government can never default. It can replace maturing public bonds with new ones. Should private buyers refuse to purchase the bonds at the interest rate set by the British government, those bonds can be sold to the Bank of England. The option to sell to the Bank of England provides a mechanism to prevent excessively high bond rates.

The size of the public debt is not a problem. Figure 2 shows that publicly issued bonds or ‘gilts’ amounted to just over £2 trillion, which was 96 per cent of GDP at mid-2018. This standard measure used by the Treasury is in line with international practice. It equals total public bonds minus government liquid assets such as Treasury holdings of foreign currencies. Part of that amount, £251 billion, represented government ownership of nationalised banks, the largest public holding in HSBC. While technically a liability, these bonds have an equivalent asset in bank balance sheets, bringing the effective debt down to 84 per cent of GDP.

The Bank of England held about 23 per cent of this amount (£466 billion), most of it the result of asset purchases from private corporations, so-called quantitative easing (QE). When this amount of debt, what the public sector owed itself, is subtracted, we get the outstanding debt, the debt that the UK government owes to others. The outstanding debt falls to 62 per cent of GDP, far below the typically cited statistic. In 2018 the outstanding public debt was not almost equal to national production (GDP), as frequently asserted.

What's the issue?

Capitalist economies tend to instability, ‘boom and bust’. An active fiscal policy can moderate that instability with short-term spending and taxation measures (see Policy idea 2, this part). Those measures will be more effective if policies reduce the systemic instability of the private economy.

Analysis

The common perception of taxation is that it serves to fund expenditures. While that is correct to an extent (see Policy idea 2, this part), taxation has at least two other major functions. It can serve as a vehicle of social policy to affect the distribution of income in society. In Britain the distribution of household income after deduction of taxes is considerably more equitable than pre-tax income. Statistics from the Office for National Statistics (ONS) show that for the fiscal year 2016/17 the pretax ratio of the richest fifth of the population to the poorest fifth was 12:1. The after-tax ratio fell by almost half, to 6.4:1.

The inequality-reducing effect of the tax system plays an important role in stabilising the economy. If a tax system is progressive, tax revenue increases more than national income increases and vice-versa. Statistics from the ONS monthly report Public Sector Finances show that during 2011–17, when the Conservative Chancellor reduced the progressivity of the tax structure, the average rate of change of public revenue remained significantly above the rate of change of GDP. The ratio of the former (rate of revenue change) to the latter (rate of GDP change) is known as the ‘income elasticity of revenue’.

That real-world behaviour relationship has a direct impact on the stability of our economy. When a recession hits, business income falls, leading to a fall in business profits, income and private employment. The fall in employment provokes households to reduce their spending as some suffer unemployment and wages tend to fall for those still holding jobs. Household retrenchment of consumption spending adds to, or multiplies, the fall in business investment. If the tax system is progressive, household after-tax income, disposable income, falls less than pre-tax income, leaving more income for consumption expenditures. Pre-tax and after-tax refer to income tax only.

What's the issue?

After the UK economy showed recovery in 2009 and early 2010, eight years of austerity policies by Conservative governments brought recession, stagnation and faltering growth. Various excuses offered by Tory politicians, from world market instability to Brexit anxieties, fail to conceal the basic cause of this historically dismal economic performance. In the foreseeable future it will be the responsibility of a different government to manage rationally the economy.

Analysis

Much of the public and many politicians believe that commitment to match public revenue with public expenditure represents a sensible, sound and achievable fiscal policy. This generally accepted fiscal balance rule (FBR) gives rise to several sources of disagreement: (1) when and how rapidly to achieve it; (2) what specific measure of the budget requires balancing; and (3) what policies the government should apply to bring the balance about.

This deficit obsession of Tory governments makes all public expenditure policy captive to hitting the zero overall fiscal balance, or overshoot into surplus. Until recently the repeated failures to achieve fiscal targets did not weaken the grip of this extreme version of the FBR over the public mind and the media.

Even the Institute for Fiscal Studies focuses on the minutiae of the fiscal deficit rather than critiquing the ideology of the budget balancing. Even worse, Tory chancellors suffer criticism for not eliminating borrowing, although doing so would provoke recession. The responsible approach to this fiscal mismanagement is not to bicker over the likely success of reaching a balanced public budget, but to label the policy for what it is – pernicious nonsense.

Tory success in inculcating belief in the virtue of balanced budgets has proved so ideologically successful that it compels all politicians to commit to some balancing rule. By contrast, the Labour Shadow Chancellor, John McDonnell, proposed a flexible and non-ideological variation. The McDonnell budget guideline commits the Treasury to balancing current (that is, non-capital investment) expenditure and revenue as a targeted outcome of policies to maintain a high level of employment and output, not as a goal that overrides all other policies.

“SIMPLICITY ABOUT HIM”: FIRST ENCOUNTERS WITH SKEMPTON

PH: I got to know Howard in the early 1970s through my sister who worked at Faber Music, as did Howard. The first time we met was at a supper party for my sister's colleagues and for composers associated with Faber. Howard at once impressed me as a person of complete artistic integrity, and when he talked about his music he had a sincerity that made a refreshing change from the relentlessly competitive and over-professionalized ambience of the Royal College of Music where I was then a student. He was engaged in writing miniatures, many of them for piano, each of which was a distillation of weeks or even months of thought. Indeed, Howard told me he liked the mundane office work he did at Faber since it left his mind free to concentrate on his music. I had the impression of someone who thought very deeply about very simple things, and he explained that for him composition involved paring his ideas down to their essentials. The appeal of his music to me was that it embodied the principle of “less is more,” in which every sound mattered, instead of being lost in a maze of complexity. Although his manner was serious, Howard was not solemn. I can still recall from that evening that he amused us all with a lengthy saga of the accumulated mishaps that had befallen him on a trip to the launderette – making us laugh through his ability to look at the everyday in a quirky way that brought out the unexpected in things we take for granted.

What Howard was writing at that time was so at odds with the world of contemporary music, as it then was, that one didn't think of him as a “career” composer.