Britain might reset fiscal policy in 2016

REUTERS
LONDON
Published 24.08.2016 23:19

British Finance Minister Philip Hammond is weighing up whether to "reset" fiscal policy later this year to help the economy cope with June's decision by voters to leave the European Union.

So far, consumers have continued spending despite the Brexit shock. But there are concerns that companies may curb investment and hiring while Britain reworks its relationship with the EU, something which could take until 2019 to settle or longer.

The Bank of England expects no growth in the economy in the second half of 2016 before picking up only weakly in 2017. It has pumped money into the economy.

Hammond, who has already signaled a softer approach to budget discipline to his predecessor, is expected to follow up with tax and spending measures at the end of 2016. Below is a summary of his options.

VALUE-ADDED TAX CUTBritain cut VAT by 2.5 percentage points in 2009 to help the economy at the start of the global financial crisis and a new cut in response to Brexit could provide immediate help. But past experience suggests many households do not use savings from lower VAT to spend more and save it instead. Furthermore, a meaningful VAT would be expensive and add to the challenge of bringing down Britain's high budget deficit.

INCOME TAX, INSURANCE CUTS

Income tax cuts are popular with the ruling Conservative Party but, again, not all the savings would be spent. They would also not help all households because 43 percent of Britain's adults earn too little to pay income tax. A cut to social security contributions would have a bigger impact because fewer workers are exempted from them.

TARGETED HANDOUTSCharles Goodhart, a former BoE rate-setter, said the government might choose to follow the lead of Japan and offer targeted handouts to lower-income households who are most likely to spend the money rather than save it. Japan plans to spend around 367 billion yen in the current financial year on pay-outs to low-income households - or 15,000 yen ($149.60) for each one.

CORPORATION TAX

Shortly before losing his job as finance minister, George Osborne said he planned to cut Britain's already-low corporation tax rate to below 15 percent to offset the Brexit shock. Hammond has signaled doubts. A further cut could add to perceptions the Conservatives are focused on helping business more than voters. Some EU countries are unhappy at the idea of Britain using low tax to lure investors, possibly impacting the Brexit negotiations.

TRANSPORT SPENDING

Spending on infrastructure delivers a higher growth return for governments than cutting taxes, and with yields on government bonds at record lows, it has never been cheaper for them to borrow.

Britain has invested less public money in transport than many other developed countries over the past 20 years as it relied on private investors to shoulder the load.

Britain's overcrowded railways have long needed upgrades but construction of a new high-speed rail line linking London with other major cities is only due to begin next year, eight years after the government began to consider it, highlighting how long major transport projects take to get off the ground.

Projects are also often held up by environmental concerns and campaigns by local residents. A decision on where to build new airport capacity in London has been put off for 25 years.

HOUSING SPENDING

Britain is trying to spur more house-building to lower the cost of buying and renting. Giving more tax breaks and grants for developers is likely to feature in Hammond's plans and he might consider ditching a tax introduced by Osborne on homes bought by landlords and on second homes.

The government would need to look at other constraints on house-building such as planning rules and a growing shortage of skilled workers. Wage growth in construction has hit 8 percent a year. HSBC says Britain needs 130,000 workers to meet its existing house-building targets.

Government support for new commuter towns, such as one being built at Ebbsfleet, south-east of London, could also spur investment in roads and other infrastructure. Although this takes a long time, Victoria Clarke, an economist with Investec, said the slower impact of infrastructure investment might actually prove to be well-suited to the long process of adjustment that Britain's economy faces in the coming years as it leaves the EU.

SKILLS, TRAINING

Some economists say infrastructure spending will not address the longer-term challenges Britain now faces. Adam Posen, another former BoE interest rate-setter and now president of the Peterson Institute for International Economics, said workers from struggling sectors would need to learn new skills.

He pointed to the example of Denmark which combines rules that make it easy for companies to hire and fire staff with retraining options.

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