Thursday, 2 February 2012

WHY It Is ‘Hurting But Not Working’

One of the established ‘facts’ of modern politics is that we need to cut the deficit. We have decided that the government cannot go on year after year borrowing in order to spend more than it receives in revenues.
There are some very clever economists who argue that this is not so, and that we can run a structural deficit as long as the economy keeps growing but, to be honest, that just doesn’t make sense to most of us, and so we’re ignoring them for the moment. Very few of us expect the economy to ‘keep growing’ anyway.

So the Chancellor, George Osborne, is making cuts. To be fair to him, Labour too say they would make cuts… just maybe not ‘so far, so fast’. This is a slogan which has spectacularly failed to catch on, despite being mentioned at least once in every official Labour pronouncement.

By contrast, the other Labour catchphrase – ‘it’s hurting but it’s not working’ – IS something that we can all relate to. As our economy spirals into depression, and as the cuts bite, each successive prognosis seems to INCREASE our planned borrowing – austerity is palpably NOT reducing the deficit.

In this article I am going to explain why.

Let’s Sack a Public Sector Worker!
First of all, let’s select our victim – perhaps he works as a learning support assistant (LSA).
He could just as easily have been a social worker, or a nurse, or one of the ‘backroom’ police staff we are so busily getting rid of.
Let’s assume that he earns £20,000 a year – so let’s sack him, and save that £20,000, which (as every Tory knows) is a burden upon the state and the honest taxpayer.

The Cost of Unemployment – Benefits
Of course we can’t just let him starve! We realise that the state picks up a tab for that unemployed person. So let’s guestimate some of the costs associated with unemployment.
Let’s say our unemployed person ends up receiving Job Seekers’ Allowance (of c.£3,500), rent (say £4,500), council tax (perhaps £1,000?), and he continues to get his National Insurance stamp (£1,500?). If he is on income-based Jobseeker’s Allowance, he will also be entitled to other help, such as free prescriptions, free school meals for his children, and help with the costs of a new-born baby. His low income will also make him eligible for help with things such as his dental charges, a new boiler and a whole raft of other things, so let’s put the average annual cost to the state of an unemployed man at a conservative £11,000.

So we have really only saved (so far) £9,000.

The Cost of Unemployment – Direct Taxes
But of course, it doesn’t stop there. Because that LSA did not keep all of his money as disposable income, did he! He paid a significant whack of it back to the Treasury in taxes.
Some of these were taken up front, from his salary – a worker on £20,000 will pay £2,500 in PAYE income tax and £1,500 in National Insurance.

So the government has lost £4,000 in direct revenue, which must also come off our ‘saved-so-far’ figure, and reduces our running total of money ‘saved-so-far’ to £5,000.

The Cost of Unemployment – Indirect Taxes
Also, you will realise, the government raises revenue from indirect taxes – VAT, duties etc. – which our now-unemployed LSA used to pay as he spent his disposable income.
Our worker on £20,000 – after paying his tax, national insurance, council tax and rent – used to have a disposable income of just under £11,000 to spend on living. Now he is trying to get by on JSA of perhaps c.£3,500, so that means a drop in his disposable income of more than £7,000 … and that will mean a drop in the indirect taxes he is paying to the government in VAT, duties etc.

Just how much of that £7,000 will be lost to the Treasury will depend on what our LSA chooses to cut from his spending. If he stops buying petrol, a massive 64% of that money would have gone to the government. If he cuts down on his smoking and drinking, similarly, the Treasury will take a big hit. Most of the other things he cuts back on – electricity, clothing, processed food – will mean a loss to the Treasury of VAT at 20%.
If he rings up the local decorator, or plumber, or double-glazing company, landscape gardener etc. and CANCELS the job he was going to have done, that will be a HUGE blow to the Treasury, which will lose not only the VAT on the job, but also the corporation tax the company would have paid, and the income tax and national insurance that its workers would have paid out from their incomes.

So the truth is that I haven’t a clue how much of that now-unemployed man’s disposable income will be lost to the Treasury in lost indirect taxation, but I would guess it could be anything between a fifth and a half, depending on where he makes his savings.
Shall we say £2,000 (28%)? This is almost certainly a cautious estimate of the loss of indirect taxation – all the evidence seems to show that people on benefits buy a greater proportion of non-VATable products.

So, if you accept my guestimates, the direct saving from sacking an LSA on £20,000 a year could be as little as £3,000.
But there’s more…

The Cost of Unemployment – the Multiplier
It’s funny how the times affect what we know. In Victorian times, everybody knew their bible. In the 1960s, we were all discussing Trotskyism and syndicalism and a whole raft of other political ‘-isms’.

Today, in these times of economic crisis, there will be very few people who haven’t heard of Keynesianism – the economic theory that money going into (or coming out of) the economy has an effect many times the original sum.
This just makes sense, doesn’t it? The £5,000 of disposable income that our LSA does not hand straight over to the government goes into the pockets of other businessmen and workers – newsagents, publicans, shopkeepers etc. All these people count his expenditure as their income … and in their turn pay direct and indirect taxes on it to the government. And in turn all their expenditure which does not go to the government becomes the income of a third set of people who… [etc., etc.]

Thus taking our LSA’s disposable income out of the economy does not only take from the government’s pockets the direct and indirect taxes HE pays, but it creates a ‘multiplier effect’ which takes many times that amount out of the economy, and therefore from the Treasury.
Most estimates of the ‘multiplier’ in the economy put it somewhere between 1.5 and 2, which will mean for the government a further loss of revenue-through-the-economy of £1,000-2,000.

The Bottom Line
So, by my figures, a government which tries to cut the deficit by sacking an LSA will find that – after paying him his benefits, and taking into account the various lost tax-revenues – it is beginning to look as though the government will be lucky to end up saving any money AT ALL.
The damage to the economy damages tax revenue to such an extent that it is simply not fiscally viable to try to save money by sacking public sector workers.

And that is BEFORE you begin to calculate-in all those hidden costs of unemployment, such as increased need for medical care, Job Centre administration, etc.

And that is BEFORE you postulate that, eventually, all the lost business associated with our LSA’s fall in disposable income may tip a local private company over the edge, and cause it to lay off one of its workers ... which would add a further £11,000 to the government’s bill, on top of the almost-nothing that it had failed to save by sacking our LSA.

Conclusion
So now you will see why ‘it’s hurting but not working’.
As fast as the government sacks workers to save money, it incurs costs, loses revenue and wrecks the economy to such an extent that it LOSES money, not gains it.
And it’s not as though we haven’t got examples from other countries such as Greece and Spain, where governments are driving their workers down to starvation-levels, yet still failing to make a dint in their deficits.
If the Tory government continues as it is doing, then this will eventually become the prospect for you and I.

We may need to reduce the deficit, but sacking public sector workers, freezing their wages, and cutting benefits to the poorest are NOT the way to do it.
Our government are behaving like lunatics, and we MUST persuade them to see sense.

What’s the Alternative?
It was the aim of this Rant to explain why sacking public sector workers doesn’t work, rather than to suggest what might work, but nowadays, to be ‘credible’, one has got to do both!

So briefly, I would suggest the following:
1. If you must cut government spending, you must cut it in ways that will not take money out of the home economy. Cutting government contracts with foreign companies carries the danger of tit-for-tat retaliations, but would transfer the impact onto another economy than our own. Foreign Aid, payments into the IMF and to the Irish banks etc., also, are good candidates for saying ‘No’. And it would help if we could keep out of wars for a while.
2. Any zero-cost plan to grow the economy will help reduce the deficit by increasing the tax-take. A government could give a firm which took on an unemployed person ALL that person’s income tax as an inducement, and it would STILL make a whopping profit in terms of avoided benefit payments and gained indirect taxes.
3. Ultimately, if a government is running at a loss, another way to increase revenues is by increasing taxation … though NOT from those for whom it will mean reduced spending, but from those who will simply be forced to reduce their saving.

1 comment:

  1. A couple of years ago, Richard J Murphy did a similar, much more thorough, analysis here: http://www.taxresearch.org.uk/Blog/2010/05/17/the-only-way-to-cut-government-debt-is-to-increase-government-spending-2/

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