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Will the stimulus package work?

Will the stimulus package work?

The fiscal stimulus package announced on Monday by the Chancellor of the Exchequer was nothing if not radical. Rarely has a government let borrowing rip to the extent that Mr Darling is prepared to do in order to stimulate the economy and keep consumers spending. But will it have the desired effect?

You'll find our thoughts on the matter , but to help us make sense of this week's inaugural Big Question are two appropriately eminent commentators: Will Hutton, executive vice chair of the Work Foundation and best-selling author, and Tom Clougherty, policy director of the Adam Smith Institute, a prominent free-market think tank.

YES, says Will Hutton, executive vice chair of the Work Foundation:

Extraordinary times call for extraordinary responses. And that’s what we saw from the Chancellor earlier this week: a package of measures that only months ago would have been unthinkable in its scale looks today like a bold and positive response to the challenges the UK is facing.

I’m more upbeat than others about the potential impact that temporarily reducing VAT will have on our spending habits; this increase in personal spending, combined with bringing forward some £3bn of capital spending into next year, should give a desired jolt to demand. Jobs will be created.

Alastair Darling’s focus on mitigating the impact of higher unemployment is welcome. JobCentrePlus will inevitably face greater flows of people and needed to increase its capacity. The rapid response initiative will enable a more nimble reaction to those made unemployed, while the employment partnership should ensure that vacancies don’t stay unfilled for long. Small businesses, employing around 60 per cent of the workforce, will have been bolstered by his measures that guarantee loans, keep flows of credit open and allow more flexible tax payments.

In this new settlement, the political lines are being redrawn too: raising the top rate of tax for those earning above £150,00 to 45 per cent - and in doing so, rolling back on Labour’s commitment not to increase tax for the highest earners - will have more impact on the backbenches than on the balance sheet. Ideology feels like it is coming back again.

There were omissions. There are risks in delaying the introduction of measures that that would encourage the flow of mortgage finance and I would have liked to see Mr Darling go further in stimulating bank lending – the genesis of this crisis. An economic plan that – with a fair wind – will only balance out in 2016 seems like a huge risk, politically and economically. No one can possibly know the state of the public finances so far away and George Osbourne’s publicly-expressed anxiety about the value of sterling unquestionably found its mark. In addition, if Mr Darling proves to have been overly optimistic in his expectations of how the economy will respond to his interventions, borrowing will be even further north of his already high forecast. But if it’s a gamble, it’s a gamble that deserves to pay off. All credit should go the Chancellor for a bold, imaginative PBR. Crisis has given Labour a renewed sense of mission.

NO, says Tom Clougherty, policy director at the Adam Smith Institute.

What stimulus package?

Is a measly (and temporary) 2.5 per cent off VAT really going to accomplish what high streets full of half price sales and buy-one-get-one-free offers couldn't, and get people spending again? I doubt it.

Anyway, VAT isn't charged on food, children's clothes or mortgage payments, and is already set at 5 per cent on domestic fuel. Petrol isn't going to get any cheaper, because the Chancellor has hiked fuel duties, and the same goes for alcohol. Few will see much benefit.

Most economists can't imagine the VAT cut prompting any significant change in consumer behaviour, or doing anything to stimulate the economy. But that's still more than can be said for the rest of the pre-budget report.

Lower taxes boost the economy by strengthening incentives to work and invest, and by increasing productivity. Yet most of the PBR goes in the opposite direction. National Insurance contributions are set to rise by 0.5 per cent, while high-earners will be hammered by marginal rates of up to 60 per cent. And we are still going to get higher corporation taxes for small business and retrospective rises in Vehicle Excise Duty, just not straight away.

Meanwhile, the UK's budget deficit is set to hit 8-9 per cent of GDP, as borrowing reaches £120bn a year. Public sector debt is likely to top 60 per cent of national income and exceed £1trn by 2012. These will be the worst figures on record. The taxes needed to service this debt will be a significant drag on the economy for years to come.

And for what? To finance wasteful public spending that we already know doesn't boost the economy? Japan spent the 1990s trying to overcome a recession with infrastructure spending, and achieved nothing except debts amounting to 180 per cent of GDP. Massive public spending increases in the US in the 1930s, 1960s and 1970s all failed to increase economic growth rates. And let's not forget 1970s Britain. "Priming the pump" hasn't worked in the past. It's not going to work now.

Ultimately, the Chancellor's only idea is to tax, borrow, and spend. This is not the route to recovery. This is the road to ruin.

WHAT DO YOU THINK?

"Just like the US, we will be looking for China and Arab states to fund us!"

"The very same people who are up to their ears in such debt are encouraged to go out and spend some more. Who is in charge of the asylum?!"

"For the life of me I cannot see the VAT reduction making the slightest difference to spending and it costs the government an absolute fortune."

Read these and other reader comments in Come off it, Darling.

And send us your comments using the Your Opinion form!

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By Jonathan Eley,
26 November 2008

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