Spending, lending or cutting – how shall we boost economy?

Nov 12 2008 by Peter McCusker, The Journal

A political consensus is emerging that tax cuts are required to stimulate the UK economy. But what does business think? And is fiscal policy the answer? Peter McCusker reports.

AT the height of last month’s banking crisis, the Government signalled it was considering a splurge on public expenditure projects to help alleviate a recession.

At the time, many economists and business leaders argued that tax cuts were a better way of putting money in people’s pockets to stimulate economic activity.

In particular, the big drawback of major spending projects is that although they can create a lot of jobs, it can take time for the effects to be felt, especially with the planning process often holding schemes back.

Now Prime Minister Gordon Brown has confirmed the Government is to look at putting more money into the economy by tax cuts or public spending rises.

And speculation mounted yesterday that a package of tax cuts is on the agenda – to be announced in this month’s Pre-Budget Report.

Yesterday the Conservatives said 350,000 new jobs could be created by giving National Insurance holidays to companies taking on staff who have been unemployed for three months, with the Liberal Democrats also favouring further tax cuts.

And this renewed emphasis on fiscal policy to stimulate the economy has been generally welcomed across the North East business community.

Colin Stratton, the Federation of Small Businesses regional chairman, said: “We are encouraged by suggestions of tax breaks for small businesses.

“We feel a six-month VAT holiday would provide welcome relief to the UK’s 4.7 million small businesses which are struggling with rising costs.

“We also are aware that 90% of all employers have fewer than four members of staff, so the plans to cut their National Insurance contributions will help shore up vital funds.”

David Elliot, tax partner at KPMG in Newcastle, added: “The key to any tax-cutting measures are that they are easy to implement and easy for businesses to understand.

“There is scope under EU rules for VAT to be levied at 5% on a number of things, such as renovating dwellings. Something like this could certainly help the construction sector.”

However, one North East economist believes a purely monetarist response is required to address the UK’s current economic problems, as a programme of tax cuts and increased public spending will lead to falling share prices and asset values.

Thomas Renstrom is a senior lecturer at Durham University Business School and is adamant that the way to deal with the looming recession is to focus on maintaining low interest rates.

He believes the Government should also remove the stipulation on the Bank of England to hit its pre-determined inflation targets.

“The problem with tax cuts is that both individuals and financial institutions anticipate tax will increase in the future to pay for them. This means the financial institutions will factor these looming increases into the prices they put on assets in the present, thus depressing asset values.”

However, Andrew Coulson, a senior lecturer in accounting and taxation at Northumbria University, is a supporter of the tax-cutting agenda.

“Using interest rates as a mechanism for stoking economic activity does not work if these interest rate cuts are not passed on. Recent evidence has shown this is the case.

“Tax cuts are one way forward but there is no guarantee that consumers will spend this money. They may well save it.

“However, there is evidence that those on lower incomes spend the extra money they get so one acceptable measure would be to increase welfare payments such as child benefits and tax credits.”

Andrew Sugden, director of membership and policy at the North East Chamber of Commerce, said it was a positive step that the major parties were debating the prospect of cutting taxes.

A six-month VAT holiday would provide relief to small businesses struggling with rising costs