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Post-pandemic: What lies ahead?

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published on 8 June 2020 | reading time approx. 6 minutes

  
Given the current unprecedented situation the World economies, governments, business and people find themselves in, let us ponder over life post-pandemic.

 

 

 

We do not know how this pandemic will end, but even before it does, as a nation, we are going to be poorer given the plunging GDP around the World. According to the IMF, the debt ratio of the average advanced economy will exceed 120 percent next year.

 

Although, this is a unique situation, a look back through history where government debt has risen and the policy aftermath would be useful to help form an expectation; especially in light of the towering piles of IOU’s building up from this crisis.

 

The rising debt

The Covid-19 pandemic has plunged capitalism into another of its periodic crises, forcing Governments to return to the frontline and inject money into the economy in an attempt to restore “normality”. But how will we afford to pay for the economic response to Covid-19?

 

The UK Government’s main policy measures in particular; the Job Retention Scheme, loans and grants to business are highly costly with furloughing alone, now expected to cost well north of £50bn.

The other reason for rising national debt is that the Government's revenues - the tax it collects through income tax, VAT and national insurance - are collapsing with the shut-down of  much of the economy. As such, the Resolution Foundation estimates that if major restrictions endure for six months, the UK government might need to borrow well over £300bn.

 

With the surge in Government debt and resulting budget deficit and debt surpassing 100 percent of GDP, there are already prompts for austerity. George Osborne, the original author of the cuts programme, has warned of the need for a future “period of retrenchment”.

 

The last time the country was in this position of high debt was in the wake of the 2008 financial crisis, George Osborne made two crucial decisions: to reduce the budget deficit swiftly and to do so overwhelmingly via spending cuts via a regime of ‘austerity’. However, leading economists are now fearing the renewed ‘risk’ of austerity policies in light of Covid-19 and are calling for increased growth and investment and progressive tax rises instead, arguing that austerity has led to increased inequality and led investment and productivity to stagnate in many countries.

 

Fears of a return to the austerity Britain

Following the 2008 financial crisis, during 2010, in defiance of advice from most economists, the Conservative-Liberal Democrat coalition government imposed austerity on the UK. A decade later, the social cost of this project is clear. ‘Sleeping rough’ in England has increased by 165 percent since 2010;  life expectancy has stalled for the first time in more than 100 years; and the n  umber of people in poverty in working families has reached a record high. Even before the coronavirus outbreak began, average real wages had once more fallen below their 2008 peak – a lost decade for living standards. 

 

Some experts argue that George Osborne’s imposition of austerity on the UK is the worst economic decision for many decades. By strangling growth through spending cuts and tax rises, his actions led to the slowest peacetime recovery in 300 years. Now, due to the expected surge in the national debt, there are calls to do it all over again, despite warnings.

 

However, Boris Johnson has insisted that austerity will “certainly not be part of our approach” but whether he can be trusted to maintain this pledge in face of rising debt and pressure is already under scrutiny. After all, he hasn’t promised no budget cuts.

 

Austerity is said to have eroded the public sector’s ability to absorb shocks. The slowest decade of per capita funding increases since the 1950s, left the NHS struggling to cope with even seasonal flu, let alone a major pandemic. Temporary increases to Universal Credit announced in March 2020 are said to have reversed just a fifth of the cuts seen since 2010, and for one year only.

 

Many Economists take the view that spending cuts transfer risk from Government to families; forcing people to rely more on savings in an emergency, while at the same time contributing to the worst decade of real wage growth for two centuries. In 2010, this left households with little to fall back on, with the savings rate falling to its lowest sustained level since the 1960s. Thereby, reducing disposable income, demand and economic growth.

 

Spanish flu – the last pandemic

2010 wasn’t the first time for austerity policies in the UK. At the behest of Montagu Norman, the then governor of the Bank of England, austerity was imposed on the UK economy after the last great pandemic of the Spanish flu of 1918, with disastrous consequences. Taxes were increased, government spending was cut, interest rates rose and the strengthened pound boosted debt servicing costs. Soon the British economy was in free fall.
 
In 1919, the British economy was recovering from a world war, as well as a pandemic. The austerity policies resulted in the UK economic output falling by  25 percent between 1918 and 1921 and did not recover until the end of the Great Depression, with some economists arguing that the UK suffered a twenty-year great depression beginning in 1918.

 

Post World War II

On the other hand, post-World War II, there was a decline in UK national debt after it peaked in the late 1940s at over 230 percent of GDP. From the early 1950s to early 1990s, we see a consistent decrease in the debt to GDP ratio.

 

It is said that the main reason UK debt to GDP fell in the post-war period was the sustained period of economic growth and near full employment until the late 1970s. This growth saw rising real incomes which in turn led to higher tax revenues and falling debt to GDP ratios and the positive inflation rate helped erode the real value of debt.

 

The difference here compared to austerity policies was that debt to GDP was definitely not reduced through cutting government expenditure. Debt to GDP fell, despite higher real government spending on the newly formed welfare state and national health service. In fact, government spending as a percent of GDP rose from around 35 percent of GDP in the early 1950s to the high 40 percent in the 1970s.

 

Another feature of the 1940s, 50s and 60s were very high tax rates. The Second World War created a political climate which tolerated extremely high-income tax rates. The highest rate of income tax peaked in the Second World War at 99.25 percent. It was slightly reduced after the war and was around 90 percent  through the 1950s and 60s. In 1971 the top-rate of income tax on earned income was cut to 75 percent. Though a surcharge of 15 percent on investment income kept the top rate on that income at 90 percent. The top rate of income tax was cut to 40 percent in the late 1980s.

 

With income tax rates of 70 jpercent plus. Rising incomes lead to significant increase in tax revenues for the government. There was more effort to tax capital. In 1965, James Callaghan, the then chancellor introduced capital gains tax of 30 percent to stop people avoiding income tax by switching their income into capital. As a result, tax revenue regularly over 40 percent of GDP. However, the post war period has some of its own very specific circumstances, in particular the general global boom with recovery of Japanese and German markets and increasing free trade and immigration.

 

Thoughts from leading economists

In light of history, we see many current leading economists argue that the alternative to spending cuts is to invest in people and places through government spending, incentives to work and, if necessary, through central bank financing. Contrary to austeri-tarian logic, government spending is argued to encourage private spending during a slump by providing necessary public goods and services that private enterprises lack incentive to supply.

 

These “essential” goods and services that a community needs are transport infrastructure, health and education services, and social housing. In fiscal terms, this means scrapping artificial borrowing rules such as a debt ceiling of 60 per cent of GDP and changing the question from what the government can afford to spend to what is it the community cannot afford to be without.

 

The logic is that continued government investment and spending will strengthen the economy, encouraging private investments and income growth. Thereby generating employment, increasing incomes and a sustainable tax base. Therefore, as seen in the aftermath of World War II, there is likely to be an increase in government debt required post crisis before economic growth can reignite and reduce debt. Economists are arguing that the critical point is investment in the economy’s productive capacity and the indispensability of the social safety net, not the source of the funding. But it does mean that the UK will need to find a way to finance, via taxation, the welfare state it needs. It is therefore highly likely that the UK will need to revisit tax increases after the Covid-crisis.

 

However, before the UK could consider using some of the future tax revenue for debt repayments, the government must continue to support business, stimulate growth and support workers through transition. Sighting that, despite the UK’s budget deficit being forecast to rise to more than £300bn per year, the cost of financing overall debt is expected to fall to the lowest levels on record.

 

The argument is that ultra-low government borrowing costs mean that the UK can carry that debt and pay it down over a long period, perhaps even decades.  Thus pushing any need for tax rises to further down the line.

Other factors to consider before tax rises will depend on the risk of future pandemics and on whether the economy resumes healthy growth. Low risk and healthy growth might mean no taxes are needed to actively return the debt-GDP ratio to where it was. But the future could prove worse than this.

 

Summary

The current consensus amongst experts appears to be that tax rises are a progressive alternative to government cuts. Although we can’t be certain what the Johnson government will do post-crisis, there is strong support for continued investment in the economy and business. It is likely that  tax rises will have to take the load (with or without corresponding spending cuts). With predicted tax rises, there are calls to share the burdens of tax more fairly amongst claims that wealth has grown faster than incomes in recent decades but wealth taxes have not risen at all.  What this call for fairness in taxes will look like is yet to be seen.

 

However, with the likelihood of tax rises come further unanswered questions of who pays the taxes? A world in which coronavirus debts are repaid by a wealth tax or a global crackdown on corporate tax havens would look very different from one in which benefits are slashed and VAT is raised. And there is still a very high possibility that debt service will be taken out of other spending, whether that be schools, pensions or national defense.

It would appear the current conclusions being drawn are no to austerity, deficits in the near-term to counter recession and potentially higher taxes to fund a more resilient economy.

 

Rödl & Partner will be keeping a close eye on developments and keep our clients informed. “Prepare for the worst, hope for the best”

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