Shop till you drop? Here’s a better plan!

We have got into a whole heap of trouble by doing too much shopping funded by borrowing.  So what is Brown & Co’s plan to get us out of this hole?  A marginal cut in the rate of VAT to encourage more shopping funded by more borrowing!  You couldn’t make it up.

At least until now we as individuals have had the freedom to choose whether or not to live above our means.  Monday’s Pre-Budget Report nationalises this decision and removes our freedom to choose.  It also proves beyond reasonable doubt that the government has little idea what’s going on in the real economy or how to respond to the crisis.  Moreover, since the government has also been living beyond its means for years, it doesn’t actually have the financial capacity to do as it now proposes (indices that measure risk on government debt are soaring) and can make it ‘work’ only by fiddling the figures with a wholly unbelievable forecast of a quick economic rebound.

Debt is perfectly fine when its adequately supported by underlying cash flows but governments have allowed banks to compound debt to levels far in excess of anything sustainable with a monstrous bubble in house prices.  Hence this is a ‘balance sheet recession’ caused by the collapse of a house-of-cards edifice of debt far in excess of sustainable levels.   It’s an avalanche that, once started, can’t be stopped until it reaches the bottom.

Now there is a further risk – that many perfectly viable and healthy businesses will be hit by what the military coyly call ‘collateral damage’ – killed in the crossfire.  But this further reduces the underlying earnings in the economy which is the only thing that will eventually stop the avalanche.  If this happens and large numbers loose their jobs, default on mortgage and credit card payments etc., the whole process turns into a death spiral and recession becomes depression.

It follows that one of the things the government badly needs to do is to improve the strength of the underlying economy.  To an extent they are doing that in leaning on the banks to keep lending but that is more about damage limitation than being proactive and it’s a tough call because lending capacity is just exactly what the banks are short of (hence ‘credit crunch’) although the government is doing its best to ignore this important detail.

I don’t think people are stupid enough to be bribed back into the shops by a 2.5% VAT giveaway at a time like this.  (Particularly so since much of the 2.5% will probably be absorbed by retailers).  In promoting more shopping the government is treating symptoms, not causes.  So what should the government do? 

Firstly, Vince Cable is absolutely right to call for a reduction in the tax burden on low earners.  In hard times people near the bottom of the pile always suffer most so social justice demands no less, especially since the whole credit crunch crisis was born and raised in the top echelons of society.

But we need to do more; we need to think about what can be done to help business weather the storm.  For if businesses stay healthy then salaries get paid, debt is affordable (even if uncomfortably high) and confidence will soon come flooding back – and flow into the shops. 

One way this could be done is to change the basis of taxation for small businesses so that they are taxed only on drawings (or dividends if incorporated as a company) rather than on profit.  Then, provided their owners choose to live modestly and keep profits in the business, they would be free to save or invest their money as they saw fit without the government grabbing it.  This would quickly make a big difference since one of the biggest problems for small businesses (even in normal times) is accumulating sufficient capital.  For those with ambitions this would make it much easier to accumulate a modest amount of capital and then expand, diversify or whatever.

(As an aside; this is the same strategy that successive governments have used vis a vis the illegal drugs trade and which has helped make it one of Britain’s most ‘successful’ industries.   Although never any government’s intention, the practical effect has been that with drug seizures – their equivalent of tax – normally at very low levels, the backers have had ample capital from retained profits to develop and diversify their criminal business).

With stronger cash flows small business would be less beholden to bank lending policies.  Many would be able to increase their bank deposits (or reduce their overdrafts) which would in turn help stabilise the banks. A proportion would soon accumulate the capital to consider an expansion and take on staff.  BERR estimates that there are over 4.6 million small business (with less than 50 staff) in the UK.  If just one in 5 of these took on just one extra person over the next two years, that is a million new jobs and many times that with renewed confidence in their job security.  It  also creates a high probability of a recovering economy.

Moreover, small businesses collectively have an enormous fund of experience; anecdotal evidence suggests a high proportion are rather well run so new investment would automatically flow to areas where it would do most good.  It is unlikely that much would go into retailing or building (although there must be some good niches even there).  In other words, helping small business would improve the accuracy and flexibility of the economic response to the crisis.

From the government’s point of view there would be a hit to cash flow into the Treasury, but only a temporary one as sooner or later owners would increase their drawings (and in any case not all owners would be willing or able to reduce drawings).  In the meantime the government revenues would benefit from increased PAYE, NI and VAT on increased economic activity.   

It could also be good politics.  If each small business influences the voting intentions of just four people (partners, family, employees etc.), that is more votes than the Lib Dems got at the last election!

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One response to this post.

  1. Posted by lambertchapman on 26 November 2008 at 8:57 pm

    Interesting read with some thoughtful ideas. Ever thought about standing for Parliament? No i’ve got that wrong you must have had a job to understand and put forward the ideas you have so that rules you out of the House of Commons!

    Reply

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