Blinded by the light

This weekend, Brown and Darling dazzled us with a blinding light. They leaked a headline grabbing story that New Labour would put up income tax to 45 percent for a tiny minority of high income earners.

The increase, in revenue terms, will be irrelevant. It did, nevertheless, excite journalists everywhere. In the confusion, the big story slipped away. Behind that 45 percent tax rate, New Labour concealed their confused thinking that led them to one of the greatest feats of fiscal irresponsibility in living memory. The package of temporary tax cuts announced today will leave a legacy of financial disorder that will take a decade to clean up.

An orgy of borrowing

Darling told us today that the government deficit, for this year and next, will rise dramatically. He told us that this year, the government will spend £78 billion more than it raises in taxes. In 2009, that figure is projected to reach £118 billion.

To make matters worse, the government accounts will not reach balance until 2016. It is little wonder that George Osbourne could confidently predict that the national debt will reach one trillion pounds.

Since UK GDP is somewhere between £1.3 and £1.4 trillion, these deficits, in GDP terms, unprecedented. This year's deficit will be around 5.5 percent of GDP, while next year, it will probably hit 8.5 percent.

VAT reduction - keeping the recession going

Next Monday, VAT will fall by 2.5 percent. Presumably, this will boost consumer spending just in time for Christmas. It will certainly empty the shops this weekend as everyone waits until the cut comes into force.

It will also accelerate some spending while the lower rate is in force. But what happens when the tax holiday expires?

A simple question requires a simple answer; consumption spending will slow sharply. Since, Darling is expecting a severe output contraction next year regardless of this fiscal stimulus package, the temporary VAT hike should be sufficient to keep the recession going in 2010, when VAT returns to its normal 17.5 percent level.

Tax cuts heading for Asia

The VAT cut will have most effect on big ticket items like electronic goods. None of these items are made in the UK anymore. So, the major beneficiary of Darling's generosity will be primarily the sweat shop owners overseas.

Taxes will have to go up

The central premise behind Darling's stimulus package is deeply cynical; he gave us money today, but he will have to take it back as soon as New Labour are re-elected in 2010.

This tax cut is nothing more than a cynical loan. Darling borrowed the money, he gave it to the tax payer, and he wants it back in a few years time. Saving this windfall is therefore the sensible thing to do. It is not a permanent rise in our income. It is only a transient flash before our eyes, which will be soon extinguished by a massive and permanent increase in the tax burden.

Interest rates will have to rise

What?? Haven't the Bank of England just cut rates?

Government borrowing means more government debt. The Treasury has to find someone willing to hold all those crispy looking IOUs. As the debt goes up, so must the interest rate. As the yield on government paper rises, it will take other rates with it. Why should a bank hand out a risky mortgage to a buy-to-let investor at 5 percent, when it can invest in a government bond with a near riskless default rate.

With long term interest rates rising, firms will find it difficult to rate capital for investment. In the long run, lower investment means slower economic growth.

Borrow in haste, repent at your leisure

Darling's fiscal package is a dogs breakfast. The 45 percent "tax the rich" ruse conceals the confused short-termism that now passes for New Labour's economic strategy.

The package will fail; the tax cuts will either flow out of the country as imports, or will be used by hard-pressed debtors to pay down their debts. The economy will slide into recession anyway.

The package will, however, leave us with a huge fiscal problem that will encumber the UK economy for at least a decade. Taxes will have to rise, interest rates will go up, and we will all be left worse off.