ED-onomics -- is that the best you can do??

Ed Balls thinks he has a plan to get the economy going.  Labour's Shadow Chancellor wants the government to cut VAT temporarily to boost consumer spending, or failing that, to cut income tax for the lower paid.

Bad idea, Ed, for several reasons. First and foremost, it's quite clear that a lack of consumer spending,  which is the only thing a VAT or income tax cut could hope to remedy, is not the economy's main problem right now. As the ONS reported last week (see previous post), retail sales rose 0.9% in January and are more than 4% higher year-on-year. Retail sales in volume terms have been rising, slowly but steadily, since August. Now that inflation is finally heading lower, even the Bank of England has turned cautiously optimistic, both that a double-dip recession will be avoided and that growth will accelerate after mid-year.

The economy's real problems lie elsewhere. First and foremost, slow growth in Europe will continue to weigh on UK output growth. There's not much that the government can do about that, though if one were cynical, one could argue that Ed's VAT cut would give a nice boost to the German auto industry.

Domestically, the UK's main problem is the low level of business investment. Many larger companies are choosing to sit on cash rather than invest in new productive capacity, while smaller ones are also reluctant to splash out because they are either unable (their version) or unwilling (the banks' version) to get the credit they need.  It's well known -- and was demonstrated as recently as 2010, when the last Labour government cut VAT in an attempt to soften the recession -- that the main effect of any temporary tax cut is to bring spending forward, rather than produce a sustained increase. Big ticket consumer spending would be dragged into 2012 from 2013, so a year from now,  when the cuts expired, the Chancellor would be facing renewed calls to "do something" to prevent growth from sliding again. Businessmen know this, even if Ed Balls doesn't, so a temporary VAT or income tax cut would do nothing to encourage business investment, which has to be based on a much longer view.

Balls estimates the cost of a 2.5% VAT cut for one year at £12 billion.  He regards it as "absurd" to call that unaffordable, when slower growth is projected to add £158 billion to projected borrowing over the next five years. It's more than a bit intellectually dishonest to compare a one-year figure with a five year projection, but leaving that aside, the fact is that there are now plenty of signs that the government's austerity measures are starting to have a measurable effect on the fiscal situation. The budget surplus for January, traditionally a strong month for UK public finances, is expected to confirm the probability that the deficit for the full fiscal year will be significantly lower than originally expected*.  If the economy really is showing signs of improvement, it would be absurd to throw away those gains now, particularly for the sake of something as pointless as a VAT cut.

You might have hoped that Ed Balls and his team, including Mrs Ed, would be taking the opportunity of a spell in opposition to come up with some new ideas. So much for that.

* UPDATE, 21 February: As expected the budget surplus for January was sharply higher than in January 2011, at almost £7.8 billion. Borrowing for the full fiscal year is likely to be more than 10% lower than the budget's projection of £127 billion.  BBC story here.