Interest Rates or Taxes
Published March 1st 2004.Interest Rates are back on the agenda. After the expected rise to 4.00% in February, all the pundits and economists figured rates would remain unchanged until May. But with the latest borrowing figures showing net lending at a massive £10.6bn for January and house prices up by 3.1% in February, according to the Nationwide Building Society, there is speculation that rates could go up on Thursday when the Bank of England concludes its monthly meeting.
Whilst the Bank of England’s Monetary Policy Committee (MPC) is desperate to curtail the endless credit bingeing they’re only weapon, raising interest rates, is proving ineffective. Money is still cheap to borrow and if the repo rate is only expected to rise to 5.5% by the end of 2005, only those who have mismanaged their borrowing or had a sudden change in circumstances will fall foul.
The problem with the raising-rates strategy is that it is already hurting manufacturing as money becomes more expensive. It is damaging exports and causing the pound to strengthen, which given its appreciation against the dollar it doesn't need any help with. The strong pound is filtering through to inflation, despite the Government’s adoption of a different system designed to exclude housing costs and Council Tax, which leaves the MPC with the only option to raise interest rates.
Now, ironically enough, there is talk about the European Central Bank (ECB) reducing their rate on Thursday. Admittedly the ECB is two years behind the rest of the world and is still trying to play catch-up after having crippled the German and French economies with a strategy of too-little-too-late.
Normally the British approach to problem solving, the ECB's procrastination has been the salvation of the United States economy and has allowed them and the United Kingdom to grow at the EuroZone’s expense. Who knows the depth of recession the UK could have been in if we had been part of that singularly mis-managed currency?
The MPC can't afford to raise rates, especially if there is the possibility that the ECB could cut theirs. That would cause more problems for exporters and manufacturers. Which means that the forthcoming Budget could well throw up a nasty surprise or two for borrowers, and homeowners in particular, as an alternate way to halt the borrowfest is searched for.
Interest rates have long been considered to have a taxing effect on people's incomes. It isn't tax but it takes money out of, and puts money in to, your pocket the same way tax cuts and hikes do.
If upping the interest rate isn't having that staunching tax-like effect, then Chancellor Gordon Brown will have to look at actual taxation as a way to putting an end to the habit of consumers using their free will to do exactly what they want . . . get into debt.
It is not like the Chancellor couldn't do with the extra money. The escalating borrowing and budget shortfalls means that he could do with a windfall. He might complain about consumers borrowing too much, but his recent track record isn't any better.
He could go directly after homeowners, but would have to be careful. As far as voters are concerned, new or higher taxes are only acceptable if they impact on those who are seen as richer than themselves. Truly democratic taxes, where everyone pays the same, tend to be unpopular.
There is still the goal to bring taxes in line with Europe. Stamp Duty on house purchases is one that is slowly being nudged in that direction. But with a level of around 15% or so as the target for the largest properties, any substantial increase would not be well received. Not something you really want to do with the local elections coming up.
Removing the absence of Capital Gains Tax on the profit you make when you sell your main residence may be one tactic. But there would need to be a raft of rules and caveats to protect homeowners from being unfairly taxed just because they happen to move home when house prices have risen.
As a way of raising tax revenue it wouldn’t raise much. Moreover, it would likely reduce the number of houses on the market and so actually drive house prices up.
Whilst it is the small percentage of truly overindebted who are grabbing the headlines, the bottom line is that the Great British public collectively need to borrow less and save more. If rising interest rates aren’t working, then it may just have to be taxes. The question is, which do you prefer?