Interest rates and tax rates are two blades of the scissors the authorities traditionally use to trim the economy. Higher taxes and higher interest rates both slow the economy down while tax cuts and interest-rate cuts will speed it up, but tax changes and interest-rate changes work in slightly different ways because higher interest rates reward savers as well as penalising borrowers, while higher taxes reduce spending power across the whole economy and also reduce the government's budget deficit.
On past experience, tax changes affect spending and investment within a year whereas the Bank of England argues that changing interest rates can take up to two years to work through the system. Interest rates seem to have more impact on inflation and exchange rates, but if there is a right time to raise taxes it is in the early years of a government when the next election is far away.
Some members of the Bank of England's monetary committee think another rise in interest rates is needed to discourage borrowing and consumer spending and to puncture the inflationary boom in house prices.
But a rise in interest rates would make sterling even stronger and hurt exporters as well as reducing growth in the next two years and widening the gap between the UK and Europe at a time when pro-Europeans want it to narrow.
(How much better, dear reader, if the incoming Government had done what this column argued last summer and raised interest rates sharply to show it meant to control inflation and, at the same time, outflank the currency speculators at a stroke, because by now we could be reducing rates again to soften the downturn rather than risking making it worse.)
Either way the next move is up to the Chancellor. The business community would like to see (personal) taxation rise so that interest rates and sterling could come down faster, but the record surge in tax receipts last month has brought the prospect of a budget surplus in 1999-2000 and there seems to be no need for a general rise in taxation next month.
Increases in tax on petrol and tobacco are certain, reforms to National Insurance, capital gains tax and inheritance tax are likely, tax relief on mortgage interest might well be phased out, and the married couples' allowance replaced by a restored child tax allowance. More tinkering with the taxation of pensions and savings, including firm plans for Individual Savings Accounts, seems certain and there could even be tax cuts on booze plus a long-promised 10p rate of tax.
But the fine-tuning of policy will be left to left to the Bank of England and its interest-rate committee.Reuse content