While Obama's team talks of the minimal package needed to fight recession being worth 2% of GDP, our own Alistair Darling has announced a stimulus package worth 1.3% of GDP by 2010, 80% of which comprises a VAT cut of dubious merit and a reduction in employers' NI contributions aimed at helping small businesses.

There is a sweetener though; the rich will pay a bit more via the introduction of a 45% marginal tax band above £150,000; equally the government will bring forward a small amount of ‘green' capital spending on home insulation.

When one thinks of the many imaginative suggestions that have been floated in the past weeks---including the creation of national banks for mortgages and infrastructural reconstruction, a windfall tax on huge energy profits, a super tax on the very rich and a myriad of muscular green initiatives---the current offerings seem pretty feeble.

Understanding Darling
The argument in favour of Darling's approach goes as follows. First, because VAT is a tax on spending, cutting VAT is more effective than giving people money through tax rebates, credits and the like, a significant part of which might go unspent today and thus fail to stimulate demand. Secondly, because many people fear that deficit financing today means higher taxes tomorrow, announcing that the rich will pay after the next election alleviates the pain. Finally, there is a serious constraint on how much the Chancellor can spend, given not just the current level of public borrowing but the fact that in a recession the financial gap widens: next year and the year after, unemployment benefit will go up while tax receipts fall. The deficit, at present just over 3% of GDP, will almost certainly more than double as the economy weakens. Darling has at least been candid about the likely length and depth of the recession and of its impact on public finances.

What's wrong here?
Take the first point above. Cutting VAT by a mere 2.5% is hardly going to enable the median household on £28,000 to fill its Christmas stocking. Moreover, VAT catches rich and poor alike; the rich don't need it, and while the poor may spend a bit more, part of that extra spending will leak into imports. The £12.5bn cost to the Treasury (about 0.8% of GDP) would have been far better spent targeting the most needy: taking the poorest out of personal tax, increasing tax credits and payments for pensioners, lifting children out of poverty, raising unemployment benefit and tapering the high marginal cost of moving off benefits as wages increase. A pension credit of £6 a week plus a one-off bonus of £60 and bringing forward a small increase in child benefit may be a start, but these measures are not enough.

An equitable budget?
As for the new 45% tax bracket to be introduced after the next general election, that smacks more of electoral cynicism than egalitarianism. New Labour is gambling on the fact that the Tories will not tax the rich, or that even if they do Labour can leapfrog them. There is a great deal of anger about the ‘super-rich' out there and the government thinks it can capitalise on this to win another term, conveniently forgetting that it has helped create the problem in the first place. Britain is one of the most unequal societies in the EU, and as shown in a recent piece for Compass by Byrne and Ruane, overall tax incidence is regressive; ie, the poor pay a larger share of their income in tax than the rich. Reversing this state of affairs would have been a measure worthy of real praise.

It is estimated that a 50% marginal tax rate on incomes above £100,000 would raise £7bn, and a 60% tax rate at £250,000 combined with a ‘super-rate' of 70% on bonuses above £1m would raise at last an additional 3bn. Had the Chancellor proposed such measures for 2008 (not 2011), he would have demonstrated a clear commitment to social justice and one which in present circumstances would have had majority public backing. I have not even mentioned the extra sums which could be raised by aligning Capital Gains Tax with personal tax rates, by uncapping national insurance contributions (in effect integrating NI into the tax system as the Dutch do), nor have I mentioned reforming inheritance tax, introducing a wealth tax and/or a land tax or, more generally, changing Britain's distribution of wealth (which is far more unequal than the distribution of income from which it derives).

A further obvious area of reform is that of company taxation, closing company tax loopholes---and in particular closing tax havens---as has been carefully documented by Richard Murphy amongst others. Minimally, the Chancellor has promised a review of financial regulation in the crown dependencies. It is estimated that fundamental reform in this area could bring in up to £25bn per annum (nearly 2% of GDP), a sum which alone would pay for the Chancellor's latest spending measures and much more besides.

Funding
This brings us to the contentious issue of ‘funded' tax cuts. Many people---including many on the left---believe that because Britain is in trouble due to excessive borrowing, it cannot get out of crisis by raising borrowing further. This argument is a variant of Mrs Thatcher's handbag economics---the notion that the national budget must be balanced in the same way as family finances---a flat-earth view rejected by Keynes 70 years ago, but implicitly supported by Labour's ‘prudence' until the recent crisis.

What matters of course is not the size of the budget deficit, but whether long term public debt is sustainable. At present, public debt in the UK is of the order of 40% of GDP (42% if nationalised bank liabilities are included at their face value); this compares favourably with Germany, France and the US where the comparable figure is over 60% and very favourably with Italy and Japan where it is over 100%. Darling is right to ditch the ‘Golden Rule' and admit that debt may peak in 2013 at 57% of GDP.

The key point, though, is not the size of the debt so much as the need to fight recession. The cost of doing nothing---not spending a penny of public money---is going into deep and prolonged recession. Because tax receipts fall in bad times, such a recession would entail a very sharp rise in public borrowing. By borrowing and spending now, the recession can be shorter and shallower; in effect, deficit spending which creates growth can help pay for itself.

Monetary Policy
One point remains unmentioned by the Chancellor: the use of monetary policy to drive down long-term interest rates and place a floor under the collapsing housing market. Keynes famously argued that the use of monetary policy was a necessary but non-sufficient condition for fighting a slump.

At the moment, the yield curve on bonds has risen at the long end and is dangerously steep. The cost of financing business expansion through borrowing needs to fall. As Graham Turner of GFC Economics has argued, if the major OECD economies are to avoid a Japanese style debt trap accompanied by a decade of stagnation, government must act on the monetary front---failure to do so could render fiscal stimulus ineffective as was the case in Japan.

Summary
A few optimists will say that New Labour has set the agenda by daring to borrow and daring to talk about taxing the rich. In truth, the pre-budget report is something of a damp squib---too pre-budget is too narrow, it's not properly targeted and there's little sign of a real concern for reversing inequality, improving Britain's infrastructure or making a difference on climate change. All one can hope is that public debate over the matter will address these problems and that next April's budget makes a real difference. Newsnight's economics editor, Paul Mason, summarized the underlying dilemma in a single phrase last week: ‘the growth model based on high debt instead of high wages has failed and will be hard to revive.'

George Irvin