Quantitative Easing: is it a magic money tree?

10 March 2021

By Ken Rayner, Verbatim RSMR Model Portfolio Manager

Coronavirus has caused one of the largest, most comprehensive and sustained economic shocks this country has ever had to face and, credit where credit’s due, this government has delivered a very broad and sustained response. In the budget announcement, Rishi Sunak pledged ‘we will continue doing whatever it takes to support the British people and businesses through this moment of crisis and once we are on the way to recovery, we will need to begin fixing the public finances’.

An inordinate amount of money has been spent on fighting the coronavirus and on supporting businesses and people through the pandemic. On top of this, people aren’t spending a great deal and less tax is being generated which has created an epic shortfall. The unlocking of the country may have begun but the government will still be shelling out on further support such as the continuation of the furlough scheme, the extension of the stamp duty holiday and the uplift in universal credit for some time to come. An extra £1.65 billion has been allocated to the vaccination roll out in England, a £5 billion restart fund for cash grants of up to £18,000 has been made available for hospitality, accommodation, leisure, personal care and gym businesses and an extension of the Film & TV Production Restart scheme is in place, with an additional £300 million to support theatres, museums and other cultural organisations in their re-opening. The government has spent an eyewatering £352 billion on help so far, rising to £407 billion after these new measures. This amount is only comparable with borrowing during the two world wars and it’s going to take many decades to pay it back.

Taxation is very divisive for governments and goes back a long way; it has existed since the earliest forms of recorded government in history. In ancient Egypt, pharaohs levied taxes in the form of shares of agricultural production and labour and in ancient Rome, farmers were required to pay a tenth of their production to the tax administration. The basic principles are the same but now we have more sophisticated systems to define who and what is taxed.

In 1628, the Petition of Right introduced restrictions on the Crown on non-parliamentary taxation in England, enforcing careful consideration of how the acquisition of money affects taxpayers. Taxation provides a fundamental source of income for running the government and providing public services but it reduces individual disposable income and business profits and can have a negative impact on decisions about work, consumption and investments. Taxes levied on the production of goods often cause producers to increase the prices of goods, passing the burden of taxation on to consumers. When prices go up, there’s less demand, so businesses earn less income and consumers buy less. Personal income tax also reduces consumer purchasing power. The trick is to levy taxes while minimising negative effects on the economy; there’s an optimal rate of taxation and getting that right is seen as the Holy Grail!

How will money be raised to repay the debt? An increase in corporation tax from 19% to 25% will come into play in April 2023, the first rise in corporation tax since 1974, raising a projected £16 billion a year. For ordinary taxpayers, the Chancellor took a stealthy approach, announcing a four-year freeze in both the tax-free personal allowance and the 40% higher rate tax threshold, which will suck millions of people into paying more tax. Personal allowances and tax bands will stay the same so when people get a pay rise, they’ll move into a higher tax bracket. This is called fiscal drag, the deflationary effect of a progressive taxation system on a country’s economy. Additional measures include a disproportionate increase in the minimum wage in comparison to inflation, fuel duty will remain the same for the 11th consecutive year at 58p per litre for petrol and diesel and the pension lifetime limit has been frozen.

You might think the government would be encouraging us to get out there and spend as we ease out of lockdown, but we’ve saved an incredible £160 billion during the last year and when restrictions finally end, we won’t need any encouragement, the splurge will be monumental!

It’s a fine line between raising taxes and choking the economy. Without kicking us when we’re down and with the Holy Grail in mind, will the government succeed in restoring the economy and making us prosperous once again?

 

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