Markets have begun to fret about whether the world’s central banks have run out of options to keep the ball in the air and meet their goal of helping relaunch economic growth. We ask what else can be done to ensure recovery post financial crisis in a world which is now very different. Could a tax break be the solution?

Growth may be recovering in the US and UK and unemployment back from its worst levels, but the story is quite the opposite in the Eurozone and even worse in some of its member countries. Furthermore, inflation is conspicuous in its absence almost everywhere, despite all that the extra money supposedly sloshing around the system from central bank assistance. An 18-month sell off in the price of oil has to take some of the blame, but not all.

Not long into the financial crisis, the major central banks took interest rates to historical lows in a first attempt to help markets out. Stage two saw them move on to Quantitative Easing (QE) in an effort to bring down market borrowing costs (and returns) to encourage more lending and risk-taking. We had 3 doses of QE in the US, and 1 in the UK and Europe, all of which helped financial markets in the short term (bond prices bid up on expectations of central bank buying; equities bid up on perceived demand for more attractive returns).

However, it never really boosted the economy per se. Sure, low rates mean borrowing costs have stayed low, but banks are now more cautious from a regulatory standpoint (don’t just lend to anyone and everyone). And low rates have merely inflated property prices even further, actually making it harder to buy. Property prices may be at the heart of consumer confidence, in the UK at least (prices up, you feel richer), but what about the millions within ‘generation rent’ who are unable to get onto the first rung of the fabled property ladder?

And we have now moved on to stage 3 with the Bank of Japan joining its peers in the Eurozone, Switzerland, Denmark and Sweden with negative interest rates. These are put in place to discourage banks from parking funds with the central bank and so keep more money out in the system. However,  investors are now wondering whether this latest step smacks of central bank policy potency on the wane. And more importantly, what is next? Of interest lately has been the re-emergence of discussion about ‘helicopter money’ – a term coined several decades ago by the late economist Milton Friedman, who likened it to stimulus by dropping cash from the sky, giving it directly to the public in order to boost spending and growth.

While this represents a viable option, we think we have another. Giving people a load of cash carries no guarantee they’ll spend it on goods and services to boost the economy. Give them too much and they may use it to merely pump property prices even higher. And what good is that? The bust could be very painful. Give them too little cash and it fails to have the desired effect. Why bother?

Our proposition moves away from the central banks and back towards the government – the Chancellor in particular. Not another infrastructure drive and quest to grow via big but painfully slow investment projects. Rather a simple tax break for PAYE employees. How about no tax for a year on monthly PAYE earnings? Or a lower flat income tax rate rate for everyone for 12 months? Not a lump sum that can be frittered away, nor an insignificant amount that you don’t care about. Rather a bonus every month for a year. This would surely help the real workers of the economy – the real spenders – who would benefit from such a marginal increase quite considerably. This would be a monthly bonus of 20 to 40% to be spent as desired, logically on goods and services.

Source: Office for Budget Responsibility (OBR); 2015-16 forecast

Chancellor Osborne would of course lose out on a fair chunk of tax for the year (up to £170bn). However, it only accounts for 25% of what he expects in any one year. National Insurance could still be paid. And anyway, a lot of what is lost via income tax would potentially be recouped via more spending on goods and services and thus more VAT (the 20% rate covering the middle ground for employees between the basic and upper tax rates). The rich might complain, but would they really spend any more? Those not working might say ‘not fair,’  but could receive a bonus through slightly higher benefits. All other taxes would still be booked (see above).

When you look at the £375bn that the Bank of England ‘printed’ post-crisis to purchase bonds (i.e. QE) from the financial markets, this is surely worth a go. In comparison to Q4 consumer spending of £294bn, it could represent a significant boost over the course of a year – one not to be sneezed at, safe in the knowledge the money is guaranteed to go straight into the pockets of the UK consumer.

We are far from claiming this to be a perfect solution. Government and tax people are sure to find holes. However, it’s an idea, and that’s what we need. What’s wrong with giving people and businesses an incentive to work more, earn more and spend more? Our tax code is ridiculously complicated. This might even prove a stepping stone to a simpler and less taxing existence.

Mike van Dulken, Head of Research, 8 March