What, if any, should be the link between the price mechanism and “fairness”? Two issues raise this question.
Conventional economics says both are bad ideas. It says:
The function of the price mechanism is to signal that some things - such as petrol or stamps - are becoming scarce or expensive and so people should economize upon them. Blunting these signals by tax cuts or subsidies to selected groups results in a misallocation of resources - over-consumption of stamps and petrol and, by implication, under-consumption of other things.
The best way to protect the worst off from price rises is to raise their incomes, not to tweak prices. The price mechanism and redistribution are analytically (roughly) separate things.
But how strong is the argument now? Three things make me doubt it.
1. At a time of mass unemployment, minor misallocations of resources are very secondary issues; it takes a lot of Harberger triangles to fill an Okun gap. Any boost to spending power, which helps fill that Okun gap, should be welcomed.
2. The rise in oil prices might not entirely reflect the rational working of the price system, but rather speculation triggered by easy money.
3. It could be that lower fuel duty is the simplest and most effective response to the recessionary impact of higher oil prices.
The UK consumes 1.67mbd of oil. The $15pb price rise we’ve had so far this year would therefore cost consumers £5.8bn - just under 0.4% of GDP - if it persists for 12 months. This is equivalent to an unanticipated tax rise. What should the government do about this?
It is, of course, mere gibber to claim - as Osborne does - that the government can do nothing as it “has run out of money. ” In principle, a tax cut or benefit rise that doesn’t (greatly) affect relative prices would be a good way of offsetting the recessionary shock. But there are drawbacks to the obvious possibilities:
- An income tax cut might be partially saved, and would not help those who suffer from higher oil prices who aren’t in work - such as the unemployed and pensioners facing higher prices generally because of higher transport costs.
- A cut in VAT imposes administrative costs onto firms and does not greatly help those who face higher food prices because of higher transport costs.
It might, then, be that a cut in fuel duty commends itself not on the grounds of fairness - most of those calling for it simply have an excessive sense of their own entitlements - but because it is one way of mitigating an adverse supply shock.