Incomes Policy and Tax Rates-an Innovative Policy Attempt in the United Kingdom

Abstract

In 1976 Budget statement, Government of United Kingdom offered an unprecedented proposal to trade union movement. In it, a large packet of cuts in direct income taxes was made conditional upon unions agreeing to a lower rate of increase in nominal wages in coming year than had previously been anticipated. The strategy behind this policy, outlined by Mr Denis Healey, chancellor of Exchequer, was substantially to reduce rate of inflation over following year by suggesting a policy proposal that had never been considered before. It was hoped that policy would improve employment situation in United Kingdom by causing a net expansionary effect on consumption, and also at same time indirectly lower inflation. While achieving both these objectives, Mr Healey proposed to guarantee that the working population as a whole does not suffer by accepting a lower pay limit rather than a higher one (Healey, 1976). Thus, combination of lower taxes and lower inflation would be sufficient to ensure that, in real terms, the majority would really be better off with a low pay limit rather than with a higher limit, but none of tax reliefs. Since economic policy was proposed by Mr Healey, there have been other complications in economic environment, such as intervention of IMF and substantial fluctuations in UK exchange rates. These have blurred effect of policy package and left its advisability, ceteris paribus, open to debate. Yet feasibility of this innovative policy package, ceteris paribus, is of itself of substantial importance. This is true for two reasons. First, it appears that wage restraint linked to tax reform has become a relatively permanent policy tool on British scene. Second, while unity and strength of trade union movement in Britain make this type of bargaining fairly unique, if successful policy has obvious application to other economies where a mechanism exists for central determination of wage levels. This paper thus sets out to analyse what impact of such a government policy is likely to be, ceteris paribus, and under what conditions it can succeed in achieving all three objectives proposed. Attention will be focused on its likely effect in first period, and its implication for sustained success. The analysis will proceed in three parts. First, a disequilibrium neo-Keynesian model will be outlined and short-run impact of policy package analysed. Then, choice-set facing economy after oneperiod policy expires will be examined in Section II. Explicit consideration of foreign sector will be incorporated in Section III, while a summary and observations on long run are discussed in Section IV.