Options for Increasing Taxes

Economic

Summary:

What taxes could the Chancellor increase in her first Budget on 30 October? And how could it be done in a way that improves tax design?

The ledgers of the public finances have rarely made for more dismal reading. Tax revenues are this year set to reach their highest level since the 1940s (and are forecast to rise further still). Nevertheless, spending plans pencilled in for future years imply big cuts to public investment and some public services. Merely avoiding spending cuts would – if debt is to fall – likely require raising tens of billions of additional revenue by 2028–29. Faced with such unenviable arithmetic, the Chancellor has indicated that tax increases are on the way – October’s Budget, the Prime Minister has warned, will be ‘painful’.

The UK tax system offers a huge number of rate, threshold and base adjustments for a Chancellor in search of additional revenue. Ms Reeves, however, has not made life easy for herself. Labour’s manifesto ruled out increases in VAT or National Insurance contributions (NICs) and increases to the main rates of either income tax or corporation tax – major restrictions to four big taxes that together comprise just shy of 75% of all tax revenues. The manifesto also pledged not to ‘increase taxes on working people’, a phrase that could plausibly be interpreted as ruling out almost any increase in taxation.

Where, then, might the Chancellor turn to for revenue come October?

Income tax

Perhaps the simplest recourse would be to income tax. Labour’s manifesto commits to not increasing the basic, higher or additional rates of income tax. But that still leaves the Chancellor with options. She could, for instance, lower the income thresholds at which those rates begin to apply. That could raise very substantial sums (although to do so it could not be confined to those with the highest incomes and it would clearly be a tax on ‘working people’). Reducing the personal allowance or the basic-rate limit (the thresholds at which the 20% and 40% rates of income tax begin to apply) by 10%, for example, would yield £10 billion and £6 billion a year in additional revenue respectively. But that would come on top of an £8 billion tax rise (in today’s terms) that is already planned for the next four years as thresholds continue to be frozen in cash terms under plans bequeathed by the previous government.

Should the Chancellor be reluctant to reduce thresholds further, another option would be to adopt a less generous income tax treatment of pensions. Several aspects of the current system are poorly targeted and could be reformed to increase revenue. The maximum amount (currently £1,073,100) to which the 25% tax-free element applies could, for example, be reduced – though any such change would likely need to be phased in over time to avoid too much ‘retrospection’, and hence might not raise large sums in the short term. Ending the absurd exemption of some pension pots from both income tax and inheritance tax on the death of the owner would also be a positive step (though it would not raise large amounts).

Ms Reeves might also be tempted to limit the amount of up-front income tax relief provided on pension contributions (which are income tax exempt up to an annual limit, instead being taxed when withdrawn in retirement). Limiting relief to the basic rate could raise as much as £15 billion (although that figure does not account for any behavioural response by taxpayers). That is a tantalising sum for a cash-strapped Chancellor, but limiting relief to the basic rate would result in a less coherent tax system – not least because it would leave those expecting high incomes in retirement with a strong disincentive to contribute. A better option for raising substantial revenues from pensions taxation would be to impose some employer NICs on employer contributions to pensions, although this would be at odds with Labour’s manifesto commitment not to increase National Insurance. If levied at the full rate (13.8%), that would raise around £17 billion per year (before accounting for behavioural responses).

Capital taxes

Perhaps the area that has engendered the most media speculation about possible increases is capital gains tax (CGT), a tax on the increase in value of an asset between the points of purchase and sale that currently raises £15 billion a year. CGT suffers from poor design in several ways. Ending forgiveness of capital gains tax at death, for example, would both raise money (around £1½ billion before taking into account behavioural responses) and improve the design of the system.

More substantial revenue could perhaps be raised by increasing rates (although anticipating taxpayers’ responses to CGT changes is particularly challenging, making revenue projections uncertain). Taxing capital gains at lower rates than other forms of income creates various problems, but simply increasing CGT rates towards income tax rates – including by removing carve-outs such as business assets disposal (BAD) relief – would exacerbate the degree to which CGT discourages saving and investment. A much better approach would be to combine rate rises with a narrowing of the base on which the tax is levied – raising revenue while reducing distortions to savings incentives (these issues will be discussed further in a forthcoming chapter of the IFS Green Budget 2024). At a minimum, any increase in rates should be accompanied by an allowance for inflation. At present, purely inflationary gains in the value of assets are subject to tax.

Changes to inheritance tax (IHT) have also been the subject of significant speculation. IHT raises around half as much as CGT (£7.5 billion forecast in 2024–25) and only around 4% of deaths are subject to the tax – although projections by IFS researchers suggest that revenue will increase more sharply than forecast by the Office for Budget Responsibility (OBR) over the remainder of the decade as the scale of inherited wealth ramps up. IHT is ripe for reform in ways that could both raise revenues and make the tax fairer. A good start would be ending, or at least capping, the unjustified exemptions for pension wealth, business assets and agricultural land – a change that would raise around £2 billion a year assuming no behavioural response (a detailed discussion of IHT reform can be found here).

Property taxation

The part of the tax system that is arguably in the most advanced state of disrepair is council tax, a tax on domestic properties which partly funds local council services. Even in the absence of revenue pressures, there is a pressing case for reform (ludicrously, for example, properties in England and Scotland are still taxed on the basis of their estimated values as of April 1991). Bills are currently highly regressive with respect to property values and the Chancellor could sensibly choose to follow Scotland in making them more proportional. In 2017, the Scottish government increased rates on band E–H properties relative to less valuable properties. Applying these rate changes to England would raise around £1½ billion (assuming that councils did not use the change as an opportunity to reduce tax on lower-value properties). Going further and increasing rates by 50% on the highest-value properties (bands F–H) would bring in closer to £3½ billion. Without an accompanying adjustment to grants, any additional revenues would flow to local government rather than to the Treasury. Moreover, like income tax, current forecasts are already predicated on council tax going up – with average real-terms bill increases of 3% a year pencilled in for the remainder of the parliament.

Another aspect of property taxation to which the Chancellor might be tempted to turn for revenue is stamp duty land tax (SDLT), which already raises the sizeable sum of £13 billion a year. She should resist the temptation. For a start, an SDLT increase worth around £1½ billion is already pencilled in for April 2025, when increases to the thresholds at which SDLT begins to be charged introduced in Liz Truss’s ‘mini Budget’ are due to expire. More importantly, in a crowded field, SDLT has a claim to be the most economically damaging tax in the UK. It makes both housing and labour markets less efficient, acting as a drag on growth. It should be reduced or – even better – abolished, and certainly not increased.

Taxes on spending

With VAT increases off the table, by far the largest source of revenue from indirect taxation is fuel duties which are expected to raise £25 billion in 2024–25 (duties are also subject to VAT, raising a further £5 billion). While substantial, this is much less (in real terms) than they raised 15 years ago, thanks in part to the prolonged cash freeze in rates – the extension of which became an annual tradition for Conservative chancellors after 2011. Had fuel duties increased every year in line with the Retail Prices Index (the Treasury default), they would today raise an additional £19 billion per year. The OBR’s current forecast is predicated on the assumptions that fuel duties will increase by RPI inflation next year and that the ‘temporary’ 5p cut to duties introduced in 2022 (and retained ever since) will be reversed. On current inflation forecasts, cancelling those increases would, in today’s terms, cost the Chancellor £6 billion a year by 2029–30. Raising revenue relative to current forecasts would require rate increases above and beyond allowing the 5p cut and the cash freeze to expire. Doing so would raise around £¼ billion for each 1% increase in the rate of duty.

Other options

Were the Chancellor to find the strictures of her party’s manifesto too irksome, she could choose to create a new tax altogether. In 2024–25, more than £30 billion of revenue will be generated by new taxes created since 2001 – ranging from the tax on sugary drinks (£0.3 billion) to the various environmental levies charged on energy supplies (£11.5 billion). This option could either permit the Chancellor to tax a particular good or activity more heavily or to circumnavigate the letter (if perhaps not the spirit) of Labour’s manifesto by creating a facsimile of an existing tax under a new name. A recent example of this was the health and social care levy, whose design (before it was scrapped under the brief premiership of Liz Truss) was almost identical to that of National Insurance contributions (which the 2019 Conservative manifesto had pledged not to increase), with the exception that the earnings of those over state pension age were not exempt. Resurrecting this levy would raise around £15 billion a year if set at a rate of 1%.

A final possibility for Ms Reeves would be to wring more revenue from the UK’s many smaller, lower-profile taxes. This could add up to meaningful money, but reaching into the more obscure regions of the tax system for revenue has its drawbacks. A cautionary tale is the insurance premium tax (IPT), rates of which have been increased steeply since 2015 with the result that it now raises more revenue than inheritance tax. While that might sound to some like a success story, IPT rates are now set far too high – unjustifiably distorting spending decisions away from the purchase of insurance.

Conclusions

Even by the standards of an era when manifesto ‘tax locks’ have become increasingly common, the Chancellor has given herself little room for manoeuvre. Many of the tools best suited to the task of significant revenue-raising have been put out of reach. If that were not enough, substantial increases to income tax, fuel duties, council tax and stamp duty land tax are already pencilled in and factored into forecasts. Strengthening the public finances through additional taxation will demand tax increases on top of these already planned hikes.

Measures that raise big revenue are few and far between and (assuming Ms Reeves intends to stick to her party’s manifesto commitments) pensions taxation and capital gains tax are perhaps the most likely candidates. Both could be perilous. Restricting up-front income tax relief on pension contributions is superficially appealing but would make for an ever more jumbled tax system and add to economic distortions. Capital gains tax, meanwhile, would need to be carefully reformed or else tax rises would risk acting as an ever greater drag on saving and investment. These are not tidy-minded quibbles. Poorly designed taxes distort taxpayer behaviour in ways that hamper growth and, ultimately, damage living standards. Unlike the broad-based tax rises on income and spending that Labour has ruled out, raising large amounts of money from either pensions taxation or capital gains tax would also mean making a big change to a relatively narrow tax base. All else equal, that will tend to mean more uncertainty in how taxpayers will respond. While no reason to hold back from sensible reforms, this could make it harder for the government to estimate how much revenue it can expect to raise from any changes it makes.

A foray into the UK’s smaller taxes is another option – enough small changes could add up to significant money. But here too there are pitfalls; increases in stamp duty land tax and the insurance premium tax, for example, should both be avoided. On the other hand, there is no shortage of areas with defects (from inheritance tax exemptions to council tax rates) that, sensibly reformed, could raise revenue while enhancing efficiency. A path still exists for the Chancellor to raise revenue without exacerbating the worst features of the UK tax system, but Labour’s manifesto has made it a narrow one. With the government signalling that growth is one of its highest priorities, Ms Reeves would be well advised not to stray from it.

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Owen Li

Economic

Introduction

Central banks have shifted their focus in the past few months. The inflation targets of 2% seem to come within reach in both the US and the euro area, as energy prices have dropped significantly, and wage growth seems over its peak. As inflation worries are receding, the focus shifts to the labour market, where signs of weakening are emerging (especially in the US). Fears of an imminent recession, however, seem overblown. Central banks have acted accordingly, as both the ECB and Fed cut their policy rates by 50 basis points already this year and hinted at more rate cuts to come.

Oil prices on the descent

Oil prices have declined quite markedly over the summer months (see figure 1). Oil prices even dropped (temporarily) below 70 USD per barrel in early September (down from 85 USD end of June). The decline is primarily demand-driven, especially in China and the US. In China, lower activity along with rapid EV adoption caused oil consumption to decline by 280k barrels per day year-on-year in July. Oil demand is also tepid in the US, as gasoline deliveries dropped in June. The International Energy Agency now expects oil consumption this year to be 2 million barrels below pre-pandemic levels.

Several problems on the supply side do little to stop the decline in oil prices. In the US, hurricane Francine is disrupting oil and gas production in the Gulf of Mexico. In Libya, a political quarrel over the appointment of a new central bank governor caused production to drop by 60% during the summer. Yet a compromise has now been found, causing a rebound in oil supply. Maintenance works in Norway and Kazakhstan also strained oil supply in August. OPEC+ also announced they would postpone the unwinding of their voluntary cuts by two months (now starting in December). Nonetheless, the market still expects oil to be oversupplied in the second half of this year. This also explains why recent escalations between Israel and the Iran-backed militia Hezbollah have had limited upward effect on oil prices.

In contrast to oil prices, European gas prices increased markedly over the summer, reaching almost 40 EUR per MWh early August. The Ukrainian capture of Sudzha, which is a major terminal for EU exports, sent prices to their highest level this year. Russia is still supplying 8% of the EU’s natural gas (via pipelines). That said, as EU gas reserves are well-filled (93% of total capacity), prices remain well below 2022 records.

Further cooling of inflation in the euro area

In the euro area, inflation fell quite sharply in August to 2.2%, down from 2.6% the month before. Especially the new fall in energy price inflation (-3%) contributed to this. The fall in core inflation by 0.1 percentage points to 2.8% was much more modest. Only industrial goods inflation (excluding energy and food products) declined (from 0.7% in July to 0.4% in August). In contrast, services inflation rose from 4.0% in July to 4.1% in August, the same level as in May and June. It illustrates the - as expected - bumpy path to sustainably lower inflation.

Nevertheless, the near-term dynamics of services inflation remain downward-sloping (on a three-month moving-average basis) and the underlying inflation drivers are also moving in the right direction. This is evidenced by the year-on-year increase in the GDP deflator in the second quarter (see figure 2). It slowed from 3.6% in the first quarter of 2024 to 3.0% in the second quarter. A slight slowdown in the growth of nominal wage bill per worker and improving productivity gains cause the contribution of unit labour costs to inflation to decline. Meanwhile, profits per unit of product - which were a source of inflation in the 2021-2023 period - declined slightly. Higher indirect taxes have a slight inflationary effect, probably the result of fading support measures from during the energy crisis.

Inflation will remain on a bumpy path in the next few months. The September figure is likely to be slightly lower than the August figure, and could possibly fall slightly below 2%. In the final months of 2024, however, adverse base effects will most likely push inflation back up. We expect the fundamental trend of gradually cooling inflation to prevail again in the course of 2025. This would bring the average inflation rate for the euro area to 2.2% in 2025, after 2.5% in 2024.

US inflation on a downward path

US headline inflation softened again in August, declining from 2.9% to 2.5%. The drop was primarily from energy prices which dropped by 0.8% last month and are now 4% lower than a year ago. As the recent drop in oil prices has yet to filter through to gasoline prices, we expect further drops in energy prices in the coming months. Food prices also remained under control, increasing by only 0.1% last month.

In contrast to headline inflation, core inflation remained stable at 3.2%. The most important contributor to core inflation was shelter inflation, which firmed in August, rising 0.5%. Though this was partly due to a big increase in hotel prices, owner equivalent rents also increased markedly last month.

Excluding shelter, US CPI inflation is already below 2% (see figure 3). Forward-looking indicators suggest shelter inflation will eventually soften. Notably, new tenant rents (which typically lead shelter inflation by 6 to 12 months) are 1.1% lower than a year ago.

Other components of core inflation were quite soft last month. Core goods prices declined by 0.2% last month, thanks in large part to a 1% drop in used cars and trucks prices, the third drop in a row. Industry data suggest that these drops might reverse somewhat in the coming months, however.

Core services (ex. shelter) increased by only 0.2% last month, the fourth soft reading for this key component in a row. This was notwithstanding a big increase of 3.9% in airline fares, a volatile component.

Average hourly earnings, a leading indicator of services inflation, firmed somewhat in August, increasing by 0.4% month-on-month (following a 0.2% increase in July). That said, at 3.8% year-on-year, wage inflation seems beyond its peak and is likely to decline further as the labour market loosens.

Overall, we downgrade both our 2024 and 2025 forecast by 0.1 percentage points to 2.9% and 2.3%, respectively.

ECB in easing mode but remains data-dependent

As expected, on September 12, 2024, the ECB cut its policy rate, the deposit rate, by 25 basis points to 3.50%. Also in September, the ECB's new operational policy framework came into effect. This means, among other things, that the spread between the refinancing rate (MRO) and the deposit rate (DFR) is set at 15 basis points. The Marginal lending facility rate will be set 25 basispoints above the MRO rate.

The quantitative policy decisions taken earlier remain in place. For example, the ECB is shrinking its PEPP portfolio by an estimated average of EUR 7.5 billion per month by not reinvesting all assets at maturity. As of 2025, reinvestments will be completely discontinued.

The resumption of the rate easing cycle by the ECB in September was expected by financial markets and in line with our interest rate scenario. The ECB's decision is consistent with, in particular, the drop in headline inflation to 2.2% in August. While that decline was driven largely by the temporary effect of a negative year-over-year change in energy prices, the overall disinflationary trend toward the ECB's 2% target remains broadly intact.

In its new September macroeconomic projections, ECB staff, expect inflation to reach the 2% target in the second half of 2025. Specifically, annual average inflation expectations remain unchanged at 2.5%, 2.2% and 1.9% in 2024, 2025 and 2026, respectively. Behind this is a slightly higher path for underlying core inflation. Nevertheless, according to ECB staff, annual average core inflation will also fall back to 2% in 2026.

Against this background, the ECB remained vague about the further timing and order of magnitude of the next steps in its easing cycle. It stressed that its further decisions remain fully data-dependent and will be (re)considered from meeting to meeting.

That pragmatic data dependence remains a sensible strategy against the backdrop of still stubborn core inflation (mainly driven by the services component), which reached 2.8% year-on-year in August. However, as mentioned above, that core inflation is likely to cool further in the relatively near term.

Fed decided on a jumbo rate cut

A week after the ECB’s second cut, the Fed also began its easing cycle, with a hefty 50 basis point rate cut. Like the ECB, the Fed stated that this is perfectly consistent with the ongoing quantitative tightening (balance sheet deleveraging).

The motivation for the rate cut is primarily found in the new Fed economic projections in September. As indicated by the downward revision of its (PCE) inflation projection to just above 2% by 2025, the Fed now believes that inflation is getting under control and that it will soon reach the first part of its dual mandate (price stability along with maximum employment).

As inflation concerns fade, the Fed’s focus turns to the weakening economy. After the September policy meeting, the Fed pointed out that for them, the risks to both parts of its mandate are roughly symmetrical. In order not to fall behind the curve, the Fed considered it appropriate to start easing its interest rate policy to protect the labour market, especially since the impact of monetary policy changes only show up with long and variable lags.

In its September projections, the Fed gave three signals. First, the September rate cut was the start of an easing cycle. For the two remaining policy meetings in 2024, the Fed expects (at least) another 50 basis points of rate cuts. Given favorable inflation developments and the moderating trend of the US labour market (see further), KBC Economics expects a slightly more substantial easing by a cumulative 75 basis points by the end of 2024.

Second, the Fed raised its expectation for the “neutral” policy interest rate to 2.9%. That level is still slightly below our expectation for the neutral rate. Nevertheless, by raising its expected neutral rate, the Fed signaled that it does not anticipate any meaningful deterioration in the economic environment that would bring down the neutral rate.

Finally, the Fed expects to gradually reach its neutral interest rate in 2026 without undershooting. This fits with Fed Chairman Powell's assessment that (for now) he sees no real signs that the risk of a meaningful cyclical slowdown is higher than normal at this time.

More rate cuts to come

Based on the overall moderating growth and inflation environment and the forward guidance from the ECB and the Fed, we now assume faster and more substantial monetary easing in our interest rate scenario, in initially larger steps of 50 basis points in the case of the Fed. A key driver of this is the downwardly revised inflation outlook over our forecast horizon.

Bond yields have already largely priced in that lower short-term interest rate path. The stronger decline in short-term interest rates will ensure an end to the inversion of the yield curve by 2025. That is expected to happen a little faster in the US than in the euro area.

The US dollar is likely to continue to hover around current levels for the remainder of 2024 and early 2025. Around the time of the US presidential election, the safe-haven dollar may possibly benefit slightly temporarily from increasing geopolitical uncertainty. Starting in late 2025, at the end of the easing cycles, the dollar is expected to resume its gradual depreciation path. This will be driven by the fundamental overvaluation of the dollar at its current rate. However, the expected depreciation over the forecast horizon is expected to remain very limited.

Meanwhile, intra-EMU government bond spreads against Germany remain subdued. We still expect them to rise slightly by the end of 2024 as part of the painstaking progress of the required budget consolidation efforts.

Waiting for the European consumer

In the euro area, real GDP grew 0.2% in the second quarter of 2024 versus the previous quarter. This was slightly less than initial estimates indicated, but in line with our expectations. Nevertheless, the aggregate figure masks some surprises. For example, the expected resumption of household consumption has not yet materialised. This was mainly due to the decline in that spending in Germany and the Netherlands. Rather modest spending growth by Italian and Spanish consumers was insufficient to neutralize this decline (see figure 4). The lukewarm development of household consumption is particularly disappointing against the background of the ongoing recovery in the purchasing power of wages and the overall resilient labour market. While it is true that the decline in the vacancy rate indicates a reduction in the acute tightness of the labour market, the unemployment rate also fell to a new historic low of 6.4% of the labour force.

Investment dynamics also remain weak, particularly in buildings and equipment. In contrast, investment in intellectual property is more dynamic. The weak development of business confidence does not immediately set the stage for a strong imminent investment recovery, but the development and outlook for both corporate and residential credit suggest that some improvement may be on the way, especially as the ECB is expected to continue easing interest rates.

A second disappointment behind the aggregate growth figure for the euro area is the new, albeit slight contraction of the German economy (down 0.1% from the previous quarter). Virtually all spending components, with the exception of government consumption, are failing in Germany (across most sectors) without the leading indicators immediately announcing improvement. Against the backdrop of weak demand, structural adjustments in the German economy are also beginning to translate into weakening labour market indicators, such as an increase in short-time employment and slightly rising unemployment. The risks of a further prolonged period of weak German economic activity there are thus increasing.

On the other hand, employment continues to increase also in Germany and households’ purchasing power is rising. Thus, as elsewhere in the euro area, the fundamentals for a gradual strengthening of domestic demand remain in place. We therefore maintain our scenario of a gradual, mainly private consumption demand-led slight strengthening of growth throughout the euro area. However, given the recent disappointing indicators, we have lowered our growth forecast for real GDP in the third quarter of 2024 from 0.3% to 0.2% (versus the second quarter). This results in a slight downward revision to the expected annual growth rate for 2025 (from 1.3% to 1.2%). The expected average year-on-year growth rate of euro area real GDP in 2024 remains unchanged at 0.7%, as the downward impact of somewhat weaker growth over the course of 2024 is offset by a larger spillover effect from 2023 to 2024 due to a revision of the 2023 GDP figures.

US economy unlikely to enter a recession in the near term

Softer-than-expected US labour market data have rattled financial markets over the summer. Indeed, labour market data have been relatively soft lately. The US only added 231k jobs in July and August combined and there were very big revisions to prior months. Job openings also declined markedly, while the number of people working part-time for economic reasons increased by 610k in July and August combined. Most worrying for financial markets, the unemployment rate stood at 4.2% in August, up from 3.7% in January. This triggered the so-called Sahm-rule, a historically reliable predictor of recessions . Yet this time might be different, as the increase in unemployment is to a large extent driven by a positive labour supply shock. Indeed, higher migration and to a lesser extent higher participation rates have driven up the labour force (see figure 5). As it takes time for new entrants to the labour market to find a job, increases in labour supply can temporarily drive up the unemployment rate.

Aside from the labour market, hard data on the US economy provide a mixed picture. On the positive side, consumption remains healthy. US Q2 GDP growth was revised upwards from 2.8% to 3%, thanks to stronger consumption growth. Consumption contributed almost 2% to US GDP growth in Q2. Consumption is likely to remain the key driver of economic growth in Q3, as retail sales grew by a healthy 1.2% over summer months.

On the negative side, residential investment is a drag on the economy. Nominal construction spending declined 0.3%m/m in July, the first drop in almost two years. Housing starts and permits also dropped sharply in the same month (though they partially bounced back in August). Net exports are also likely to make a negative contribution to GDP this quarter, as the goods trade deficit increased by 6.3% in July.

Business surveys also provide a mixed picture. While manufacturing surveys remain in recessionary territory, non-manufacturing surveys remain in expansionary territory (especially in the S&P Global Survey).

Overall, we still expect GDP growth to weaken as the labour market is loosening and monetary conditions will remain restrictive (Fed cuts notwithstanding). Given the better than expected Q2 GDP figure and the decent Q3 hard data, we upgrade our 2024 forecast from 2.5% to 2.6%, while maintaining our 1.7% 2025 forecast.

Source: KBCBANK

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Justin

Economic

New York City Comptroller Brad Lander, a progressive Democrat who is challenging Mayor Eric Adams in next year’s primary, backed away from a proposal to increase the city’s income tax on the top 1% of earners.

In May 2023, as federal pandemic aid wound down, Lander recommended raising the city’s top 3.876% income-tax rate to help pay for pre-kindergarten, universal child care, public transit and affordable housing.

But on Monday, Lander said he made the proposal because funding for pre-kindergarten and summer programs for elementary and middle-school children was in doubt. With funding for those programs now intact, Lander said additional revenue wasn’t needed.

“I’m pleased to say those programs were able to be maintained with no tax increases so we are not continuing to make that proposal,” he said in response to a question at a Monday breakfast in Manhattan hosted by the Citizens Budget Commission. “We can do universal pre-K and Summer Rising with the resources we have. I think the same is true with a lot of areas.”

The majority of the city’s pandemic stimulus funds went to education.

Lander’s proposal to raise the city income tax was among four options he suggested for new revenue sources to pay for services. The others included a surcharge on pied-à-terres and removing Madison Square Garden’s tax exemption.

Tax Burden

High-ranking state Democrats like Governor Kathy Hochul and state Comptroller Thomas DiNapoli, who also attended the breakfast, have warned that steep taxes and living expenses are pushing both wealthy and middle-class residents out of New York. Last week Hochul, who’s less popular with state voters than former President Donald Trump, said she won’t increase income taxes in next year’s budget despite massive funding gaps for the Metropolitan Transportation Authority.

The state last raised income taxes in 2021 on earners making more than $1 million, pushing combined state and city income levies above California’s 13.3%. The temporary tax hike is set to expire in December 2027.

According to US Census data cited by the Empire Center for Public Policy, a fiscally conservative think tank, more than 550,000 New York state residents left from April 1, 2020, to July 1, 2022. Many moved to Florida, which doesn’t have a state income tax.

In May 2023, Lander said the city could raise as much as $900 million by boosting the income tax on roughly 40,000 filers. The tax rate would increase to 4.46% for married filers earning between $750,000 and $5 million, and as high as 5.5% on all filers making more than $25 million. State lawmakers would need to approve a city income-tax increase.

At present, the city’s top rate of 3.876% kicks in at $90,000 for those who are married and filing jointly.

Lander said income taxes on high earners haven’t deterred hedge funds and asset managers that are moving or expanding in New York City. Bridgewater Associates is planning to open its first office in the city and Citadel plans to build an office tower on Park Avenue.

“We will lose some people who think it’s great to retire in Florida and it’s lovely to retire in Florida,” Lander said. “We need to keep this the place people come to make the next fortune.”

Source: The edge markets

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ING

Central Bank

Economic

Statement showed the BoJ's confidence in securing its sustainable 2% inflation target, and the importance of FX movements in prices

In the statement, the BoJ assessed that the economy has recovered moderately, benefiting from accommodative financial conditions. On the price front, services prices increased but the effects of the pass-through of cost increases led by past rises in import prices waned and inflation expectations rose moderately.

In terms of the outlook, the BoJ expects the economy to grow above its potential, supported by moderate growth in the global economy and an improvement in consumption driven by solid income growth. In addition, underlying CPI inflation is expected to increase gradually, and inflation is likely to remain broadly in line with the price stability target.

In our view, the most interesting comment in the statement was presented at the end. It read, “With firms' behaviour shifting more toward raising wages and prices recently, exchange rate developments are, compared to the past, more likely to affect prices”. This means that FX movements have become more important to the BoJ when deciding policy. We believe this means that the virtuous cycle between income growth and consumption will eventually increase the resilience of consumption to inflation, giving firms more flexibility to set prices to reflect changes in input prices, including the impact of exchange rate movements.

The overall message of the statement was supportive of the continuation of policy normalisation, but it didn't give a clear indication of the pace of normalisation.

Governor Ueda suggests that a rate hike is NOT imminent

During the press conference, Governor Kazuo Ueda reiterated that the BoJ will continue to adjust the degree of easing if the price stability outlook is achieved and the economy improves in line with the BoJ forecast. In saying so, he clearly left the door open for further rate hikes in the future. However, he did not seem to suggest that there was any reason for the BoJ to rush into a rate hike. The BoJ will continue to assess the impact of two rate hikes this year, while upside risks to prices from yen weakness have eased. It has no timetable for the next hike, but he has a strong interest in October’s service prices and mentions the outlook for wages next year. This is in line with our view that October inflation will be the key to gauging the timing of the BoJ’s next rate hike.

August inflation came exactly in line with market expectations

Headline inflation rose 3.0% year-on-year (vs 2.8% in July) and core inflation excluding fresh food also rose 2.8% YoY (vs 2.7% in July). The pickup in August was already signalled by earlier Tokyo inflation data due to base effects related to the utility subsidy programme, thus it was not market-moving or would not have had much impact on the BoJ's policy decision. Fresh food prices rose sharply to 7.7% probably due to severe weather conditions and utility prices jumped to 15.0%. On a monthly basis, consumer prices rose 0.5% month-on-month, seasonally-adjusted, in August (vs 0.2% in July) with both goods and services prices increasing by 0.7% and 0.2%, respectively. We found it encouraging that service prices rose for the third month in a row, which supports a sustainable inflation trend.

Over the next few months, the restart of the utility subsidy programme in September and the usual price increases in October may cause inflation figures to fluctuate. In September, inflation is expected to ease quite meaningfully to the mid-2% range as the government re-introduces the temporary energy subsidy programme for the summer. October is typically the month for second-half price increases, so it is worth looking at whether the recent solid wage growth and corporate earnings have changed companies' price-setting behaviour.

Service prices continued to rise in August

Source: CEIC

BoJ outlook

Having listened to Governor Ueda’s remarks and read the statement, we believe that the BoJ is in no hurry to raise rates, but the option of a December hike is still on the table. The recent JPY appreciation has clearly eased the BoJ’s concerns about the negative impact of rising import prices, so the probability of an October hike is quite low. However, demand-driven price increases are expected in the coming months, and this will be confirmed in the October inflation data.

Thus, the BoJ will take a wait-and-see approach for a few months to analyse inflation developments. We believe that the BoJ is concerned about financial market stability as well. While short-term market jitters will not prevent the BoJ from normalising policy, the pace of JPY appreciation and its impact on inflation should be carefully monitored. In that sense, the Fed’s efforts to avoid a recession will work in favour of the BoJ taking its time and responding cautiously. Going forward, the key data developments should be October inflation along with wage growth and household consumption data.

BoJ and CPI outlook

Source: CEIC, ING estimates

USD/JPY corrects higher

USD/JPY has corrected higher on Governor Ueda's press conference. Probably two factors have driven that move: the first is the sense that the BoJ is in no hurry to deliver the next rate hike and still assesses financial markets as unstable. The second was Governor Ueda's comments that upside risks to prices from yen weakness were fading - suggesting that the BoJ was a little less sensitive to USD/JPY strength than it had been earlier this year. As we write this, USD/JPY is up some 1.2% since Governor Ueda started speaking.

Yet we think the medium-term USD/JPY trend is down. Global interest rates (with a few exceptions such as in Brazil) are converging on the low interest rates in Japan. US exceptionalism is waning and the Federal Reserve has started a front-loaded easing cycle. A BoJ hiking cycle is certainly a bonus, but not a necessity for a lower USD/JPY. And we think the yen offers investors some protection should US hard landing fears materialise and hit equity markets.

We doubt USD/JPY holds any gains over 145 near term and remain happy with a year-end target at 140 - with risks to the downside.

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Energy

COP29, the UN Climate Change Conference, taking place in Baku, Azerbaijan, in November has been described by some as a ‘transitional’ COP; a follow-on from the global stocktake negotiated at COP28 10 months ago, and the precursor to next year’s deadline for setting out new, more ambitious national climate targets at COP30 in Brazil in 2025.

But for Rwanda, where until recently I advised the government on climate policy, and other developing economies, what happens in Baku will be decisive. Decisions made on climate finance – and how to close the $6.7 trillion gap required each year to reach global net zero targets by 2050 according to the European Commission – will heavily influence the ability of developing countries to fund and implement their national climate targets by COP30.

In Africa, this shortfall in climate financing is particularly acute. According to research from the Climate Policy Initiative, African countries require an estimated $2.8 trillion annual additional investment over the next decade to decarbonize their economies and attempt to keep the rise in global warming to below 1.5C.

The imbalance in climate finance between advanced, emerging and low-income economies is stark. In 2020-2021, less than 3 per cent of global climate finance went to the world’s least developed countries, which represent 13 per cent of the world population. Yet there is a pressing urgency to increase investments in climate adaptation in these countries, which are most vulnerable to the effects of climate change.

The catastrophic flooding and landslides Rwanda experienced in May 2023 showed the cost of this underinvestment. This climate-related disaster displaced 20,000 people, devastated homes, roads and bridges, and reduced national GDP by 4 percentage points. Additional adaptation funding would have increased the country’s climate resilience through the development of early warning systems and improved disaster preparedness capacities.

The power of private finance

Burundi, Kenya and Uganda have each faced comparable climate catastrophes in recent years, but the flow of public climate finance to developing countries in Africa has been extremely limited. The main obstacle is the threat of sovereign debt default, which has led to heightened scrutiny in the allocation of global public spending to low-income and emerging economies.

The scarcity of global public finance and the competing demands that advanced economies face in funding healthcare, education and infrastructure needs, mean that a reliance on public finance alone is not a viable long-term option.

Addressing the global climate finance deficit therefore hinges on the private sector, which will need to supply about 80 per cent of the required climate investment. But for these investors, Africa is still considered a risky bet.

The perception of greater investment risk and lack of comparative advantages have restricted the flow of private capital into developing economies across the continent, even though these risks do not always align with reality.

Rwanda for example, has maintained an impeccable record of debt repayment over the past 30 years but still borrows externally at an average interest rate of 9 per cent. By comparison, OECD countries borrow at significantly lower rates, averaging 3.3 per cent in 2022.

If developing countries are ever to fully decarbonize their economies and deliver their national climate targets by COP30, then this disparity in lending costs – and the conventionally agreed wisdom on climate financing – needs to change.

Changing the orthodoxy

To kickstart this shift, developing countries must press for a new approach from advanced economies and international public financing institutions.

The argument that developed countries should ‘pay for the cost of climate change’ based on their responsibility as historic polluters is compelling, but existing models of financing – including development aid – are failing to support low-income countries’ attempts to adapt to climate threats in any long-term or sustainable way.

What developing countries need is a re-imagined partnership with advanced economies, based on the prioritization of concessional climate finance. On a practical level, this means moving away from traditional project-by-project financing to a strategy that reduces investment risks for the private sector.

This includes initiatives that directly lower interest rates to encourage greater private sector investments across the developing world, which will help fill Africa’s $247 billion annual shortfall in available climate finance.

Models of success

This approach is already proving successful. Last year, the Development Bank of Rwanda launched one such initiative, the Sustainability Linked Bond, which uses concessional financing from the World Bank as collateral to reduce the risk for private investors and lower the cost of borrowing. Unlike other financing mechanisms, the funding from the bond is not allocated towards specific climate projects, but instead incentivizes borrowers to meet sustainability targets by offering them lower interest repayments.

Rwanda’s ‘Green Bank’, Ireme Invest, is another example of how to effectively harness private finance through public funds. Launched at COP27 by the President of Rwanda, the Ministry of Finance, Environment and other partners, the Green Bank works by combining the resources of international public investors to lower the cost of financing and mitigate the burden of risk associated with green projects in Rwanda.

With this capitalization, the Green Bank acts as an early investor for startups, small and medium domestic enterprises in food waste reduction, e-mobility and ‘Climate Smart Agriculture’ across the country. The successful companies are then rewarded by the credit facility, providing larger concessional loans to the most bankable green projects.

Elsewhere, the Bridgetown Initiative in Barbados is taking important steps towards reforming the global financial architecture and rethinking how rich countries can best support developing economies to cope with and adapt to the effects of climate change.

One of the initiative’s proposals, spearheaded by Barbados Prime Minister Mia Mottley at the Paris Climate Summit in June 2023, is based around the idea of debt suspension for climate-vulnerable countries. So far, its achievements are limited, but it offers a promising model of concessional climate financing on a world scale.

Crucially, these approaches give developing economies greater autonomy in climate-decision making. This is particularly important for states on the front lines of the climate crisis, where the effects of rising emissions are not just ravaging the natural environment but affecting their ability to govern effectively.

Reaching climate resilience therefore becomes a matter of national sovereignty and ensures nations can safeguard their populations, build their economies and pursue development on their own terms.

Making COP29 matter

COP29 in Baku is an opportunity to bring this model of climate financing to scale. But this will require political will and a recognition from both advanced and developing economies that private investment is the only way to bridge the chasm in global climate finance.

Simplicity is the key to closing the climate finance gap

My hope is that whatever agreement is negotiated at COP29 it includes a set of indicators that measure the level of private investment mobilized and lights the flame for the trillions of dollars in additional private finance needed.

To fully realize the potential of the private sector, climate ambitious nations must press for a new relationship with advanced economies that goes beyond traditional development aid and recognizes the cost of climate inaction for the world’s most vulnerable countries. Reducing the burden of risk and closing the disparity in lending costs is the most effective way to increase private investment in developing countries and mitigate this threat. The onus now falls on public institutions to make these systematic shifts happen.

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Owen Li

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Even before the Federal Reserve approved its outsized half-percentage-point interest rate cut last week, financial markets had begun making credit cheaper for households and businesses as they bid down mortgage rates, cut corporate bond yields, and chipped away at what consumers pay for personal, auto and other loans.

How fast that process will continue now that the U.S. central bank's first rate cut is in the books is unclear, in particular whether easing credit conditions will become tangible to consumers in ways that shift attitudes about the economy before the Nov. 5 U.S. presidential election.

Recent surveys suggest that while the pace of price increases has declined dramatically, the public's mood is still marred by nearly two years of high inflation - even if falling rates signal that chapter of recent economic history is closed and will begin making it cheaper for people to borrow money.

"My daughter has been trying to buy a home for years and cannot," said Julie Miller, who works at her son's electrical company in Reno, Nevada, a state where home prices rose fast during the COVID-19 pandemic. One of seven key battleground states in the presidential race, Nevada is being aggressively contested by Vice President Kamala Harris, who replaced President Joe Biden as the Democratic candidate, and former President Donald Trump, the Republican challenger.

If housing costs are vexing Miller's daughter, higher prices at Taco Bell have caused Miller to cut back on the usual Friday night trips to the fast food retailer with her granddaughter, and left her inclined to vote for Trump because "I don't think Biden has done a great job with inflation."

Harris supporters had similar concerns about high prices even as they vouched for her as the best candidate to address the problem.

BORROWING COSTS DECLINE

The Fed's rate cut on Sept. 18 is likely to be followed by more, with at least another quarter-percentage-point reduction expected when policymakers begin their next two-day policy meeting a day after the U.S. election.

Just as rate increases feed through to a higher cost of credit for families and businesses, discouraging them from borrowing, spending and investing in order to cool inflation, reductions in borrowing costs change the calculus for would-be homebuyers and firms, particularly small businesses wanting to finance new equipment or expand production.

Looser monetary policy, which the Fed had been signaling was on the way, has already put money back into people's pockets. The average rate on a 30-year fixed-rate home mortgage, the most popular home loan, for example, is approaching 6% after nearing 8% just a year ago. Redfin, a real estate firm, recently estimated that the median payment on homes sold or listed in the four weeks through Sept. 15 was $300 less than the all-time high hit in April and nearly 3% lower than a year ago.

Indeed, under baseline estimates from the Fed's own staff, mortgage rates are likely to level off somewhere in the mid-5% range, meaning most of the relief there has already occurred.

Banks have begun trimming the "prime rate" they charge their most credit-worthy borrowers to match the Fed rate cut. Other forms of consumer credit - the auto and personal loans where a better deal might be available to households - have changed only marginally so far, and it may take longer for banks to give up on charging higher finance costs.

Investors and economists saw last week's rate cut as less important than the message it carried of a central bank ready to loosen credit and confident that recent high inflation won't recur.

Inflation in fact has registered one of its fastest ever declines, with the consumer price index's annual increase falling from more than 9% in June 2022 to 2.6% on a year-over-year basis last month. The Fed's preferred personal consumption expenditures price index rose at a 2.5% rate in July, near the central bank's 2% target.

SOUR SENTIMENT

The U.S. economy has been performing reasonably well despite concerns the job market might be on the brink of weakening.

New claims for unemployment benefits remain low and unexpectedly fell in the most recent week, while the unemployment rate, at 4.2% in August, has risen from a year ago but is around the level the Fed feels is sustainable without generating excess wage and price pressures. A Philadelphia Fed index of manufacturing rose recently and retail sales for August grew despite expectations for a drop.

But none of that has led to a decisive shift in public sentiment.

The share of Americans who see the economy as heading in the right direction climbed to 25% in August from 17% in May 2022, according to Reuters/Ipsos polling. Yet the share that sees the economy on the wrong track has eased to 60% from 74% over the same period.

A New York Fed survey that through early this year showed people feeling better off than a year ago and expecting more improvement in the year ahead has since been moving in the other direction even as inflation slowed further and rate cuts became more likely.

The University of Michigan's consumer sentiment index had been improving but then dropped in recent months and remains below where it was before the pandemic.

The most recent U.S. Census "pulse" polls of households showed the share who reported trouble paying household expenses in the past week has ebbed from 2022, when inflation hit its peak, but has made little improvement recently.

In his press conference following the rate cut last week, Fed Chair Jerome Powell said his aim was to keep the economy on track between the central bank's two goals of stable inflation and a healthy job market. To that end, credit will ease but at no guaranteed pace.

"This is the beginning of that process," Powell said. "The direction ... is toward a sense of neutral, and we'll move as fast or as slow as we think is appropriate in real-time."

Source: Theedgemarkets

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Central Bank

Economic

The BoE is much more cautious than the Fed

What was striking about the Bank of England decision is how different the messaging was compared to the Federal Reserve. The Bank has kept rates on hold in an 8-1 vote and the language in the statement makes it abundantly clear that it’s not in any hurry to lower rates. By promising a “gradual approach” to rate cuts, the Bank is effectively endorsing quarterly rate cuts of 25 basis points. That suggests the next cut is highly likely in November.

None of this is particularly surprising, but it does beg the question of whether the Bank of England’s easing cycle needs to look that different to that of the Federal Reserve. Markets, for some time, have concluded that it will. There are fewer cuts priced this year relative to the US and the terminal rate is some 40-50bp higher too.

It’s easy to see why. Not only is the BoE sounding more hawkish, UK services inflation is higher than in the US and eurozone, and at face value, it is going in the wrong direction.

The Bank’s hawks worry that corporate price and wage-setting behaviour has permanently shifted in a way that’s going to make it perpetually harder to get inflation down on a sustained basis. We’re not convinced that’s the consensus view on the committee right now – August’s decision to cut rates certainly suggests it isn’t. But so long as wage growth and services inflation remain sticky, then the committee as a whole seems happy to tread carefully.

We think BoE rate cuts will accelerate beyond November

We’re less convinced that the UK’s easing cycle will deviate that much from the Fed or others. As the Bank readily concedes, the recent stickiness in service sector inflation is mostly down to volatile categories that hold little relevance for monetary policy decisions. Strip that out, and the picture is slowly looking better.

Meanwhile, the jobs data, though admittedly of dubious quality right now, points to an ongoing cooldown too. The number of payrolled employees appears to be falling now and that will inevitably feed through to wage growth. Companies are consistently lowering their estimates of expected and realised price/wage growth, according to a monthly BoE survey.

We therefore think that Bank of England rate cuts will accelerate after November. Beyond then, we think the Bank will grow more confident in the persistence of inflation and there will be sufficient consensus on the committee to switch to back-to-back rate cuts. Like investors, we expect a cut in November and December, with further cuts in 2025 taking us to 3.25% by the end of next summer.

BoE stays the course on quantitative tightening (QT)

Besides the decision to hold rates unchanged, the BoE also decided to continue reducing the size of its asset portfolio by £100bn over the coming 12 months. Of this amount, £87bn will come from maturing Gilts, and thus relatively little will come from active bond sales. There was some talk that this pace could be increased, but ultimately the Committee seems to prefer maintaining a predictable path going forward. Remember the Bank wants this to be a background process, which allows Bank Rate to remain the active tool for controlling monetary policy.

The impact on market rates will be minimal from the decision to keep the current pace, bearing in mind that this was also the consensus view. QT will continue to play a role in the term risk premium, but we are likely talking in the range of about 10bp for the 10Y yield over the next year. Regarding liquidity conditions, QT should be less impactful, because the BoE’s short-term liquidity facility (STR) has shown significant uptake of late (£44bn) which is helping to mitigate the risks of QT abruptly draining too many reserves from the system.

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Economic Perspectives September 2024

Introduction

Oil prices on the descent

Further cooling of inflation in the euro area

US inflation on a downward path

ECB in easing mode but remains data-dependent

Fed decided on a jumbo rate cut

More rate cuts to come

Waiting for the European consumer

US economy unlikely to enter a recession in the near term

Source: KBCBANK

NYC Comptroller Brad Lander Backs Away From Income-tax Hike Proposal

Tax Burden

Source: The edge markets

Bank Of Japan Pauses But Signals Normalisation Will Continue

Statement showed the BoJ's confidence in securing its sustainable 2% inflation target, and the importance of FX movements in prices

Governor Ueda suggests that a rate hike is NOT imminent

August inflation came exactly in line with market expectations

Service prices continued to rise in August

Source: CEIC

BoJ outlook

BoJ and CPI outlook

Source: CEIC, ING estimates

USD/JPY corrects higher

Developing Countries Need Cheaper Loans – Or the World Will Miss Its Climate Targets

The power of private finance

Changing the orthodoxy

Models of success

Making COP29 matter

Simplicity is the key to closing the climate finance gap

Fed Rate Cuts Will Put Money in Pockets, But a Mood Shift May Take Time

BORROWING COSTS DECLINE

SOUR SENTIMENT

Source: Theedgemarkets

Why The Bank Of England Won’t Diverge From The Fed For Long

The BoE is much more cautious than the Fed

We think BoE rate cuts will accelerate beyond November

BoE stays the course on quantitative tightening (QT)

Risk Disclosure