Yesterday Rishi Sunak, the British Chancellor of the Exchequer (though that job title belongs to no other country so far as I know), showed why is considered to be the country’s top performing minister after Boris Johnson, the Prime Minister. It was Budget Day; he got most things right, while putting off a lot of decisions for another day.
The central issue for the government is, of course, dealing with the pandemic. His decision was to continue with a whole raft of fiscal support measures, such as the furlough scheme, until the end of September. This is well after the vaccine programme is supposed to have brought society back to normal, sort of. This shows that Mr Sunak has learned from his mistakes. Last year he was too eager to hurry things back to normal and withdraw fiscal support. Like his boss, he seems to have effortlessly risen above the mistakes of 2020.
But how is this to be paid for? Government finance does not work like household finance, and especially not for a medium-sized developed country with its own currency, like the UK. Mr Sunak has simply added the costs to the national debt without any serious plans to repay it. After dealing with short-term support for the stricken economy, Mr Sunak’s next priority is to show how he will stabilise government finances in the new, shrunken, normal by reducing the budget deficit. He did this by freezing tax allowances and raising the rate of corporation tax (from 2023). The former will allow the government to benefit disproportionately from incomes increasing through inflation. This allows the Conservatives to stick to their pledge not to raise personal tax rates, nowithstanding the hurricane that has hit the economy.
A lot is missing from this plan. Public spending plans have not been changed once the emergency subsides, though it isn’t hard to see many ways in which the stress on public services will rise; some are painting this as strategic choice for a return to austerity, but surely it is too early to say for sure. The long-promised solution to social care funding did not materialise. The temporary increase in Universal Credit, which many want to make permanent, has been prolonged only until 30 September. There were various gimmicks under the heading of “growth strategy”, i.e. measures to encourage business investment, but nothing major. Tax advisers will indeed get an economic boost, especially from his 130% capital allowance scheme for “productive” investment. So the Budget was not the long-term strategic rethink many had been hoping for. The big question is whether the government has such a rethink in mind at all, or whether it is saving it for later. Saving it for later would be perfectly sensible in the current fast-changing environment. A lot of criticism is focused on these missing items, however. Another line of attack, notably from the Liberal Democrats, points to gaps in the emergency support, especially for smaller businesses. This is valid, but it is a bit late for a government rethink.
The leaves two bigger questions: is it sensible to put off dealing with the expanded national debt? And is it sensible to raise the rate of Corporation Tax? My answer to both is “yes”. The limits to government finance are very tricky to assess. On the one extreme we have countries like Argentina, constantly overdoing it and stuck in a world of inflation and debt crisis; on the other we have Japan, whose mountainous public debt and frlarge budget deficits are simply shrugged off. A large national debt needs to be refinanced over time, as the bonds that finance it mature. For now this is cheap and there are plenty of buyers. But that can change; interest rates can rise; investors can be scared off. There’s no sign of this at the moment, but this debt will be with us for a long time. Can’t the Bank of England take on the debt that the markets can’t digest anyway? Yes, but this is a bad idea if inflation is in the system, especially wage inflation. But some wage inflation is good – it is the process by which living standards increase, especially in poorer households. Another problem is if the country requires a lot of foreign currency (the position Argentina got itself into); this is a risk if the country has a large current account deficit. But there are no warning lights flashing on either inflation or currency needs. If that changes the government might need to raise taxes further – but not yet.
And as for Corporation Tax, the government’s reversal of strategy is spectacular. Starting with the Coalition with the Lib Dems in 2010, the rate has been steadily reduced to 19%; the plan now is to bring it up to 25%. This rise is widely portrayed as an attack on business. But that isn’t the right way to look at it. As a tax on profits, rather than on sales, employment or property occupation, it is a very efficient tax. The incentives to run a business efficiently remain unchanged by the rate. It is better regarded as a tax on capital. It is certainly one of the things that companies look at when deciding where to locate a business internationally – but it is still quite competitive at 25%, and basing attractiveness to business investment on tax rates is an invitation to footloose capital, not secure growth. Capital is already cheap, and the story of this century has been the rise of rewards on capital compared to labour. This looks like a good place a tax hike. There are problems with the tax, especially in its treatment of foreign trade and borrowing, but the rate is surely not too high.
Politically, though, this Budget is part of a general revival of the Conservatives’ fortunes. Mr Johnson and Mr Sunak are often painted as rivals, and doubtless they are, but so far this year they are working well together, promoting a narrative of a sure-footed, cautious but fiscally generous recovery from the pandemic. Labour, who had opposed the rise in Corporation Tax, are floundering.
The pendulum swings rapidly in politics, but Rishi Sunak is showing a sure touch. Later this year, as his bluff is called on public spending, it will be interesting to see what he and the rest of the government do.
While I agree that the budget was adroit in respect of the fiscal dilemmas this post focusses on, I see it as failing to face up to an important strategic dilemma. The inconvenient truth is that the Government provides public services whose price will rise relative to the general price level because they are labour intensive – what used to be called the ‘relative price effect’ of the cost of Government services. So, once we reach the point where the continued degradation of the quality of public services has become unacceptable, either the level of taxation must rise as a proportion of GDP or the Government must be relieved of some of its responsibilities. In my view, the crisis point has now been reached, since the health service needs to expand to cope with the continued problems in prospect from COVID-19 – including the enormous waiting list already created; yet it has 100,000 job vacancies. Sunak is doing nothing to alert the public to this problem, which will need to be understood by the public before it can be solved.
My interpretation is that the fiscal dilema has been deferred until the spending review in the Autumn. Austerity is the working assumption of the forecasts, but until ministers confront the implications in detail they won’t truly appreciate the political costs. I have a feeling they they will be a lot more generous in practice than this Budget implies.
“Mr Sunak has simply added the costs to the national debt without any serious plans to repay it.”
Governments hardly ever do repay it. It just keeps growing and only shrinks in terms of GDP because GDP usually rises. Even when Govts do claim to have repaid some debt, such as their well publicised claim that they had repaid the remaining WW1 debt the process simply involved cancelling bonds which paid out at the rate of 3.5% and replacing them with other bonds which paid out much less.
“Mr Sunak’s next priority is to show how he will stabilise government finances in the new, shrunken, normal by reducing the budget deficit. He did this by freezing tax allowances and raising the rate of corporation tax…..”
Except he hasn’t shown anything. Politicians nearly always mistake counter inflation policies for deficit reduction policies. They overlook what I would have thought were the obvious points that if they cut their spending they also cut their income. If they raise taxes they slow the economy which also cuts their income.
There are only three ways to reduce the govt deficit. Some would say the first two amount to the same thing. Firstly be getting everyone spending rather than saving. That boosts taxation revenue. Secondly by encouraging everyone to borrow more and spend that too! This was possible after the 2008GFC by reducing interest rates sharply. That’s not going to be possible now. Thirdly we could do what all the net exporters do and hold down the value of the pound. If there is no net money leaving the economy to pay our import bills there is much less need for the govt to deficit spend into the economy to try to maintain economic activity.
The only way forward is to do what it takes to keep the economy going and forget about govt deficits. Japan hasn’t got it quite right but the economy ticks along well enough with relatively low unemployment and inflation. That’s really all that matters.
Argentina is a far more volatile economy which borrows far too much in US dollars rather than its own currency. It’s not a reasonable comparison.
All these are hard choices for a Tory govt so we could see bumpy times ahead. The real worry is that the property market collapses and then we really will know what has hit the fan.
Actually I agree that there is a lot of masterful nothing in this budget. He’s done what he needs to, but put off the harder choices for later. Interestingly Corporation Tax shouldn’t damage demand much – it’s a tax on excessive corporate saving – it is a very efficient tax.
The interesting thing about your three options is whether the third option actually exists for Britain in its current state without austerity that, as you say, would undermine it. As Chris Giles in the FT has pointed out, according to conventional statistics the UK economy pre-pandemic was at, or even beyond, capacity (high employment and high current account deficit). So we don’t actually have the capacity to export more and import less – not without a substantial productivity boost. I know you think there is actually quite a lot of hidden potential in UK economy, but it would take some quite clever policy to flush it out.
I agree that we are closer to Japan than Argentina. But Japan runs a consistent current account surplus. Our deficit carries the danger of us heading in the direction of Argentina (in this view persistent deficits lead eventually to having to borrow in foreign currency). That is probably too alarmist in fact, as I suspect we have a lot of real estate to sell off to foreigners to finance the deficit – but I think it explains a lot of Treasury thinking.
Meanwhile I think the government can make life easier for itself by its spending and taxation choices: some are better than others in supporting or damaging tax revenue prospects.