Sunak’s task tomorrow. The best way of reducing the deficit is to go for growth
My column appeared in ConHome on 22nd March, 2022, the day before the Spring Statement
Rishi Sunak needs to provide context, actions and vision when he delivers his Spring Statement to the House of Commons this week.
Context, so that people can understand the present difficult economic environment and what lies ahead. Actions will be needed to cushion the imminent cost-of-living crisis. And the Chancellor needs to outline a vision, both from a domestic political perspective and to reassure financial markets and investors about the outlook for the economy.
The current context is a difficult one. The war in Ukraine and the associated high level of oil and commodity prices has added to uncertainty, both here in the UK and globally. This will be reflected in the economic forecasts from the Office for Budget Responsibility (OBR) that will accompany Sunak’s statement.
At the time of their previous forecast, last October, the OBR was forecasting growth of six per cent and inflation of four per cent this year. Now, depending upon their assumptions, the OBR’s growth forecast could be half and their inflation forecast almost twice as high as then. Hence the increased fear of stagflation – where inflation is higher, and growth lower.
For next year, the OBR will be expecting growth to slow further and inflation to ease. It is their cautious future growth outlook that limits the Chancellor’s room for fiscal manoeuvre. Sunak will also stress that higher inflation and interest rates increases the amount spent on servicing the national debt.
Despite this, the Chancellor should not feel constrained by the OBR’s forecasts into limiting the actions he can take. The margin of error for the budget deficit forecasts has been high in recent years – for obvious reasons, perhaps.
Importantly, the fiscal numbers, while poor, are clearly on an improving trend. During the first ten months of this fiscal year, public sector net debt was £138.5 billion, around half the level of a year earlier. So Sunak may have around £25 billion more to use in this statement than previously expected, and still be able to stick within his fiscal rules. He thus has the opportunity as well as the need to provide some help this week.
What then of the actions that can be taken? There are two areas he should focus on.
One is actions linked to the war, such as more immediate defence spending or help for refugees. The other is finding money to cushion the cost-of-living crisis.
While he may mention issues linked to levelling up and incentives to boost investment and improve skills, the bulk of tax changes and spending announcements linked to these will have to wait until the Budget in the autumn.
The imminent cost-of-living crisis is explained by higher inflation, rising fuel and energy bills, and increased taxes. The approach that the Chancellor is likely to take to address these is best captured by the three “t’s” – timely, temporary and targeted measures.
Even though people across all incomes, including the squeezed middle, are being impacted, help will be targeted to those on low incomes and most in need.
The rise in inflation is out of his control. But we shouldn’t pretend that no-one is to blame. Costs have risen across the board – initially because of supply disruptions triggered by the pandemic and now because of the war. At some stage these pressures will ease, but not yet.
But inflation has also risen because the Bank of England has been asleep at the wheel. Last year, when inflation was already rising, it printed an excessive amount of money as quantitative easing reached £895 billion. That made the inflation outlook worse, feeding inflation expectations.
The Chancellor can act on fuel duties. During the next fiscal year, fuel duties are expected to raise £28 billion. By comparison, income taxes will raise £229 billion and national insurance £182 billion. A bold step would be to suspend fuel duties completely for a period. But then the pain would be felt when reintroduced.
Indications are that fuel duty will be cut, perhaps for a temporary period. A similar approach has been seen recently in France and Ireland.
For example, take a litre of petrol at £1.65. This price includes fuel duty of 57.95 pence and VAT of 27.5 pence. So total tax is 85.45 pence. If fuel duty is reduced by five pence per litre, then, after taking into account VAT, this would reduce the price per litre by six pence, in this case from £1.65 to £1.59. A small but significant saving for many people.
A radical – but very unlikely – step would be to move environmental levies from fuel bills onto general taxation. From this April these levies on household energy bills will raise £9.2 billion over the fiscal year, around £325 per household per year. The importance of addressing climate change is critical, it is peoples’ ability to pay that is the issue. This leads onto the big issue that Sunak needs to address: taxes.
Two tax increases will bite this spring. There is fiscal drag: as pay creeps up it drags people into higher income tax brackets. Normally, this is addressed by allowing tax allowances to rise in line with inflation. Allowances have been frozen for a couple of years, so it is unlikely anything will change here.
The other tax is the increase in national insurance, which will rise for both workers and employers, and which comes into effect in a couple of weeks. For workers this rises from 12 per cent to 13.2 per cent, so someone earning £30,000 per year will pay £214 more and a £50,000 earner will pay £339 more.
In April 2023, this is replaced by a new health and social care level (which in all likelihood will rise in future years) and the national insurance rate falls back to 12 per cent.
There was no need for this tax to have been increased in the first place. It was already clear last autumn that the public finances were improving. Furthermore, it is a tax on jobs that it is coming into effect now when incomes are being squeezed.
Sunak appears keen not to reverse or delay this tax. Instead, he could raise the threshold at which national insurance is paid by workers. From April, national insurance is paid after you earn £190 per week. By contrast, the threshold for paying income tax is based on annual income but is equivalent to £242 per week.
The Chancellor also recently announced measures totalling around £9 billion to help people most in need. He could find other targeted help. For instance, benefits and allowances could be raised in line with latest inflation figures.
One lesson from following fiscal statements over the years is that, when it comes to chancellors, don’t just listen to what they say, watch what they do. During the pandemic, Sunak responded well. Further action is needed now.
Finally, despite uncertainty, it will be important for the Chancellor to outline a vision. The UK’s trend rate of growth is too low. The UK needs to become a more competitive economy. Sunak wants to reduce the budget deficit. That is understandable. His choices are: borrow, raise taxes, austerity via cutting spending, focus on boosting growth – or a combination of these.
Austerity is rightly ruled out, although public sector reform is needed. The trouble is that taxes are already high, even for people on modest incomes. The best way to reduce the deficit is to boost economic growth, allowing the ratio of debt to GDP to come down gradually, over time.