The Budget: Tax cuts today based on magical thinking for tomorrow

By prioritising tax cuts and sidestepping tough choices in his Budget yesterday, Chancellor Jeremy Hunt has put short term political gain before the long term health of the country – electoral expediency ahead of good governance.

Instead of answering calls for more money for ailing public services or addressing the crisis of local government funding, the Chancellor spent what little headroom he had within his fiscal rules on a pre-election tax giveaway. Tax cuts announced yesterday and last November will supposedly be paid for, in part, by £19 billion worth of public service cuts after the election, with 4.1% real terms annual cuts penciled in for all but a handful of protected departments. No-one serious thinks these number are credible, and it is no coincidence that the Treasury quietly confirmed yesterday that the next Spending Review will not take place until after the election, allowing the government to remain vague about exactly how and where those eye-watering spending cuts will fall.

Another source of funding for tax cuts comes from two of Labour’s revenue raising policies, artfully pinched by the Chancellor – namely scaling back the non-dom tax regime and extending the windfall tax on oil and gas companies. Seeing these pledges make their way into the Budget has left the Opposition searching for other revenue sources to fund its promises.

This is the political and fiscal context in which the next election campaign will be fought. Again and again over the course of the campaign, parties will be challenged to either commit to Hunt’s spending plans  and explain how on earth they make the numbers work  or set out their alternative.

Part of the Conservatives’ answer lies in their new public sector productivity plan, announced yesterday, which aims to use an ‘invest-to-save’ approach to get more value for money from public spending. This is sensible and a welcome shift  thinking longer-term about public finances rather than obsessing over short-term metrics. But the idea that it will be enough to offset the supposed £19 billion cut in public spending is plainly fiction.

Beyond that, both main parties will insist that their plan is to boost overall economic growth and so avoid the nightmarish scenario they are currently facing. Above-trend GDP growth increases tax take, eases pressures on public services and means the £19 billion cuts question never materialises, the thinking goes. That is ambitious, to say the least.

For the Conservatives, this means betting the house on the growth-inducing properties of tax cuts. But this seems to be based more on wishful thinking than empirical evidence: as the Office of Budget Responsibility’s accompanying economic and fiscal forecast makes clear, yesterday’s new measures will add just 0.3% to GDP over the forecast period.

Labour, meanwhile, will point to their five missions, a revived Industrial Strategy and an active state working in partnership with the private sector to turn the economy around. This would be a progressive departure from the increasingly laissez-faire status quo. However questions remain over what Labour’s plans will look like in practice, with the party’s backtracking from its £28 billion green investment pledge showing how vulnerable elements of it are to the political and fiscal headwinds.

In both cases – the Conservatives’ tax-cutting liberalism and Labour’s muscular industrial policy – the central question as to whether growth improves will be whether government investment policy can successfully unlock private sector investment. 

Both in terms of total public and private investment, the UK already lags far behind international comparators. And under current plans, public investment is only set to deteriorate: OBR forecasts show investment falling every year for the rest of the decade (we’ve come a long way from then Chancellor Rishi Sunak’s 2020 commitment to raise public investment to 3% of GDP). That exerts more pressure on the private side of the equation.

Figure 1: UK investment compared to G7

So how can government investment policy be used to mobilise more private capital? It’s something FGF looked at in our first report in November last year: Rebuilding the Nation 01which called for government to think creatively about how to crowd in private investment and deploy savings and pension capital to best effect. 

We also emphasised the need to restore stability to boost investor confidence. The UK is starting from a low base here: the government has had 11 different economic strategies since 2010. Setting out, and sticking to, a long term economic and fiscal strategy would increase certainty, while moving to a single annual fiscal event would help minimise policy churn.

On the public investment side, it may also be necessary to reconsider the fiscal parameters in which the government operates. The Chancellor’s manoeuvrings yesterday offers a case in point: while meeting the government’s fiscal rules, the Budget’s numbers only add up on the assumption of spending cuts widely dismissed as not credible. Here, a debate has started to emerge, with the Labour Party recently committing to ‘take greater account of public sector assets as well as debt in fiscal policy’. This would mean a move away from the current debt and deficits measure, which disregards public sector assets and non-debt liabilities entirely.

Figure 2: UK national accounts measure

Taking a more expansive view of the public accounts would increase incentives to invest effectively and would allow HM Treasury to take a longer term view of public investment. Making such a move would not be without its political and technical challenges, to say the least, but it is surely an option worth exploring.

Instead of wrestling with any of these challenges however, Jeremy Hunt has made them harder to solve. It has become tradition, for better or worse, for a Chancellor to use their pre-election Budget as a political exercise to maximise the prospect of a win at the polls. But yesterday was effectively a scorched-earth strategy, leaving an incoming government staring down the barrel of impossible spending cuts to implement and mere months to produce a spending review setting out how they would do it. Whoever wins the election, that is a bad outcome for the country as a whole. 

The irony, of course, is that if the Budget has the electoral effect he intends, the occupant of No.11 Downing Street falling into Jeremy Hunt’s cunning political ‘trap’ may just be Jeremy Hunt.