David Gauke: The pluses, minuses and risks of Trussonomics. And the looming shadow of Lord Frost.

1 Aug

David Gauke is a former Justice Secretary, and was an independent candidate in South-West Hertfordshire at the 2019 general election.

Economics is at the heart of this leadership election and will be at the heart of the wider political debate for the foreseeable future. Low growth, soaring inflation (especially energy prices), high taxes and public services under financial pressure all contribute to a focus on economic vision and competence.

Part of Liz Truss’s appeal to the party membership is that she is the economic change candidate. She has a retail offer – tax cuts – and a willingness to challenge powerful institutions such as the Treasury and the Bank of England. She believes that her policies will increase economic growth by strengthening the supply side of the economy. The big question is whether Trussonomics will work.

The issue that has attracted the most attention is her policy on tax cuts. Her argument is that by not going ahead with the increase in National Insurance Contributions and Corporation Tax she will assist with the cost of living challenge and attract more investment to the UK. She maintains that these tax cuts will encourage economic growth and, therefore, help the public finances and strengthen the supply side of the economy, thus potentially being deflationary. Rishi Sunak’s counter-argument is that loosening fiscal policy will be inflationary at a time when there is no spare capacity in the economy.

On Corporation Tax, Truss has a point that international investors have a choice as to where they invest and reducing their rate of return on investment (which is what increasing Corporation Tax does) is bound to have a negative behavioural impact. It is not the most important factor influencing investment decisions (our falling rates were insufficient to counteract the uncertainty created by the result of the 2016 referendum), but it is one that the Government can easily control. An efficient tax system would seek to rely less heavily on it as a source of revenue.

I spent six years in the Treasury bringing down the Corporation Tax rate and was one of the few who objected to its increase when announced in March 2021. Having said that, Corporation Tax cuts do not pay for themselves and the benefits will only be seen over a long time period. They are certainly not disinflationary in the short term.

The more fundamental argument on tax policy is whether her approach is reckless. The inflationary argument can be overstated. When Sunak announced in May measures to help with the cost of living with a net giveaway of £10 billion, the Treasury thought that this might add 0.1-0.2 per cent to inflation all other things being equal.

A £30 billion giveaway would presumably add 0.3 to 0.6 per cent to inflation. In practice, looser fiscal policy will result in tighter monetary policy, so the net effect will not be higher inflation but higher interest rates. Assuming that market confidence is maintained (to which I will return), the additional increase in interest rates is unlikely to be very substantial.

The real problem is not inflation, but that Truss’s plans look set to widen the structural deficit by reducing the tax base. It is not plausible to think that this is going to be removed by lower spending (she plans to spend considerably more on defence and the pressures on health spending are immense), with demography increasingly working against us.

Truss has a point that the UK is moving faster than other countries to restore the public finances post-Covid, but it is not clear when or how she would ever take action. For a party that once prided itself on fiscal responsibility, it is an approach that looks risky.

In addition to having a go at Treasury fiscal orthodoxy, Truss has also been critical of the Bank of England and talked of setting “a clear direction of travel” on monetary policy. The Bank of England has been slow in tightening monetary policy and cannot expect to be exempt from criticism, even though it has been operating in challenging circumstances.

What is not yet clear is whether Truss’s intention is simply to tell the Monetary Policy Committee to pull its socks up and be more vigilant in future (with an implicit rebuke to the Chancellor of the Exchequer for the past two years) or if Ministers are set to interfere more. There is a lower profile debate ongoing in respect of financial services regulation, in which Ministers may end up with greater powers contained in the Financial Services and Markets Bill to rewrite regulations not to their liking.

If Truss’s plan is for a greater role for Ministers – and a reduction in independence for bodies that were previously operationally autonomous – problems lie ahead. Some will argue that such moves would increase accountability, but they would also mean a greater concentration of power and greater politicisation of matters that have, until now, been in the hands of experts insulated from public opinion. Many Conservatives may welcome this; the markets may not. Weakening independent institutions also comes with substantial risks.

An issue that has not featured heavily in the leadership debate so far is Europe. Both candidates are (now) Brexiteers, both deny that Brexit has contributed to delays at Dover (which is clearly untrue), both support the Northern Ireland Protocol Bill. Sunak, however, gives the impression of being a relatively pragmatic. Notwithstanding his vote for Leave in 2016, party members are detecting this attribute and do not like it.

Truss, by contrast, has the zeal of the convert and owes the European Research Group and Lord Frost for getting her to the final round. Rumours are swirling in Whitehall that a Ministerial position at the Foreign Office – possibly as Foreign Secretary – awaits Frost, and it is difficult to see how Truss can retreat from the hard line position she has taken in negotiations with the EU hitherto. It is also hard to see that the EU would be keen to reset its relationship with the UK in the event that Truss won, especially if they have to deal with Frost.

This issue has attracted little attention during the contest but the risk of a further deterioration in UK/EU relations is underestimated. A failure by the UK to comply with our obligations under the Trade and Cooperation Agreement may result in severe retaliation from the EU which could involve the loss of tariff-free, quota-free access to EU markets.

Finally, Trussonomics apparently involves lots of deregulation. But promises of deregulation in the abstract without the details count for little. Vague pledges won’t unleash growth.

So where might Trussonomics leave us? The best case scenario is that her fiscal policies give us a short-term boost, an increase in the structural deficit and marginally higher interest rates; the institutional changes amount to very little; and she finds a way to resolve the Northern Ireland Protocol challenges that leaves the TCA intact, even if that means disappointing some of her backers.

The worst case is that the UK appears fiscally irresponsible; our independent institutions are undermined; and we have a trade war with our most important export market. This combination of factors causes a perfect storm in which we lose market credibility, sterling takes a further hit, interest rates rise sharply and business investment and consumer confidence collapse.

My guess is that she is too smart to allow the worst case scenario to happen. To do that, however, she is going to have to move swiftly from focusing on winning the confidence of Conservative MPs and party members to winning the confidence of the markets. That may prove to be a much tougher test.

The post David Gauke: The pluses, minuses and risks of Trussonomics. And the looming shadow of Lord Frost. appeared first on Conservative Home.

Anthony Browne: It’s the economy, stupid. Or should that be: it’s higher growth, stupid?

30 May

Anthony Browne is MP for South Cambridgeshire, the Chair of the Conservative backbench Treasury Committee and a member of the Treasury Select Committee.

“It’s the economy, stupid!”: the phrase at the heart of Bill Clinton’s successful 1992 election campaign in America may have become a political cliché. But like many clichés, its use lingers on because it contains a fundamental truth. 

These are words the Conservative Party needs to remember as we plan for the next two years and the looming general election. A clear, concerted focus on growth and the economy would not just be good for the country, but good politically. It would help to relieve many of the problems the country has – or make it easier for the Government to sort them – and it would also help the Conservative Party hold together its new political coalition of red wall and blue wall. 

When I stepped down as the Observer’s economics correspondent in 1999, it was in part because economics had become too predictable to be newsworthy, with growth and inflation steady.

There is no risk of that now. We have had unparalleled battering from many directions. The global financial crisis, the pandemic, and now the massive surge in global energy and commodity prices that has left the economy seriously wounded.  

Even in this age of fury, most fairminded voters think the Government has dealt with these shocks admirably. Rishi Sunak’s £400 billion support package during the pandemic drew international praise, with economists who appeared in front of us on the Treasury Select Committee falling over themselves to applaud it.

Last week’s support package for families facing the cost-of-living crisis won praise from a wide range of campaign groups who normally condemn the Government. But we are still left with the national debt and taxes at their highest since the aftermath of the Second World War – a risky economic position to be in, and a politically uncomfortable one for a party that claims to believe in low taxes.  

The surprise for most economists, though, is how, given all the battering, the economy is not in worse shape than it is. We had predictions of unemployment rocketing up to 1980s levels – but it is now at record lows, with more jobs than jobless people for the first time ever. Unlike the 1980s, we retain many fundamental economic strengths. 

But still the economy is very precarious. Stagflation looms. Quantitative easing is being unwound. The massive national debt makes us vulnerable to rate rises. The ageing population will steadily build up pressure to increase public spending.

The solution is growth. Higher economic growth – and higher productivity – leads to higher incomes, relieving the cost of living crisis. It would increase tax revenues and reduce welfare payments, improving the national finances, and give the Government flexibility to bring in much needed reforms. On average, one person going from joblessness to job improves the Government’s finances by £6,000 a year. 

The western world has had sluggish economic growth for 15 years, and driving it up should now be the defining mission of this Government. It needs the policies to deliver it, and it needs to communicate it.  The Chancellor set out the mission in his recent Mais lecture, where he laid out the strategy to deliver growth based on “a new culture of enterprise”.

His focus was on what he summarised as Capital, People, Ideas” – encouraging investment, increasing skills and trainingand promoting research and development. His central thesis is that the key to drive up growth is to increase business investment, where the UK lags most of the OECD.

That is why he introduced the temporary “super deduction” tax relief on it, and is now consulting on what to succeed it with, to be announced in the Autumn budget. The 1922 Treasury Backbench Committee, which I chair, is currently gathering evidence from politicians, think tanks and business groups, on which reforms could help to promote growth.

There are many other Government policies that help to do so – from agreeing free trade deals, to investing in infrastructure such as new railways (the newly opened Elizabeth Line in London is an inspiration), introducing freeports, and dramatically increasing research and development funding.

The recent Queen’s speech was full of legislation that will help growth, from removing the ban on gene editing (important for businesses in my constituency) and removing red tape on trade documents to modernising business rates and making financial services regulation more competitive.

But clearly there is much more that can be done. As the editor of this site pointed out in Conservative Home last week, there are many sensible recommendations from the Taskforce on Innovation, Growth and Regulatory Reform that have not yet been implemented. We should use tax breaks to encourage regional development not just public spending. 

Going for growth also needs a mindset change across Government. As one Cabinet Minister put it to me recently, the Treasury has never been interested in growth, just in collecting taxes. Many sensible tax reforms are undermined because the Treasury doesn’t fully assess their impact on longer-term economic activity – just on what first order impacts they would have on government receipts. All policies should be assessed across every Government department on what impact they would have on growth, and those that are beneficial should be prioritised. 

The Government also needs to turn this into compelling narrative that everyone can buy intoDavid Cameron and George Osborne repeated their “Long Term Economic Plan” so often they got ridiculed, but it won them the surprise 2015 outright election victory.

We now need a similar clear plan. Cabinet ministers should mention it in every speech. Every MP should know instantly when asked in TV interviews what the key mission of the Government is: growth. Every civil servant working on a policy should know what the overarching priority is. The whole country should know that is what the mission is.

The Prime Minister is instinctively pro-business, but business clearly needs to be persuaded. The Government needs to ramp up the case for free enterprise and business, and to push back against more statism being the answer to every problem. We need to turn our rhetoric about being the party of low taxes into reality. The public will not believe us if we say we want low taxes when they are at their highest since the Second World War. With the budget deficit shrinking fast, the Government can soon start cutting taxes; a faster growing economy will make it easier to cut them further.  

Having a clear mission on growth is also good politics. In its bid for the middle ground, the Labour Party is trying to position itself as the party of low taxes and of business, but that puts the political frontline on our natural territory.  Just as Conservatives can’t win a bidding war on spending, Labour can’t win a bidding war on growth. Labour can’t stop thinking about how to cut the pie, rather than making it bigger.

Growth can also bridge across the new political coalition. Many other policies that might appeal to Red Wall voters – such as the Rwanda asylum policy, dialling down on net zero or stoking culture wars – risk alienating more liberal Conservative voters in the south.

But a clear mission to promote growth, help business, and cut taxes while balancing the budget appeals to both wings of the party, and can unite it rather than divide it. Being economically liberal and fiscally responsible is the clear political middle groundWhen it comes to what the Conservative mission should be until the election – it’s the economy, stupid! 

Five questions about Sunak’s statement today

26 May

Rishi Sunak, having made his Spring Statement, wanted an autumn follow-up – saying last month that it would be “silly” before to take further major action before then, when the energy price cap is due to rise again.

With poverty for working families hitting a record high, almost a fifth of adults having less than £100 in savings, one in five families facing fuel poverty and Britain facing the biggest drop in living standards since the 1950s, it is scarcely surprising, welcome and almost inevitable that he has been forced off course.

But while there may be some good news today for voters, I am not so sure that it will mean good news for the Conservatives – or the Chancellor.  The downsides of spending money or cutting tax or both now means that those same tax cuts and spending rises can’t be made later – during the run-up to the next election.

Nor are voters, having become used to Sunak deploying his big bazooka during the pandemic, likely to thank him for firing it once again now: familiarity with spending sums so vast as to elude most people’s comprehension may not breed contempt, but it seldom brings gratitude.

And while it is right to give more help to desperate people, the timing of the statement is suspect: clearly, the Government is attempting to “move the story” on from yesterday’s report by Sue Gray.  Which provokes the question: are these measures coherent – or opportunistic?

Confidence that they will be the first is undermined by the weak position of the Chancellor in the wake of the non-dom controversy – and by him having to return to the Commons within only a few months of his last major statement.  And he is worse placed to resist the demands of a Prime Minister whose economic instincts are different from his.

Jack Sunak would eat no fat, and his boss would eat no lean.  It would be unfair to claim that the Chancellor has no interest in growth: his recent Mais lecture was preoccupied by it.  But there is a clash within the Government and elsewhere about the main economic problem facing Britain.

To the Treasury, rising prices are enemy number one.  And so it leans towards lower borrowing and tax rises: it is preoccupied by further interest rises that could intensify an economic downturn. To its critics, low growth is our main foe and, with the deficit lower than was forecast, the Treasury is choking off growth through unnecessarily high taxes.

Johnson’s instincts are to cut tax, spend, borrow if necessary, whack up infrastucture, and “eat, drink and be merry, for tomorrow we die”.  It has been briefed that Sunak will splash out another £10 billion today.  That would be a relatively small proportion of the £90 billion or so by which the deficit undershot the Treasury forecast.

So, then – five sets of questions for today.

  • To what degree will the Chancellor target his measures on those most in need?  Crudely speaking, what will be the trade off between Universal Credit rises and tax cuts (if any)?  If the latter happen, will they be concentrated on workers and business or the retired?
  • How much of this new spending will he seek to find from new windfall taxes and how much by relaxing his plans for deficit reduction and debt repayment…?
  • …And so where will he settle on the relative threats that rising prices and low growth pose to the economy and our future? Will the Treasury shift its position?
  • Will the statement be relatively narrow or broad?  The broader it is, the more of a Spring Statement or Budget-type event it will be.  And the more problematic for Sunak it will become if he is forced to make further such statements before the Budget.
  • If the statement is relatively broad, what will he have to say about supply side reform, faster growth and borrowing to invest in infrastructure, science and skills?

In sum, to what extent will he present a clear plan projected by a clear message?  My starter for ten is “help hard-working people and go for more growth”.

I’m sure that the Chancellor, David Canzini, Isaac Levido and so on can do better than that.  But in order to do better, they need to say something.

Peter Franklin: Don’t turn the Conservative Party into a cargo cult

23 May

Peter Franklin is an Associate Editor of UnHerd.

In the 1930s and 40s, the US military established military bases across the south Pacific. As a result remote island cultures, with little or no contact with the outside world, suddenly found themselves face-to-face with the might of twentieth century America. Though the islanders were in no position to understand the outsiders’ technology, for a brief moment they were able to share in its benefits. But then something terrible happened: the visitors went away again.

It may be that some of the islanders were happy to see the back of the Americans, but others were desperate for the visitors — and their hitherto unimaginable wealth — to return. Indeed, in some places that longing took on a religious aspect.

So-called cargo cults sprang up in numerous locations. Cult practices sometimes took the form of ritually re-enacting the mysterious things that the visitors got up to — like clearing landing strips in the jungle. In other cases, mock aircraft were created out of local materials and symbols like the Red Cross reproduced as objects of reverence. The hope was that such rites would somehow bring back what had been lost.

Cargo cults might seem ridiculous to us — and in fact the term itself has fallen out of academic favour for that very reason. However, we westerners would be foolish to assume that we’re not susceptible to the same kind of thinking. Instead of working through the challenges that face us in the here-and-now, it is often easier to re-enact scenes from an imagined heyday.

Of course, there’s nothing wrong with respecting the past and trying to learn from it. But equally we must be aware that our problems are constantly changing, and the solutions that we apply must change with them.

I’m worried that a discombobulated Conservative Party has forgotten this. Consider, for instance, our response to the return of inflation — and the criticism directed at the Bank of England for not getting on top of it. Clearly, we’ve got a major problem on our hands, but the idea that we can solve it by yanking up interest rates — because that’s what worked before — is pure cargo cultism.

The inflationary monster today is not the same beast that was slain in the 1980s. Nor does its origin lie in the last decade or so of very low interest rates, otherwise it would have shown itself years ago. Rather, the beast was born out of the extraordinary disruption to global supply chains caused by the pandemic and compounded by Putin’s war.

There was a furious reaction when the Governor of the Bank of England, Andrew Bailey, suggested that policymakers were helpless in the face of these inflationary pressures. Bailey could have chosen his words more carefully, but he’s a lot closer to the truth than those who believe that UK interest rates can control global commodity prices.

Other Conservatives see a lack of growth as a bigger problem than rocketing prices. In the long term, they’re probably right — but they’re wrong about the means by which they want to revive the economy: i.e. tax cuts. Again, we see a demand for the ritual re-enactment of policies from the Thatcher era; but the conditions that applied then don’t apply now.

We’re not perpetually on the wrong side of the Laffer Curve. Rather our number one economic problem is the chronic failure of British business to invest in productivity improvements — despite the incentives of lower Corporation Tax, cheap migrant labour and minimal borrowing costs. The Chancellor acknowledged this structural impediment in his Mais Lecture earlier this year, but even he felt the need to appease the tax cut fetishists in his ill-fated Spring Statement.

The ritual re-enactment of past triumphs isn’t limited to economic policy. The Conservative cargo cult is also attempting to resurrect the Right to Buy. To widespread groans, the Government has dusted off a policy to extend the Right so that housing association tenants can buy their homes too.

This is fine in principle, but the offer isn’t attractive without a hefty discount on the market value of the relevant properties— and who is going to pay for that? First proposed in 2015, the Government has already tried, and failed, to make this policy work. There’s no reason to suppose that a second attempt will be any more successful. One has to ask whether a serious effort will be made at all — or whether the announcement was just an excuse to conjure up the past.

However, I don’t want to give the impression that the conservative cargo cult is only about the 1980s. Thatcherite nostalgia is big part of it, but there are more recent triumphs to hark back to — not least, our miraculous escape from the clutches of the EU.

However, the problem with getting Brexit done is that you can’t do it again. Or can you? One fears that the main reason why the government has chosen this moment to unpick the Northern Ireland Protocol is that it needs a Brexity distraction. But if they think they can summon up the spirit of 2019, they’re badly mistaken. Brexit was about getting the EU out of our lives and allowing the UK to forge its own path. That means levelling-up and shaping and economy that works for everyone, not refighting old battles.

That’s why my heart sank when I read about Suella Braverman’s call to bring back the Conservative Party’s torch logo. Digging up this old totem really would be the ultimate cargo cult move. But anyone who thinks that dressing up in Margaret Thatcher’s clothes is going to stop Labour from taking back the Red Wall or the Liberal Democrats from making in-roads down South is deluding themselves.

If the Conservative Party really wants to honour its past, then, like Thatcher, it must fearlessly face-up to and tackle the problems of the present. If that means breaking new ground and attempting the previously impossible, then so be it. After all, our greatest duty to tradition is to take it forward into the future.

Help hard-working people and go for more growth. The economic policy and message that Johnson needs.

23 May

Sue Gray is set to present her report this week.  Boris Johnson’s fate may hang on it.  But whether he stays or goes, the cost of living crisis will remain.  Britain faces the biggest drop in living standards since the 1950s.  And the Government seems to have no agreed plan for what it wants to do or who it wants to help.

Some MPs want benefit rises.  Others want tax cuts.  For some, axeing green levies is the priority.  For others, reductions in VAT. For others still, transferable allowances for families.  Cabinet Ministers are freelancing over a windfall tax.  This is nature abhorring a vaccum with a vengeance.

Essentially, there are two schools of thought.  To the first, the main enemy is rising prices.  Those who believe this tend to want tight monetary and fiscal policy.  To the second, it is low growth.  Those who hold it look favourably on looser monetary and looser fiscal policy, though not necessarily at the same time.

Enter a variant of the second school, as expounded by our columnist, John Redwood.  Essentially, he makes the agonising choice between more borrowing, and the higher interest rates that could come with it, and less spending or more taxes vanish – “just like that”.

This is because Treasury forecasts are consistently wrong, and the deficit came in “at £90 billion below the Office for Budget Responsibility and Treasury forecast”. It follows that Rishi Sunak could use some of that £90 billion before the autumn to help people meet the cost of living.  Which is indeed what most Conservative MPs want him to do.

If this sounds a bit too good to be true, that’s because it is – in a certain sense. Any windfall spent now is one that can’t be spent later (assuming it’s still there).  So the Chancellor would be splashing the cash this year, with the last feasible election date some eighteen months off.

And, of course, money spent now can’t be used to pay off debt. Furthermore, if Sunak goes on a spree, voters won’t be grateful: they never are.  That, after all, is a lesson of Coronavirus.  In any event, the Treasury disputes rosy inflation and interest rate forecasts – arguing that at four per cent of GDP the deficit is stubbornly high.

Nonetheless, voter need requires Sunak to present a package, whatever the party politics. With poverty for working families hitting a record high, and almost a fifth of adults having less than £100 in savings, and one in five families facing fuel poverty, the Chancellor will act before the energy price cap rises again in the autumn.

Having cleared the first hurdle (in other words, decided to present another mini-budget), Johnson, Sunak and company will face the second – namely, determining who it will most aim to help.  Here, the answer is straightforward and uncompromising: those in most need of it.

That means voters who have less room, if any, to cut back their household commitments. They would be helped by a further Council Tax cut for lower bands, extending the warm homes discount, shifting green levies from household bills, and uprating Universal Credit: remember, some 40 per cent of those who receive it are in work.

Raise moral hazard or work disincentives all you like: special help in hard times will always start from the poorest up.  Though it won’t stop there: many of those on Universal Credit, for example, are Nick Timothy’s “just about managing”.  This is a programme for Erdington as well as Easterhouse.

If that sounds discouraging for Conservative voters in Blue Fade seats, or for those clamouring for a cut in the standard rate of income tax now, I have if not exactly good news now then at least the prospect of some later – if they’re interested in the higher growth that helps to fund spending increases and tax increases in the first place.

The first bit is that boosting growth has at least as much to do with supply as demand.  That means Jacob Rees-Mogg, who has made a start in efficiencies with his plan cut civil service numbers, streamling regulation. He has an entire report by Iain Duncan Smith, Theresa Villiers and his colleague George Freeman to draw on.

Its menu covers everything from risk margins in Solvency II through deploying low-carbon technologies on to the National Grid and repealing the EU Clinical Trials Directive to scrapping the Port Services Regulation 2019 to remove
unnecessary, EU-derived regulatory burdens on UK ports.

The biggest supply-side issue of all is housing – the shortage of which harms family life, slows labour mobility and lowers wages.  Michael Gove is tasked with squaring the circle of winning local consent, raising home ownership – and building more houses.  Then there are Sunak’s own productivity-boosting plans.

The second slice of better news is that the Chancellor may be able to persuade the markets that more borrowing and tax cuts should bear no interest rate penalty (whatever is done with a Windfall Tax).  The condition is that these are clearly focused on boosting growth rather than consumption.

On spending, that would imply more for infrastructure, especially in provincial England, for science and technology, and for skills – for example, the rebalancing between academic and vocational courses that the Government wants to see.  On tax, that would suggest cuts for business and workers.

Some of those cuts, if there is enough of that £90 billion left to draw on, could simply be cancelling increases – including the Health and Social Care Levy and, if Sunak can find no convincing replacement for the “super-deduction”, scrapping the Corporation Tax rise.

Rob Colvile wrote yesterday about the negative signal that the rise sends to business and, as so often, the message is almost as important as the detail (such as the rate at which the tax will take the most revenue).  This takes us to the Prime Minister and the Chancellor.

Sunak is able to detail a mass of spending to which he is already committed.  What he and Johnson have not yet done is roll these up into a package and a message.  Remember George Osborne “not balancing the budget on the backs of the poor”?  His “long-term economic plan”?  “We’re all in this together”?

Johnson and Sunak need a message.  Voters will roll up their sleeves and stick it out if they think the Government has a plan for the country, as they did after 1979 and 2010. My starting bid is: “we are helping hard-working people and going for bigger growth”.

I appreciate that many voters don’t know what growth is, and that my draft needs rather a lot of work.  But at least it’s a start.  What alternative is there?  Ministers could sit on their hands and do nothing this year.  Or seek to please the right-wing entertainment industry with performative tax cuts.

Sunak tried a bit of that in his Spring Statement – and look where it got him.  Mention of Sunak leaves me with a riddle.  The non-dom row has sapped his authority.  A Government needs its Chancellor to command fear.  Sunak may do so once again one day, and revive his status as a potential Conservative leader, but at present he doesn’t.

The puzzle is that, on the one hand, Johnson wants a big animal at the Treasury, to deliver for the Government. And that, on the other, he doesn’t, since such a creature would be a threat to him.  I leave this conundrum for our readers to solve.

Gerard Lyons: Ministers have an opportunity to cut taxes, drive supply side reform – and help reduce the cost of living

17 May

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

“My Government’s priority is to grow and strengthen the economy and help ease the cost of living for families.” These opening two lines of the Queen’s Speech provided a powerful message.

Further action is needed to address the cost of living crisis. Also, those affected are not just families, but the vast bulk of households that are being squeezed. If the Government doesn’t appreciate this, then it may have its work cut out.

To its credit, the Government has already announced a host of targeted measures. These include a £150 refund on council tax for those in bands A to D. While welcome, the gains are partially offset by a rise in the average Council Tax in band D of £67.

The main help by far, though, was announced by the Chancellor in the Spring Statement – an increase in the threshold at which the higher rate of national insurance is to be paid. This has now been aligned with the starting threshold for income tax, around £242 per week. There is also the expectation that the Government will act again, as energy bills are expected to rise again this autumn, when the new price cap kicks-in.

Indeed, the cost of living crisis looks set to get worse, before it gets better. UK inflation is set to peak soon, probably above 10 per cent, and will then stay elevated for some time. While inflation is set to decelerate next year, it seems unlikely to return to its two per cent target anytime soon.

It also vital to appreciate that we are very quickly moving away from the main problem being inflation to it being a lack of economic growth. There thus needs to be a reiteration of a clear, executable vision and strategy to grow and strengthen the economy. But first, the cost of living crisis merits further attention.

High fuel and food prices are already exacerbating problems for lower income households, who spend a higher proportion of their income on these areas. At the same time, a large part of peoples’ disposable incomes fund their housing costs. Furthermore, as the retail price index heads higher, rail fares will rise, and changes earlier this year added to the cost of repaying student loans.

While some have savings they can dip into, many don’t. Thus, overall, discretionary spending will be squeezed with widespread negative consequences for retailers and many firms. In turn, there will be upward pressure on costs, prices and wages.

Even the labour market, where unemployment is low, could see change since a sharp economic slowdown is likely, including the possibility of a technical recession with two successive negative quarters of economic growth.

The challenge is that, surely, the Government can’t go on spending taxpayers’ money at every sign of trouble? That is right – but downside economic risks mean intervention is needed, not only to ease the burden but also through low taxes to revitalise growth. The situation also highlights the need to restore both fiscal and monetary stability, once the economy allows, allowing scope to cope with future shocks.

The economic and political shock-absorber is a looser fiscal policy over the next year. Although the budget deficit is higher than one would like, the good news is that it is falling sharply: from £317.8 billion in 2020/21 to £151.8 billion in 2021/22, and is expected by the Office for Budget Responsibility to decline further to £127.8 billion in 2022/23. Moreover, higher inflation is already bolstering tax receipts.

So what should be done? Relaxing fiscal policy and targeted support should not add to inflation since demand is already slowing. Targeted help is needed for those on low incomes, but also there is a need to help the squeezed middle.

Other countries have enacted policies to shield people from rising energy prices, including reduced taxes on energy or VAT; retail price regulation; wholesale price regulation; transfers to vulnerable groups; mandating firms’ behaviour; windfall profits tax; business support; or other measures (such as cutting the green levy in Germany).

While other countries, too, are tightening monetary policy, the UK is unusual in that it is squeezing fiscal policy. Benefits, for instance, were not raised in line with higher inflation in the Spring Statement, when perhaps they should have been. Crucially, the tax take is at an all-time high. The latter needs to be reversed. It includes too many people being dragged into higher tax brackets, and this can only be addressed by raising tax allowances and the levels at which people enter higher tax bands.

Quickly executable targeted measures could include a further increase in the Council Tax rebate. Another would be to use Universal Credit to direct more money to those in most need, while preserving work incentives. A mid-year rerating of benefits to raise them in line with higher inflation may take longer to implement but is another option

Temporary removal of some of the permanent components of fuel duties should be considered although, like many of these measures, further cuts in taxes on energy are not cheap. The temporary five pence cut in fuel duty is set to cost £2.4 billion this fiscal year. Suspending VAT on domestic energy while gas prices remain high has been suggested by some MPs.

Another possible but unlikely option is a temporary suspension of the environmental levy paid on energy bills. It would not, in my view, compromise the Government’s commitment to the green agenda, and could free up about £340 per household per year. The importance of addressing climate change is critical; it is peoples’ ability to pay that is the issue.

There is a clear case for bringing forward the one pence cut in income tax that has been pencilled in for before the next election. The Treasury calculates that this will costs £5.4 billion in its first year, but it would address an important issue in that income tax collection is now heavily concentrated, with roughly four in ten adults only paying it. A broader tax base with low tax rates makes more sense, but that may be a future aim.

There is also a search for non-fiscal measures that can help businesses and households. Measures that both ease the burden on firms and employers, while bolstering their confidence about the future, should figure prominently.

The most obvious is to implement supply-side measures from the Taskforce on Innovation and Growth Report. Although some may take time to feed through, they should bolster business confidence and encourage investment.

Also, measures to turbo-charge the housing market are welcome. Planning reform, while necessary, appears to have taken a back burner. A year ago, in a research paper for Policy Exchange, I outlined measures on the demand side that could help Generation Rent become Generation Buy, including allowing those who cannot afford deposits to use their history of regular rent payment to enter the housing market.

If the economic climate deteriorates, banks should be encouraged to exercise forbearance on loans if firms encounter difficulty. The Bank of England should also re-examine prudential requirements to ensure that these are not having a negative impact on growth.

This proactive policy response to address immediate challenges is complimentary to other areas of policy. It should not threaten the inflation outlook. Crucially, it is consistent with the existing fiscal strategy of reducing the ratio of debt to GDP from its present level of 96.2 per cent and the aim to achieve a significant improvement in the public finances. Strengthening the economy is the aim, easing the cost of living crisis is the immediate focus.

Gerard Lyons: Sunak should raise the lower tax threshold this autumn to put more money in people’s pockets.

5 Apr

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

Higher inflation is inevitable. An economic slowdown is expected. Recession is possible. That is the economic outlook and challenge facing the UK. The question is whether policy makers are doing enough?

This troubling economic climate is not unique to us. All western economies are facing an imminent inflation challenge. And, alongside the war and its consequences, this is starting to weigh on confidence and growth prospects for later this year and next.

It was against this backdrop that the Chancellor delivered the Spring Statement two weeks ago. In many respects, it was a missed opportunity. While he cannot be blamed for higher inflation or fuel prices, and although there were some welcome measures, he has to accept some responsibility for the tax take continuing to rise and failing to increase benefits in line with inflation ahead of the cost-of-living crisis.

As expected, the Official for Budget Responsibility (OBR) projected a slowing economy over coming years and higher inflation before it subsides. After 7.5 per cent growth last year, growth is expected to slow to 3.8 per cent this year and 1.8 per cent next. Inflation, meanwhile, is expected by the OBR to rise from 2.6 per cent last year to an average of 7.4 per cent this, and then be four per cent next and 1.5 per cent in 2024.

Such an outlook – with the cost-of-living squeeze hitting people hard, and an economic slowdown ahead – added to the pressure for the Chancellor to do more to help.

Rishi Sunak stepped up to the plate during the pandemic, and perhaps the challenge from that is that it has created the impression that there is a bottomless pit of money into which he can dip. There isn’t.

Yet, as the Spring Statement showed, while debt is still historically high, the public finances are on an improving trend because of the strong rebound in the economy over the last year. This presented the Chancellor with ample room to act. Public borrowing was £321.9 billion in 2020-21 and is now expected to be £127.8 billion in the last fiscal year, 2021-22, which is £50.9 billion lower than the OBR forecast only last October.

But even last autumn it was clear that the finances were improvingm and at that time this cast doubt on the need to announce the increase in the national insurance. Moreover, the margin of error on these budget forecasts is high, suggesting the Chancellor should not feel bound by them when it comes to fiscal policy – especially for predictions several years into the future.

There is still much uncertainty about how resilient the economy will prove to be, as previous monetary policy stimulus is replaced by tightening, as the post-pandemic rebound loses momentum and as the cost-of-living squeeze bites. Measures of confidence have already started to deteriorate. The GfK measure of consumer confidence fell to its lowest level in sixteen months of -31 in March. This will likely get worse.

The biggest problem has been monetary policy and in this context the Chancellor should – at some stage – call for a fresh look at the Bank of England’s remit, operations and communication.

For more than a decade, the UK has suffered from a cheap money policy. This has had three damning consequences, each with economic and political implications.

First, it has fed rampant asset price inflation, not just in financial markets, but in property prices. This has fed inequality and inter-generational problems.

Second, the combination of low rates and the Bank’s buying of government debt through large-scale quantitative easing has contributed to financial market instability, with markets not pricing properly for risk.

Third, monetary policy has contributed to inflation. Even though the pandemic and supply shortages may have been a catalyst for rising inflation, the Bank’s complacency last year fed the problem. Moreover, it now means too that if the Bank has to tighten monetary policy, it will do so at a time when the economy is less able to cope.

With monetary policy having been too loose for too long, the uncertain economic climate might suggest the need for the Bank to tread carefully. It also added pressure on the Chancellor to do more.

Now, two weeks after the Statement, the dust has still not settled. In part, this is because there is increasing concern about what lies ahead economically, and whether the Government may be forced to act further.

The Treasury’s mindset is on balancing the budget – which they don’t do well – at the expense of economic growth. The prospect of slower future growth means more of the deficit is viewed as structural, not cyclical, necessitating fiscal caution. Furthermore, the fiscal rules which are aimed at making the fiscal numbers appear credible can end up embedding tax increases into future numbers to pay for spending plans.

Concern about the rise in debt service payments in the coming fiscal year also appeared to weigh on the Spring Statement’s plans. Perhaps this was overdone, with this rise explained by the increased cost of the principle of index-linked debt. This future liability counts as borrowing in the year in which it accrues, hence the spike in the next fiscal year which should not divert attention from the improving trend in the budget finances.

The Chancellor did unveil some significant and welcome targeted measures to cushion the pain. Most notably, increasing the National Insurance threshold, bringing it in line from July with income taxes at £12,570. This helped many people.

The other was the immediately fuel duty cut by five pence per litre until next spring – although this has not been fully passed on. This followed on from help announced before his Statement on council tax, fuel bills and changes to the universal credit taper rate. He also pre-announced a cut in income tax.

The alignment of national insurance and income tax allowances was a big deal. It not only helps simplify the tax system, but may be a stepping stone to abolishing national insurance completely. This is something many Chancellors have talked of, but none have done. This moves that closer.

Despite this, more should have been done and more help is now likely. This leads onto whether the Government is seen to be on the front foot, or are forced into acting. For instance, benefits could have been increased in line with the latest, higher inflation numbers. Also, recently announced changes to student loan repayments were unnecessary, and expensive for students, but bring in the Treasury sizeable revenues.

Looking ahead, there is still scope for the Government to cut taxes such as VAT on fuel, and shift green taxes from fuel bills onto general taxation (else they might be seen as a green poll tax, not linked to peoples’ ability to pay).

I would suggest raising the lower tax threshold this autumn, if not sooner, to put more money back into peoples’ pockets and to start to reduce the overall tax burden. Raising the upper tax threshold may be too expensive, or not politically acceptable.

Overall, the OBR reported that living standards are expected to fall by 2.2 per cent this coming year – the largest fall on record. And, despite the statement’s measures, previously announced policy measures and the more tax-rich composition of economic activity, the tax burden is set to rise to its highest since the late 1940’s, from 33 per cent of GDP in 2019/20 to 36.3 per cent in 2026/27.

Alleviating the cost-of-living crisis, keeping inflation in check and delivering stronger growth is the aim. This should be supported by smarter regulations and sensible taxes that lower the overall tax burden.

Gerard Lyons: Sunak’s task tomorrow. The best way of reducing the deficit is to go for growth.

22 Mar

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

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.

David Gauke: To cut taxes and raise spending would be unsustainable – and so fail to salvage the cost of living

14 Feb

David Gauke is a former Justice Secretary, and was an independent candidate in South-West Hertfordshire at the 2019 general election.

Last week, inflation in the US hit 7.5 per cent, the highest for nearly 40 years. In the UK, inflation is expected to hit seven per cent in the spring, the highest level since 1991.

There are clearly some temporary factors in play as the world economy returns to a new normality after two years of a pandemic causing major disruption. The transition will inevitably be bumpy and, the optimists argue, as long as we do not allow ourselves to assume that inflation is here to stay (which could result in a wage price spiral), high inflation should be a relatively short term phenomenon, as the spike in energy costs pass through the system.

The more pessimistic view is that there is a more fundamental over-heating of the economy. We have had years of quantitative easing and low interest rates, unemployment is remarkably low and labour shortages (caused predominantly by older workers retiring earlier) are likely to persist, and energy prices look set to remain high. We cannot assume, say the pessimists, that the current inflation is largely transitory. This latter view is gaining ground, including in the Monetary Policy Committee which has voted for two increases in interest rates in recent weeks, with a minority of members wanting to go further.

Whichever view is correct, inflation and its consequences will be the big domestic issue affecting people’s lives in the next few months. Most obviously, we will see a squeeze in living standards that is going to be very painful for many households.

The Bank of England is forecasting the weakest growth in real post-tax labour incomes in more than 70 years. This will have negative political implications for the Governmen,t with the local elections in May likely to be very difficult for the Conservatives, whoever is their leader at that point.

All of this will increase pressure on the Government to assist households facing higher costs. We have already seen an announcement of a loan scheme for energy costs, but there will be plenty of calls for more action, whether that is dropping or postponing the national insurance increases, cutting VAT on domestic fuel or increasing Universal Credit.

The Treasury will rightly worry about affordability and credibility. On affordability, the public finances are performing better than was predicted by the Office for Budget Responsibility at the time of last year’s October Budget, but the Chancellor will not want to get into the habit of spending all the proceeds of an improved forecast as a matter of course. Scrapping the National Insurance increase would also raise questions of credibility and suggest to the markets that the Government – with an 80 seat majority – is too weak to put up taxes. That is not a good signal to send.

A further problem is that if fiscal policy is being used to soften the consequences of inflation by putting more money into people’s pockets, the Bank of England might be compelled to move further and faster on interest rates. Mortgage holders may find that tax cuts are accompanied by interest rate rises.

The issue of pay rises is already proving to be contentious. The Governor of the Bank of England, Andrew Bailey, attracted criticism for his remarks that workers should not chase pay increases that match inflation.

These words – although well-intentioned – were unfortunate. Putting aside the inevitable criticism that he is in a position than most to afford a pay freeze, it could be interpreted that he was advocating a return to an incomes policy where the man in Whitehall (or, in this case, Threadneedle Street) told everyone else how much they should be paid. Private sector pay should be a matter for the market which can reflect changes in the labour supply and consumer choices.

Bailey was not really advocating a return to incomes policies, even though it sounded a little like that. His point was that large pay rises will make the process of getting inflation under control all the more painful with interest rates potentially having to go higher than would otherwise be the case and workers finding themselves priced out of a job. The higher cost of global commodities is going to have to be absorbed somewhere, and ultimately this will result in a fall in people’s real term income.

Pay rises in the public sector will be a contentious issue. Again, the issue is not really about controlling inflation (at least, only indirectly), but about the public finances. Big increases in public sector pay will place further pressure on spending and, understandably, the Chief Secretary to the Treasury, Simon Clarke, is calling for restraint. Controlling public spending, ensuring that public sector pay is sufficient to recruit, retain and motivate the workforce and avoiding a summer of disputes with the public sector unions will be no easy task.

There are measures that the Government can take to protect people from the squeeze in living standards, but the fundamental problem is that costs are going up faster than we are getting more productive. We can smooth the pain of a short term spike in energy costs – if that is what it is – but in the end these costs will have to be paid by real people, whether taxpayers or consumers.

If this all sounds somewhat fatalistic about the short term, that is true. Ultimately, our standard of living will be affected by factors such as global commodity prices as well as our own productivity. For multiple and complex reasons, many negative factors are coming to a head this spring.

The immediate focus of the debate will be distributional – who we should protect and how we should do it. Such a debate is understandable, and there is a very strong case for protecting the most vulnerable who will struggle to pay their bills.

But if the response to the cost of living pressures is cut taxes or spend more to protect the bulk of the population, we just end up borrowing more and passing on costs to future generations. Such an approach is unsustainable.

The reality is that our national living standards depend upon our success in delivering a highly productive, strong economy. Even in those circumstances, we will always be vulnerable to being buffeted by high commodity prices, but we are more exposed because of a relatively weak currency and low productivity growth.

The predictions made by the Prime Minister as recently as last autumn that we are about to enter a period of high wage growth now ring hollow as, in real terms, wages are falling. There is a risk that both the Government and Opposition focus their energies on short term solutions – often involving borrowing more money – without addressing the fundamentals.

Our living standards reflect the strength of the economy. It has faced a number of difficulties in recent years – some unavoidable, some self-inflicted – and this will have consequences. The challenge for policy-makers, about which we hear too little, is how we deliver that strong economy for the future.

Gerard Lyons: How to tackle the cost of living crisis

11 Jan

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

Crisis? What crisis? The good news is that the economic rebound continues, and the jobs market has returned to broad health. We may also be over the worst of the pandemic, although possible new variants mean that learning to live with Covid and avoiding further restrictions may be a key priority this year.

Yet it is not this recovery but two other economic matters that look set to dominate policy this year: the immediate cost of living crisis and, less talked about, where growth will settle post-pandemic. Views on the latter may influence how policy responds to the former.

While the consensus expects growth around 4.5 per cent this year, after seven per cent last, there is still much pessimism about the future trend rate of growth.

It decelerated following the 2008 global financial crisis. If future growth is low, more of the budget deficit is structural, not cyclical, and needs to be addressed through fiscal restraint – a squeeze on spending or higher taxes. That thinking, which seems to dominate at the Treasury, will be resistant to reversing planned tax hikes for this spring.

Moreover, the economic consensus is that Brexit will exacerbate this challenge. However, despite this common refrain, tax rises are not inevitable. It is not leaving the EU but what you choose to do after you have left that helps determine future growth. In this respect, the Government still needs to articulate a market-friendly pro-growth economic strategy.

It also has bearings for now. There is no easy way to stop a cost-of-living crisis, but the first thing you should do is not implement policies that will make it worse.

The present crisis has multiple components. Inflation that is set to peak at over seven per cent in the spring. Higher energy prices though global in origin, are exacerbated here by decades of poor energy policies, including price caps that are now being lifted.

Furthermore, there have been two separate decisions taken to raise taxes this spring: higher national insurance, and a stealth tax in the form of a freeze on income tax allowances. And then there is a postponement of the triple lock on pensions, which means that they will rise by less than the increase in inflation this year.

Often at times of economic shocks, the search is for a timely, targeted and temporary response – that is, one that addresses the immediate problem but does not change longer-term policy.

Currently, policy is looking at how to support those most in need, which raises questions of how it can be funded.

Temporary financial help as offered during the pandemic would be one approach. It could be paid for by a windfall tax on energy firms. Such a measure would not be ideal, but it has been tried before, for example on North Sea oil producers and banks.

The argument against a windfall tax is the message that it sends. Firms across all sectors may need to factor in that high future profits could be seen as a cash cow by future governments, and this might deter planned investment in the UK by attaching a risk premium to it. Corporate tax rates have already risen, adding to the anti-business perception.

Another option is to cut the five per cent VAT on fuel. The saving, while small, will help those on low incomes. That measure alone, however, would not be enough in itself. And the Prime Minister seems to have ruled the move out as a blunt measure that disproportionately benefits higher earners.

It also appears that the planned tax increases will not be reversed – particularly as the hike in national insurance was effectively presented as a hypothecated tax for health and social care. Reversing this would reopen questions about how to fund the latter.

However, reversing the tax increases makes more economic sense. Not just because it would alleviate the cost-of-living challenge, but because the fiscal numbers, while poor, are improving and mean that such tightening is a choice, not a necessity.

These decisions are not easy. There is no right or wrong answer.  They are about judgement calls – to address the immediate challenge as well as to position for the future.

A current economic debate is about how much fiscal space governments have, despite public debt levels being at an all-time high globally. The debate is less concerned with providing a case for rampant state spending, and more with avoiding being pushed into tightening fiscal policy unnecessarily.

A high level of debt adds to problems, but if the rate of interest is less than the rate of economic growth it creates fiscal space, and improves the chances of debt sustainability. Debt to GDP can be reduced steadily, provided growth is solid and inflation does not let rip. The latter forces rates and yields up, hampering growth.

However, the Bank of England has been asleep at the wheel over the last year. The risk is that the inflation genie is already out of the bottle, as inflation expectations rise and firms increase prices.

In all likelihood, inflation will peak in the second quarter – since some of the initial supply shocks are now over and imported inflation may have peaked already – and, after staying elevated for a short while, will decelerate.

But chances cannot be taken and inflationary risks will force the Bank to raise policy rates this year, and reverse its printing of money by implementing Quantitative Tightening (QT).

We witnessed a short-lived cost-of-living crisis in the wake of 2008, when a weaker pound triggered a temporary rise in inflation. But the last such major crisis was in the mid-1970s.

There is a need not to be taken in too much with current comparisons being made with that decade, since the economy and environment are so different.

While there are not many economic lessons to heed from that period, one springs to mind. In a battle against a rising cost of living, it is vital to have the public on side. Not only so that they can understand the tough policy context, but also in the case of inflation to avoid what are called second-round effects – or put more bluntly, a wage-price spiral.

In June 1975, the annual rate of inflation hit 26 per cent. The then Prime Minister, Harold Wilson, decided that every household needed to receive by post a pamphlet about his policy to fight inflation. I still have a copy.

Entitled Attack on inflation: A Policy for Survival – a Guide to the Government’s programme, its 16 pages made clear why inflation needed to be brought under control. One telling message, in bold capitals was: “the battle (against inflation) cannot be won in one year…but the battle could be lost in one year.”

In the event, the Labour Government lost the battle. Policy focused on a wages and income policy, culminating in the “winter of discontent” in 1978-79. The annual rate of inflation did not fall back into single digits until 1982, after Mrs Thatcher was in power, and also following a deep recession.

I am not advocating such a booklet now, but rather stressing the importance of ensuring that people understand the context of what is happening, especially when here is so much uncertainty and the pain may be severe but short-lived.

The best that can be done is to control the controllables. Provide assistance, ease the pain, reverse the tax hikes, explain why – and focus on a pro-growth strategy.