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.

David Gauke: It’s right that the civil service become more efficient, but I doubt that these plans to reform it will work

23 May

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

Government Ministers want to reduce the size of the civil service. Jacob Rees-Mogg, the Minister for Government Efficiency, has let it be known that he wants to reduce the civil service headcount by approximately 90,000 which would be a fall of 20 per cent and return the numbers to the levels of 2016. Sky News reported on Friday that departments have been asked to model headcount reductions of 20, 30 and 40 per cent.

There is plenty of politics in these announcements and I will get to that in a moment. There are also a large number of practical challenges which are worth highlighting. Having served as Chief Secretary to the Treasury as well as being the Minister responsible or relevant for the three biggest employers of civil servants (at the Department of Work and Pensions, HMRC and the Ministry of Justice), I have a few thoughts on that.

Before turning to those issues, however, it is worth acknowledging that seeking to ensure that public money is spent wisely and that public services are delivered efficiently is a perfectly reasonable thing to do.

Indeed, it would be irresponsible not to seek to do this. We spend taxpayers’ money on public services in order to serve the public. This requires the employment of public servants, but the employment of public servants is incidental to the Government’s purposes, it is not an objective in itself. This is an obvious point, but I can remember at least one meeting with civil service staff where this point had been lost.

Governments should seek to achieve more for less and, if it is possible, to deliver satisfactory public services whilst employing fewer people. This can result in savings for the taxpayer and release workers to make a contribution elsewhere in the economy. Jobs are a cost not a benefit.

Some will argue that reducing headcount results in a deterioration in public services. That is not inevitably so. To take HMRC, for example, this is a department that has grown in confidence and capability over the last twelve years at a time when the number of employees has fallen.

The reason it has been able to do this is that it has embraced technology which means that many clerical tasks which once had to be undertaken manually have been automated, whilst its sophisticated use of data has enabled it to deploy its skilled workforce more efficiently, significantly reducing the tax gap.  But this does not mean that the plan to reduce numbers by 90,000 is realistic.

It is worth analysing why civil service numbers have increased over the last six years and well worth looking at a paper by the Institute for Government on the topic.

The principal reason is that we have wanted the civil service to do more things. The obvious example of this is Brexit. We have returned certain responsibilities to the UK Government from the European Union, and we need to employ people to fulfil those responsibilities. We previously did not have (or need) a Department for International Trade; now we have one employing 2,000 people. We have increased the number of policy staff in the Environment and Culture departments because there is now more policy that needs to be done here. We also have new operational requirements, such as operating a new customs border with the EU, which will require civil servants to operate.

The employment of a few thousand extra civil servants as a consequence of leaving the EU is not a killer argument against Brexit (there are better arguments, but let us leave that for another day).  However, it is an undeniable consequence and it cannot be dismissed, nor is it just temporary. If policy for some matters is permanently going to be located in the UK, then we permanently need to maintain policy capability here.

There are other policy objectives that have risen up the political agenda. Levelling-up – ensuring that prosperity is more equally shared across the country (I think that is what it roughly means) – will not be achieved without a vast effort. This will require people – civil servants – to be employed to make the vast effort.

In some cases, the Government has observed what civil servants are doing and concluded that we would like more of it. Let us take DWP’s work coaches who provide holistic support for those looking to get into employment. Successive Work & Pensions Secretaries have been impressed by the contribution they have made to turning people’s lives round, solving problems ‘upstream’ and contributing to low levels of unemployment. So the number of work coaches has been expanded. For a Government that believes that work is the best way out of poverty, it would be very odd to reverse this.

Of course, some of the additional tasks have been pandemic-related and there are saving to be made. But Covid also raises questions about our overall resilience to future public health emergencies which will have ongoing implications for staffing.

Looking at the public sector as a whole, the Government has clearly concluded that job cuts went too far in some areas over the ‘austerity years’, hence the pledge to recruit 20,000 more police officers. If our intention is to reduce crime, there are other (arguably better) examples of where numbers fell by too much after 2010. The Government is rightly committed to offender rehabilitation. This means we need more probation officers. Probation officers, like work coaches and customs officers, are civil servants. As are those who work in DVLA, the Passport Office and the Courts where there are backlogs and delays that need to be addressed.

There is also something odd about a process which requires departments to come forward now with proposals which in aggregate sees a 90,000 headcount reduction. It is right that spending departments, the Treasury and the Cabinet Office work together to ensure that strategic and bold thinking is undertaken to identify possible savings, including by deprioritising some activities and identifying opportunities for automation. The problem is that there is a time at which this should happen – at the point at which the Comprehensive Spending Review is being determined – and that happened only seven months ago alongside the 2021 Budget.

At the time of the CSR, the Government set out plans which implied a reduction to the civil service headcount of 28,500. This, presumably, was part of the discussions within Government and provided a key assumption in the departmental spending settlements. Now, we have new numbers and a new process is being commenced. Spending departments are entitled to ask what is going on. Is the CSR being reopened or not?

The suspicion is that this is driven by political considerations as part of a desire to be more ‘ideologically Conservative’, appealing to those who think that civil servants are lazy and useless and spend all their time watching daytime television whilst claiming to be working from home.

Putting aside the unfairness of this observation (most current and former ministers would, I suspect, speak highly of the professionalism of the civil service), it is not an attitude that is likely to bring out the best from those upon whom the Government depends to get things done. Nor is it coherent with the big state conservatism that contributed to the 2019 general election victory.

Squeezing greater efficiency from the civil service is to be welcomed but I fear that these proposals have all too familiar characteristics – unrealistically optimistic, politically motivated and ideologically incoherent.

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.

James Kirkup: Sunak’s task next week. To get cash into the hands of those who need it. And launch an energy efficiency mission.

17 Mar

James Kirkup is Director of the Social Market Foundation.

Perhaps it’s because now, as then, I have Covid, but when I ponder Rishi Sunak’s approaching Spring Statement, my thoughts go back to March 2020. Then, Sunak made his bones with the British public with nerveless statements about the support he’d offer for an economy – and a population – teetering on the brink of panic.

Those early days of his chancellorship seem a long time ago now: it’s been a long two years. But there’s a lot to learn from those moments, even if both economics and politics have changed since then.

Then, the dominant issue was a pandemic that would prove to be longer and more serious than most people realised. Today, the same is true of what Westminster calls the “cost of living crisis”.

That phrase is so familiar that a lot of people who use it think that it’s old news – that everyone out there “up and down the country” knows full well how much prices will rise and real incomes will be squeezed.

Well, if they think that, they’re wrong. Rising prices, especially on energy, are still going to come as a nasty shock to a lot of voters. Just because us media and political types know something will happen, don’t assume the wider public does too.

So the first job for next week’s not-a-Budget statement is ruthless honesty about what’s coming – and the limitations of what the state can do, in the short term, about energy prices.

That doesn’t mean doing nothing. The compassionate, responsible response to rising prices should be to concentrate help on those who need it most. That should start with benefits uprating. As things stand, benefits will rise by 3.1 per cent in April, because that’s what CPI inflation was in September. But it’s now at 5.5 per cent and will likely exceed six per cent for the rest of the year.

If Britain really is One Nation, not two, then preventing a deep real-terms cut in the incomes of the poorest should be a priority for Sunak next week.

There’s more to do, of course. Current plans for a £150 council tax rebate for most homes and what amounts to a £200 loan towards energy bills are both over-complex and poorly targetted.

Instead, HMT could simply give £500 to every benefit-claiming household, and £300 to non-benefits households where no-one pays higher rate tax. That wouldn’t cost any more than the current plans: the SMF proposal would cost around £8.4 billion, pretty much the same as existing measures.

Simplicity and speed are key here. What’s needed is a return to the spirit of furlough: just get cash into the hands and accounts of people who need it.

And some people who don’t: the Treasury’s natural objections to the waste involved in universal payments are normally reasonable, but these – still – are not normal times. The strong and natural desire to declare that the exceptional circumstances of the pandemic have passed should not blind us to the fact that Russia’s war on Ukraine is another event of arguably even greater historical significance.

And that offers something of an opportunity, for a politician big enough to seize it. Here’s how Sunak can do so next week.

The immediate and obvious impact of Russian aggression on British lives is via energy. Even though we buy relatively little fossil fuel directly from Russia, we’re still exposed to international prices that are directly and badly susceptible to Russian malfeasance.

Hence the various Government schemes afoot to reduce that exposure: some more wind power, some more extraction from the North Sea, and some wishful thinking about the Saudis and others agreeing to pump more to prices down.

The remarkable thing about all these efforts is ministers almost totally ignoring the best path to reducing British exposure to international energy prices and so easing household energy bills: use less energy.

This is Sunak’s opportunity, though he’ll have to override Treasury orthodoxy and his own inclinations to take it.

By any international standard, Britain’s homes are poorly insulated and badly energy inefficient. This is one of those big, slow and boring national problems that successive governments have nibbled at then pushed aside over several decades.

There are many reasons for this. Voucher schemes are hard to design and easy to exploit: the people most likely to use them would probably have made home improvements anyway. There are always sexier, more immediate things to promise, which are more likely to pay off in time for the next election. No one wants to be the politician telling people to clear their lofts out and fill their wall cavities. Lagging is boring.

More recently, the Treasury has been resisting energy efficiency drives on the grounds that UK industry can’t deliver: not enough workers, not enough material, inadequate supply chains to provide it.

None of these problems is imaginary. But none is insurmountable, to someone with adequate ambition and understanding of how markets work.

The ultimate reason British energy efficiency schemes have failed over decades is a lack of consistency. No policy has stood for long enough to provide confidence and certainty, either to households or industry. The evidence from successful efficiency policies worldwide — New Zealand, Japan, the Netherlands, to name a few – shows that what’s needed above all is the long-term certainty that only strong government policy can offer.

And that’s what Sunak should offer next week: nothing less than a national mission to make Britain’s homes more energy efficient. That mission will take a decade and more, and should be put above party politics: the Chancellor should make a Big Tent offer to Labour to sign up to his aims.

Importantly, this can all be done without so much as mentioning the words Net Zero. The Chancellor’s public ambivalence on climate issues is regrettable, but might not hurt at all here. The best way to get the public to buy in to the national energy efficiency mission isn’t to talk about carbon foregone but pounds saved. The difference between Energy Efficiency Certificate Bands C and D is around £100 per year. And that’s a recurrent saving: who wouldn’t fancy £1000 more in their pocket over the next decade?

This doesn’t all have to be state provision, incidentally. Some banks and building societies are gagging to lend to households to fund home efficiency measures. The Chancellor should use his bully pulpit to egg them on, and prod the rest to do more.

This advice isn’t original or novel, because the energy efficiency issue is a longstanding one that hasn’t really changed. What has changed are the times.

Britain may not be a direct combatant in Russia’s war, but we face wartime economic impacts. That requires a response of similar scale, a great national effort to defend our homes and incomes from unnecessary over-exposure to international energy markets. If he wants to be

the leader of this decade, Rishi Sunak should use his statement next week to launch that unabashedly patriotic drive for energy efficiency, declaring loudly and proudly that it’s time to Lag for Victory.

David Willetts: The case for Sunak to announce a windfall tax on energy companies next week

15 Mar

Lord Willetts is President of the Resolution Foundation. He is a former Minister for Universities and Science.

The Treasury is supposed to work on a stable and predictable annual calendar of economic events. Other departments, like the Foreign Office or Home Office, may just respond to one crisis after another but the Treasury has a regular timetable it can stick to – rather like the annual pattern of rural life in one of those beautiful illustrated medieval cycles of the seasons.

Key anchors for this are the twice yearly updates of the economic forecasts – in the Spring and the Autumn. Autumn makes more sense for public spending decisions, as spending departments need due notice of change in spending plans for the following year.

Tax is rather different and a Spring Budget can help limit forestalling before the new tax year. At the moment, the Treasury is trying to make the Autumn event its main budget announcement, with the Spring forecast much more modest. There has been strong briefing to lower expectations of any big policy announcements next week. But having emerged from one crisis – the pandemic – the Chancellor now finds himself straightaway in a new one driven now by the invasion of Ukraine. He needs to do something.

There is now intense pressure on living standards from the combination of energy prices, food prices and increases in tax. Our forecast at Resolution Foundation is for real household incomes to fall by four per cent this coming financial year – the sharpest squeeze since the 1970s.

We are about to have an unexpected and significant surge in inflation which will hit families hard unless we get help to them promptly. A key mechanism for doing this is through the uprating of benefits, from Universal Credit to the State Pension. The problem is that benefits are uprated every April, based on the previous September’s CPI inflation rate. But last September was a different era – we hadn’t even heard of Omicron back then.

This means that benefits will rise by 3.1 per cent even while inflation is forecast to rise to over 8 per cent. Over the year this amounts to a £10 real-terms cut in support for millions of low-and-middle income families, as well as pensioners.

One solution would be simply to bring forward next year’s likely uprating increase to this year. There would be a period when benefits are higher than they otherwise would be, but the aim would be to do an uprating of less than inflation next year so as to get back on track. The key advantages of bringing forward benefits uprating is that it is targeted and temporary. The same cannot be said for many of the alternatives being proposed.

There is also pressure from Conservative MPs to help families with tax cuts. One candidate is to postpone or abandon the National Insurance increase to fund the NHS and social care. This measure has turned out to be badly timed, but it is still right to recognise that if we are to spend more on health and social care we have to pay for it. If it were delayed it would come in closer to the next election.

Moreover, low-income families hit hardest by high food prices and energy bills would gain the least from cancelling or postponing this tax rise. And it is important that it does not look as if the Chancellor retreats in the face of political and media pressure. He is earning a reputation as a true fiscal Conservative. That reputation helps him maintain the confidence of markets. He should not endanger it by abandoning the national insurance increase.

Another candidate to deliver tax cuts is fuel duty. Robert Halfon is an indefatigable campaigner on this. It is emblematic of white van man. But how much the financial reality lives up to this is not clear – affluent people have bigger cars and drive further. But the Treasury knows that fuel duty is one of their revenue sources now in long term decline as electric vehicles replace the old gas guzzlers, so they may be more willing to give some of it up just to ease the political pressure.

Another option would be to cut the rate of VAT on energy. This could be branded as a measure made possible by Brexit as we now have more control over our own VAT rates. And it helps a wider range of people than car drivers with higher mileage. I believe it would be a stronger candidate than either reversing the national insurance increase or cutting fuel duty.

However if the Chancellor is spending money bringing forward next year’s benefits increase and cutting taxes he needs some way to help fund that. And there may be emergency increases in spending on military help for Ukraine and support for its refugees. Of course, in a crisis such as the one created by Russia’s invasion of Ukraine now, he could say that some of the spending is generated by war, and that can be financed by borrowing. We spend the money now to make life safer for future generations who may eventually pay – way out in the future. That was demonstrated in a 1958 TV interview exchange between the young Robin Day and the then Governor of the Bank of England, Lord Cobbold:

Day: Have we paid for World War Two?

Cobbold: No.

Day: Have we paid for World War One?

Cobbold: No.

Day: Have we paid for the battle of Waterloo?

Cobbold: I don’t think you can exactly say that.

But a Conservative Chancellor may wish to show that not all of any increases in spending will be financed by borrowing. Whilst many groups are suffering from high energy prices heavily driven now by the Ukraine crisis there is one group which is clearly benefitting – energy companies.

Their costs of production have not increased significantly but the price of oil and gas has so they are making exceptional profits. There is a case for a windfall tax on them. The political problem is that this is what Labour has proposed, but this policy option should not belong to Labour alone. Conservative Chancellors have levied windfall taxes on banks and on energy companies in the past. And the Chancellor could broaden the base further than Labour. There could be other tax measures too – a tax on the sale of ultra-high-value mansions for example?

So I hope we see help for those under pressure and perhaps other spending as well. And if it costs a lot it should be funded not simply by borrowing but also by a tax on the energy companies who are doing well out of the crisis. But we must promise not to call it a Budget.

David Gauke: Higher Universal Credit, public sector pay, state pensions – perhaps some tax cuts. What Sunak should do next.

14 Mar

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

In nine days’ time, Rishi Sunak will deliver his Spring Statement. It was clearly his intention that it would be a relatively low-key event. The Office for Budget Responsibility would update its forecasts and perhaps a few reviews would be announced, but there would be little by way of big announcements on tax or spending policy. Spending matters were dealt with last October in the Comprehensive Spending Review, and tax announcements belong in a Budget – with the next one due in the autumn.

The Treasury likes having just one big fiscal event a year. It allows enough time for policies to be properly considered and it reduces the scope for other parts of Government to lobby for voter-friendly policies that cause havoc for the public finances. Sunak, wary of his Downing Street neighbour who is susceptible to such temptations, is likely to take the view that limiting this tiresome process to once a year is highly desirable. For one thing, it extends the period of time before the Prime Minister learns to spot the various Treasury tricks used to frustrate any attempt by outsiders at interfering in Budget matters.

The Chancellor was already under pressure to make the Spring Statement more substantial because of the cost of living squeeze. He pre-empted this with an announcement on a Council Tax rebate and loans on energy costs, and dug in on the forthcoming increase in national insurance contributions. We were heading for a tough spring, but it looked as if he could hold the line. And then came Russia’s invasion of Ukraine.

There are certain items of additional immediate expenditure necessary in response to the invasion that should not cause the Treasury too much difficulty. Additional emergency defence expenditure, including arms to Ukraine and NATO allies in the region; humanitarian aid for Ukraine and Ukrainian refugees; targeted interventions to expand domestic energy sources. There is a case (about which I suspect the Treasury is sceptical over the practicalities) for a big push over the next few months in improving home insulation.

It would be understandable if the Treasury’s focus is currently on what we need to do now, and address the more strategic questions later when the position with Ukraine has become clearer. The answer to such questions will almost certainly result in higher defence expenditure in the medium term, which will leave the Treasury with the headache of funding it. Both the long-term spending and the funding can be resolved at a later date.

Where it gets really difficult for the Treasury is the cost of living crisis. Before determining his policy response, the Chancellor will need to determine to what extent the crisis is the consequence of short-term, exceptional factors, such as this war, or whether it reveals that the cost of living is permanently higher than previously thought. If it is largely the former, the case for borrowing to intervene is stronger; if it is principally the latter, the case for taking those higher costs on the chin (preferably whilst protecting the most vulnerable) is increased.

We know that Sunak is a fiscal conservative. He will not consider it morally acceptable to subsidise current living standards at the expense of future generations in normal times. This is an important caveat. After all, Sunak the fiscal conservative is also the Chancellor who broke peacetime borrowing records in his first year in office. Needs must in exceptional circumstances.

There is a respectable argument to say that much of the squeeze in living standards is the consequence of high energy prices that stem from the invasion of Ukraine and our response to it; that this is the cost of economic warfare in a struggle in which we must prevail; and that future generations should not object to paying off debts incurred to combat threats to our way of life. In other words, protecting living standards now is to some extent analogous with creating a war debt.

The analogy only goes so far. We accumulated a lot of debt in two world wars and future generations did not resent it, but we also spent a great deal on defence during the Cold War during a period of time when debt generally fell as a percentage of GDP. Are we in a conflict lasting, at most, a few years or is this the new normal which may last decades? If the former, we can take a hit to our borrowing, if the latter we need to worry more about fiscal sustainability.

The situation is also complicated by the fact that much of the squeeze pre-dates the Ukrainian war. Energy prices were already high; living standards already set to fall. We are poorer than we previously thought, and that is unlikely to be immediately reversed, even if the Putin regime falls tomorrow and the Ukrainian conflict is quickly resolved. This suggests that we cannot avoid at least some hit to living standards,

A reasonable response would be to be willing to borrow to soften – but not eliminate – the squeeze in living standards. Higher increases in Universal Credit, the State pension and public sector pay than previously planned, perhaps some tax cuts (as many Conservative MPs are demanding), maybe an expansion of the council tax rebate scheme. Even taking into account that tax receipts have been higher than the OBR predicted in October, measures which only go half way to avoid falling living standards will see a deterioration of the public finances.

The Treasury then has two further complications.

First, inflation. The intention may be just to protect standards of living but borrowing more will constitute a fiscal stimulus at a time inflation is approaching double figures. This could result in the Bank of England increasing interest rates faster than would otherwise have been the case, which will impose further pressures on many mortgage-holders.

Economists differ on how big an inflationary problem we have and how far interest rates will rise (a further increase by the Bank of England is widely expected this week). Clearly, prices are rising quickly but higher commodity prices also take money out of the economy and suppress demand elsewhere. The risk is that we see stagnation – inflation and a stagnating economy as we saw after the oil shock of 1973.

The second problem is that temporary fiscal measures to address temporary cost of living pressures will have to be reversed when circumstances change. The experience of reversing the temporary UC uplift was a politically difficult one and, I suspect, has driven the Treasury to the bespoke council tax rebate scheme, which will be easier to drop in future. This might be good politics, but ends up with more complexity in our tax and benefit system.

All of this makes next week’s Spring Statement much more difficult than previously assumed. The briefing from the Treasury is that it is going to be policy-light, but I am sceptical. Domestic politics for the next few months will likely be dominated by the squeeze on living standards and inaction in the face of this will be unsustainable and politically perilous for the Chancellor.

Finding a response, however, that satisfies the public and Conservative MPs but does not further weaken the long-term outlook for inflation or the public finances may be Rishi Sunak’s greatest test yet. March 23 will be a big political moment after all.

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.

‘The Prime Minister’s tax rise’

25 Jan

Last autumn, before the Government’s foot-shooting spree began in earnest, it pushed ahead with the controversial decision to increase taxes on working-age people in order to protect the asset wealth of older people.

By pushing up National Insurance, the ‘Social Care Levy’ is supposed to avoid the need for elderly citizens to sell their homes in order to pay for end-of-life care.

At the time, there felt as if precious few Conservatives were speaking out against the policy. Just as with abandoning planning reform, it looked like another area in which the party was set to strangle its future coalition in order to pander to powerful vested interests amongst its current one.

Yet just a few months on, the NI hike is now under sustained internal attack. High-profile MPs such as David Davis and Robert Jenrick have warned that Tory support will ‘evaporate’ unless the move is abandoned. And more tellingly still, Rishi Sunak has started calling it “the Prime Minister’s tax”.

Is the appellation fair? A tax rise wasn’t the only way to fund social care, after all: the Chancellor enjoyed a £30bn/pa windfall at the most recent budget, which would more than cover the money raised by increasing NI. He chose to spend it elsewhere.

Sunak would probably counter that this is what being a proper fiscal conservative looks like. I summed up the ambition set out in his Budget speech thus: “the Government must only be borrowing to actually invest, with everyday spending covered by taxation”. If the Prime Minister and the Health Secretary want more spending, then his duty as Chancellor is to find a politically-saleable way of raising the money.

And what’s the alternative? Our own Gerry Lyons suggests the Government should be more relaxed about borrowing against growth; asking older voters to actually pay in is likely politically impossible; so too is the sort of wholesale overhaul of the healthcare system which Ministers apparently concede, in private, is increasingly necessary. If Sunak would rather meet the challenge without this tax, he’ll need to explain how he would pay for it – and MPs may not like his answer any more than Johnson’s.

Regardless, it is a testament to the unravelling of Boris Johnson’s authority that the consensus behind his grand bargain on social care is coming apart so quickly, and Sunak’s positioning suggests that it may not survive a leadership contest.

Whether or not any of the candidates can come up with a better and more sustainable alternative than just borrowing the cash and hoping for the best, on the other hand, remains to be seen.

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.