On Wednesday, Philip Hammond will deliver his first – and last – Spring Budget. But how much freedom does he have? What measures should he prioritise? And how strong is the economy anyway? CapX’s editor, Robert Colvile, asked the biggest brains at Britain’s leading think-tanks to deliver their verdict, in the ultimate Budget roundtable.
Are you optimistic or pessimistic about the state of the British economy?
Julian Jessop, chief economist at the Institute for Economic Affairs (IEA): I’m relatively optimistic. Fears that inflation will surge and investment collapse as EU exit approaches are overdone. Intense price competition and a robust labour market should help to protect household real incomes, while the UK can still build on its many advantages as a location for international businesses. I therefore expect the economy to continue to surprise on the upside, as it has since the Brexit vote itself.
Alex Wild, research director at the TaxPayers’ Alliance (TPA): Reasonably optimistic. I’m pro-Brexit but thought there would be a small short-term hit. But then, I don’t think a lot of businesses, especially big ones, had ever heard the case for Brexit that most Outers in the Conservative Party have been making for years until Theresa May’s Lancaster House speech.
Matt Whittaker, chief economist at the Resolution Foundation (RF): Following two years of relatively good growth, I’m concerned that we’re moving from a “mini-boom” in living standards back into a period of stagnation. But I am hopeful for the capacity of policy flexibility to help.
Daniel Mahoney, head of economic research at the Centre for Policy Studies (CPS): Developments since the EU referendum give cause for cautious optimism. The UK’s robust economic growth is encouraging, and the fall in the value of sterling was probably well overdue. However, the upcoming squeeze on living standards is, of course, a concern. And many of the UK economy’s underlying issues persist – including a stubborn budget deficit and growing levels household indebtedness.
Warwick Lightfoot, head of economics and social policy at Policy Exchange and former special adviser to Nigel Lawson, John Major and Norman Lamont (PolEx): Optimistic. The UK economy is flexible and adaptable and has received a powerful stimulus from a lower exchange rate.
What do you see as the biggest problems facing it?
IEA: The process of Brexit will obviously be disruptive, and it is hard to see how any new trade deal with the remainder of the EU can be as “frictionless” as the current arrangements. I am also concerned that the UK will lose some of the economic benefits of free movement of labour. But there is time to get the details right – while also making the most of the opportunities to deregulate the economy and truly embrace free trade. The greater risk may be that the Government fails to take advantage of these opportunities, preferring instead to increase intervention in the economy (including ill-judged “industrial strategies”) to try to mitigate the “shock”.
RF: With so many unknowns about just what Brexit could – and should – look like, it’s extremely difficult to second-guess what might happen next. That in itself is a problem, of course, because it militates against long-term planning and investment. Indeed, one in three firms say they’ve under-invested in the last five years, and nearly all of them point to uncertainty as being one of the key barriers.
But perhaps the biggest threat in the near-term relates to the one thing we can be fairly certain of, namely that inflation will continue to rise. Given that employment is already at a record high, productivity continues to stagnate and working-age benefits are frozen in cash terms, that will almost certainly result in a slowdown in earnings and income growth.
If our economy remains as reliant as it has been in recent years on consumer spending – private consumption drove more than 100 per cent of GDP growth in 2016 – we are likely to be faced with a choice between sustaining growth rates via increased borrowing or accepting a slowdown in our already modest levels of GDP per capita growth.
TPA: There are still enormous fiscal challenges which are being ignored – and the appetite for addressing them is waning. There remain big questions about how and when to tighten monetary policy, though these are nothing new.
CPS: Probably the dangers arising from a prolonged period of loose monetary policy. Dangerous levels of asset price inflation and the growth in household debt are real concerns. And the Bank of England’s ability to respond to any upcoming economic shocks is severely constrained.
PolEx: I have some concerns about the need to establish a stable long-term monetary policy framework that will keep inflation low.
What are you expecting Philip Hammond to focus on?
TPA: I’d be surprised if there was much beyond social care and business rates. Hammond seems genuinely keen to make the spring fiscal statement more of an update rather than a policy making event so I think it will be very limited in scope. This isn’t necessarily a bad thing.
PolEx: I think he’ll want to remind Parliament about the importance of controlling public expenditure and will want to do something to enhance the competitiveness of the business tax regime, as well as reassure people on business rates and social care.
Over the last few years, the tax system has become incredibly complex. Tax credits, the withdrawal of tax allowances and child benefit have created a personal income tax regime that resembles a Manhattan skyline. I will be interested to see whether he does something to simplify that landscape.
RF: In practical terms, the Chancellor is likely to put a lot of emphasis on the Autumn Budget. Having made much of the need to switch to a single annual fiscal event, it would be odd if he were to produce a final Spring Budget that’s filled to the brim with measures.
In setting out future themes, though, we can expect to hear more about reform of taxation for the self-employed, further discussion of the importance of investment and industrial strategy, and the announcement of new funds for social care – funded in part by “new” departmental efficiency savings in 2019-20 that were actually announced by George Osborne.
IEA: This Budget will probably be a holding operation ahead of the “main event” in the autumn. Nonetheless, the Chancellor is unlikely to want to waste the opportunity to make a few politically savvy tweaks now. This will surely include some additional measures to ease the burden of the business rates review on smaller companies – raising the threshold for the rateable value at which they start to pay tax, and/or extending the tapering above this threshold.
Daniel Mahoney: He will, of course, need to tackle the discrepancies with business rate reform and underfunding in social care. But the overall theme of the Budget will likely be productivity and competitiveness.
And how much freedom of action does he have?
TPA: That really depends on relations between No 10 and No 11. There’s been a lot of talk about “wiggle room” but I’d hope any loosening would come from the tax side. Why is it that every time the borrowing figures are worse than expected, there are no further spending cuts, but when they’re better than expected, the “windfall” is sprayed around?
IEA: The public finances do look a little healthier than they did in November. Borrowing is on track to be as much as £10bn lower than anticipated this year and perhaps £5bn lower in each of the next few years. The relaxation of the fiscal rules in the wake of the Brexit vote has also given the Chancellor some more flexibility.
But it would be wrong to regard these sums as a “windfall” that can be spent at will. The budget deficit and the levels of both public spending and taxation are all still too high.
CPS: Although Hammond is expected to undershoot his borrowing target for this financial year, the Budget cannot be full of giveaways. The deficit remains high and the national debt continues to grow. Ensuring that national debt to GDP levels remain under control is important, particularly as a high national debt can affect long-term economic growth rates.
RF: The changed circumstances associated with Brexit vote provide the Chancellor, and the government more generally, with a rare level of freedom of action. While all governments have to measure themselves again manifesto promises, this one can legitimately argue that the world has moved on in a way that requires some new thinking.
By sensibly establishing a very loose set of fiscal rules for himself in last November’s Autumn Statement, Phillip Hammond also has significant flexibility in relation to his overall tax and spending envelope.
PolEx: I think he’s got very little freedom – UK fiscal policy is both politically and practically constrained. Previous commitments by the Conservative Party make it difficult to raise taxes, and there are a series of spending pressures that arise from an ageing population.
The Government’s narrow majority in the House of Commons means that any discretionary change in the tax system, or spending plans that requires contentious primary legislation, would be difficult to accomplish.
Should Hammond still be trying to eliminate the deficit? And how much of a priority should he make it?
TPA: Absolutely, it should be a high priority. We’re about to enter the 16th consecutive year in which the government has run a deficit and it will still be greater than the rate of growth. For all the bluster, this year government spending is projected to be less than 0.001 per cent lower than it was in 2010-11 in real terms. And demographic headwinds will continue to put upwards pressure on public spending, which is forecast to drive the national debt to 234 per cent of GDP in 50 years’ time.
CPS: Dropping the 2020 budget surplus target in the immediate aftermath of the referendum had some merit: there were legitimate worries about a hit to confidence and the prospect of a recession. However, these concerns turned out to be unfounded. Hammond should therefore still be targeting a surplus by 2020 – although some flexibility is, of course, necessary if problems emerge in the coming years.
RF: The annual deficit remains well above its historic norm, but it’s edging towards the sort of territory we’ve been comfortable with in the past. The difficulty is that it does so against a backdrop of highly elevated national debt. As such, there’s still some work to do to bring the deficit down. But the Chancellor doesn’t necessarily have to target balance – it’s perfectly possible to run a modest annual deficit and still reduce the stock of debt as a share of GDP.
IEA: The case for fiscal discipline is arguably even stronger now than ever. The economy is in good shape and there is no need for additional support. In particular, the Chancellor should resist the siren calls for a splurge on infrastructure spending – a clumsy tool at the best of times. What’s more, even after years of “austerity”, public sector spending still accounts for around 40 per cent of GDP – higher than before the global financial crisis.
PolEx: Government’s priority should be to control public expenditure, so further progress does need to be made in eliminating the structural budget deficit. He should be aiming to roughly balance the budget over the economic cycle.
There’s been a lot of talk about business rates and social care as key issues ahead of the Budget. Are there any other areas you’re especially concerned about?
TPA: The lack of interest in deficit reduction, and ministers becoming complacent because of the opposition’s incompetence!
IEA: There are lots of things wrong with the economy, but the solutions rarely involve the Chancellor doing (and taking) more, rather than less.
PolEx: Successive governments have flunked the issue of social care since the NHS and the welfare state were created in the 1940s. The Government should re-examine the recommendations of the Sutherland Royal Commission that reported in 1999 and recognise that it has to be funded out of general taxation.
CPS: Marginal tax rates continue to be problematic, particularly for the low paid. The introduction of Universal Credit has helped reduce these rates, but the taper rate is still a very high 63 per cent. That’s more than 50 per cent higher than the top rate of income tax.
RF: The tax credits U-turn of November 2015 highlighted the extent to which the public – and large numbers within the Conservative Party – disliked the idea of sharp cuts in government support for hard-pressed working families. Yet many of those cuts are still set to be delivered over the coming years under the new system of Universal Credit. While less visible than the tax credit proposals were, these and other working-age benefit cuts are set to significantly reduce incomes across much of the bottom half of the working-age income distribution between now and 2020. They also risk undermining the very purpose of Universal Credit.
If there was one big headline measure you’d like to see from the Budget, what would it be?
CPS: Scrapping of air passenger duty. It would reduce air fares for holiday makers, and evidence suggests that the Treasury’s overall fiscal position would be unaffected.
TPA: A big overhaul of property taxes is overdue. Stamp Duty should go and introducing some additional bands of council tax at the top end would be an acceptable price to pay for this. Business rates also.
RF: Scrapping plans for further reductions in corporation tax and income tax, and instead putting money into restoring the support offered by Universal Credit and other working-age benefits.
IEA: The announcement of a long-term review with the aim of cutting public spending back to no more than 35 per cent of GDP (preferably lower), alongside fundamental reform and simplification of the tax system to reduce the burden on the economy.
PolEx: A clear statement from the Government about their objective to reduce public expenditure as a share of national income, with the aim of stabilising the ratio of government spending to national income over the economic cycle at no greater than 35 per cent of GDP.
And if there were two or three smaller, cheaper things that could be done, what should the priority be?
IEA: Reduce “sin taxes” on spending that hit poorer households particularly hard, including long-overdue reform of the taxation of alcohol, and abandon the levy on sugary drinks. Failing that, bring forward the promised increases in the personal allowance for income tax. On the spending side, something more for mental health.
CPS: Some measures to tackle the cost of household bills. This could include a review of energy levies, announcing retail competition in the water industry and backing more open access on UK railways.
PolEx: Progress on addressing the very high marginal tax rates that result from the withdrawal of child benefit and personal allowances.
RF: A focus on fixing our chronic productivity problem and shifting the economy’s reliance away from consumption could be supported by tax – and potentially regulatory – reform that countered the trend towards short-termism in British business, and instead increase incentives for longer-term approaches towards investment. I’d also like to see a commitment to exploring the potential for reform in the politically difficult area of land and wealth taxation, given the increasing narrowness of the tax base.
TPA: The annual limit on pension contributions should be abolished. A lifetime limit is necessarybut the annual limit just punishes people on lumpy incomes by stopping them from making big contributions in good years. Hammond should also get rid of Osborne’s crazy “main residence nil-rate band” for inheritance tax. It’s a tax cut of £630 million next year, so just increase the existing nil rate band to an equivalent level rather than introducing complications that discriminate in favour of property assets.
Hammond’s spoken a lot about Britain having a productivity problem. How would you tackle it?
TPA: These are not just challenges faced by the UK, and we have to be very careful comparing figures from different countries with different unemployment rates. For example, statistically France has superior productivity than Switzerland. This is because the less productive are unemployed and their public sector workers are overpaid, inflating the figure.
There are many issues that need addressing but the tax system is a big culprit. Stamp duty has a terrible effect on labour mobility by deterring people from moving across the country to take up better jobs.
IEA: Less intervention, not more. One cause of the problem is that many unproductive businesses are being protected by lobbying groups and keep afloat by ultra-loose monetary policy. The market should be allowed to redirect resources towards more productive uses, even if this means some “zombie” firms are finally put to rest. The education system should also be free to provide the types of training that businesses want.
CPS: It’s difficult, but infrastructure policy is clearly key. The Government can help boost productivity by offering clear political commitments to necessary infrastructure improvements – particularly in areas such as airport expansion.
PolEx: Productivity in advanced economies is a complex subject that Policy Exchange is exploring in our industrial strategy work. The Chancellor should concentrate on work incentives in the tax and benefit system, like the marginal tax rates and marginal rates of withdrawal of benefit.
RF: I think I answered this in the question just now!
Where do you think the economy will be in a year’s time?
PolEx: In a similar position to where it is now – but probably growing at a faster pace.
IEA: Growth last year was close to 2 per cent and I expect a similar performance this year and next. I hope that the Bank of England will feel confident enough to raise interest rates within a year too.
CPS: Economic growth will have probably seen a modest slowdown, and earnings growth will likely be lagging inflation. However, the overall outlook will not have seen significant change.
RF: Much will depend on how consumers respond to rising inflation and any associated slowdown in earnings growth. Towards the end of 2016 they reacted by charging up their credit cards and carrying on spending. If that trend continues, then growth rates might hold up – but with question marks over the sustainability and potential problems being stored up for 2018.
My guess is that they’ll be less willing to borrow as the year goes on, particularly if the recent employment plateau turns into a modest reduction as firms continue to put recruitment plans on hold amid Brexit uncertainty. If that transpires, then we can expect growth rates to drop.
TPA: About 2 per cent bigger. But as Tim Harford says, forecasts are like Pringles – we find it hard to resist them, but there’s no great virtue to them. For example, the IFS’s forecasts are being quoted left, right and centre as facts – but their child poverty projections from 2011 have been proved massively wrong. That isn’t a dig at the IFS, it’s just that they’re the most quoted. At Budgets, it’s more important to look at policy decisions than forecasts.
Are there any potential shocks that you’re particularly worried about? Brexit? Greece? Trump-style protectionism?
RF: The worrying thing about 2017 is that a whole range of potential risks feel a little more likely today than 12 months ago. If there is a wobble, then the position of China looks particularly troubling. The scale of credit expansion that has occurred since the financial crisis leaves the banking system looking hugely exposed. Trump-inspired higher US interest rates could prove the catalyst for a Chinese property and banking crisis that quickly ripples out across an already nervous world economy.
CPS: The possibility of President Marine Le Pen in just a few months’ time would lead to enormous economic and political fallout across the continent. Of course, French political insiders do not seem to think Le Pen has a chance, but the betting markets disagree. Don’t be too surprised if she takes the crown.
TPA: Worried might not be the right word, but there is real potential for some shocks. Trump has adopted a more conciliatory tone recently, but who’s to say he won’t turn the international corporate tax system on its head with a destination-based cash flow tax?
Greece also needs another bailout this summer and there remains a big gulf between the IMF and the eurozone leaders on the subject of debt relief – is that something else Trump could derail? And as Daniel says, the upcoming elections in France pose an urgent and very serious threat to the EU.
IEA: The continued strength of the UK economy since the Brexit vote has been helped by improvements in the global backdrop, notably fading fears over oil prices and China. These external risks therefore still need watching. Political and economic developments in the rest of Europe will also remain a source of uncertainty, but I’m wary of underestimating the degree of popular support for the EU project outside the UK – including in Germany and France, as well as Greece.
Trump is the wildcard. His administration does appear to be rowing back on the most extreme rhetoric on protectionism while saying some good things on deregulation. I am worried, though, that there is too much optimism about the scope to boost US growth by unfunded tax cuts and infrastructure spending.
PolEx: Further crises within the Eurozone are possible given its inherent defects. The big challenge will come in the more mature phases of the present economic cycle, as central banks led by the Federal Reserve begin to wind down their balance sheets, and the regulation of banks and financial markets is re-examined and potentially liberalised at the stage in the cycle when monetary conditions may need to be decisively tightened.
Finally, this is the last Spring Budget before we move to having one major financial statement a year. Will you miss them?
RF: No!
CPS: No.
IEA: No. Twice-yearly fiscal events simply encourage short-termism and provide more opportunities for Chancellors to come up with gimmicks that complicate the tax and benefit system and add to the burden on the economy. Indeed, once you have the basics right, even once-yearly Budgets could be downgraded.
TPA: Absolutely not. The more set-piece events, the more opportunities there are for Chancellors to throw taxpayers’ money at politically expedient projects. Hammond is doing the right thing by going down to one major statement and having it at the end of the calendar year. Let’s hope he can resist the temptation to revert to the old system.
PolEx: I think that much of the rhetoric about the merits of the timing and character of the Budget statement is exaggerated. Budgets are inherently political events. The traditional British budget with its “Derby Day” atmosphere has provided an opportunity to stimulate public interest in the nation’s finances and the decisions taken on their behalf.
John Major’s government decided to move to an autumn Budget that brought decisions about spending and taxation together in a single financial statement. It is not clear that the quality of the decisions and the measures were any better than those made in the previous years. And having supported the idea in opposition, Gordon Brown swiftly abandoned the practice and reverted to spring!
