4 July 2019

Hammond’s last hurrah deserves at least one cheer

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Most commentary on the fiscal plans of the two remaining candidates for Prime Minister has focused on their promises on taxes, rather than spending.

This is both a good thing – tax cuts are at least back on the agenda – and a bad thing, because it shows that reducing the burden of tax is still a much harder sell than ramping up spending. Indeed, tax cuts are often criticised as ‘giveaways’, rather than what they actually are, which is taking less from people’s pockets in the first place.

Spending promises tend to get an easier ride. This can sometimes be justified – increased spending on welfare might be more likely to reach those most in need, while increased spending on infrastructure or skills might be more likely to pay for itself in the longer term. But even then, it is right to ask where the money is coming from, and whether it could be better spent by individuals, families and, yes, by companies, than by the government on their behalf.

So far, there doesn’t seem to be a huge difference between the approaches of Boris Johnson and Jeremy Hunt towards public spending. Both want to do more, perhaps a lot more. Of course, the race for No.10 is no different from any other election campaign and it would be naïve to expect every political promise to be met, or even add up. Or, putting it less cynically, some commitments are firmer than others.

For example, Hunt has argued that ‘it is simply not sustainable to expect one NATO ally [the US] to spend nearly 4 per cent of its GDP on defence while the others spend between 1 per cent and 2 per cent’, and that ‘over the coming decade, we should decisively increase the proportion of GDP we devote to defence’. However, this does not necessarily mean that Mr Hunt thinks we should double our spending from 2 per cent to 4 per cent as well. So far he has only promised an increase to 2.5 per cent of GDP over five years, which might cost an additional £12 billion annually.

It’s also not always clear whether new spending is genuinely new, or simply the allocation of money that has already factored into existing plans. For example, the Office for Budget Responsibility has assumed that the savings on contributions to the EU will be recycled into additional spending, but not yet assigned these savings to any particular department. Initially this will be eaten up by the EU financial settlement (or ‘divorce bill’, assuming we pay one), but Brexit should release around £10 billion for domestic priorities each year from 2023-24.

Nonetheless, the scope for spending increases is clearly limited, especially given the ticking demographic timebomb. Commitments to inflation-busting increases in public sector pay across the board are particularly difficult to justify.

Public sector pay restraint may have hurt, but it has simply allowed private sector pay to catch up and the two sectors now pay about the same on a like-for-like basis. It is therefore hard to argue that public sector workers as a whole are disadvantaged, especially once other benefits, including pensions, are taken into account. Substantial increases should therefore be limited to those areas where there is genuine evidence of recruitment and retention problems, and accompanied by greater regional variation.

To his credit, Philip Hammond has at least tried to inject a little fiscal discipline back into the leadership race as, presumably, he prepares to leave the Treasury. For example, the two leadership candidates have both suggested that their promises could be partly funded by the ‘fiscal headroom’ of around £27 billion built into the latest Budget. This is, as the Chancellor rightly points out, dubious.

This headroom is simply the difference between an official forecast for borrowing (which, like all such forecasts, will almost certainly be wrong) and the level implied by the government’s fiscal rules (which are not that ambitious to begin with). In other words, this isn’t some magic pot of money sitting around waiting to be spent, without requiring additional borrowing on top of what is already a mountain of debt. What’s more, it’s only a one-year figure.

On a no deal Brexit, though, the Chancellor’s recent comments have been less welcome. Indeed, the fact that they have been enthusiastically trumpeted by the Liberal Democrat’s new Treasury spokesperson, one Chuka Umunna, is a bit of a clue. Mr Hammond has made two additional points here, both weak.

First, he has has argued that the fiscal headroom will not be available for spending increases and tax cuts in the event of no deal because it will be needed to cushion the economy from the immediate impact of a “disorderly” exit. However, if the economy does indeed take a dive, this would actually be the ideal time to let the deficit take the strain by spending a little more and taking a little less in tax.

Second, Mr Hammond has argued that the economic damage caused by no deal might cripple the public finances in the longer term too. The Chancellor has cited Treasury analysis suggesting a potential hit to the public finances of “around £90 billion, which will also have to be factored into future spending and tax decisions”.

This is shaky. In particular, the £90 billion figure (plus or minus a few billion) is only a guess at the hit to the public finances in, wait for it, 2035-36. It is not, as some imply, the immediate impact, and both revenues and expenditure would still be much higher than now. It also assumes that ‘no deal’ is where the UK ends up, rather than an alternative stepping stone to a better deal.

Above all, the Treasury’s dire numbers rely on implausibly pessimistic assumptions about the economic impact of no deal, including the cost of non-tariff barriers to trade with the EU. In reality, there is much that both the UK and EU could and would do to limit the damage, and plenty of scope for the UK to make the most of the new opportunities that Brexit would bring.

This at least, then, is familiar Treasury ‘Project Fear’ and the Chancellor can perhaps be forgiven for endorsing work led by his own department. But while the scary Brexit forecasts should be viewed with a healthy dose of scepticism, let us hope his warnings on the need to maintain fiscal discipline have a much longer shelf life.

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Julian Jessop is an independent economist