14 September 2021

Rishi’s reasons to be cheerful


The Treasury is keeping busy, but hopefully not too busy. On the same day as the Prime Minister unveiled the ‘health and social care levy’, the Chancellor revealed last week that we will only have to wait another 50 days for the Autumn Budget, due on October 27.

The focus next month will probably be on spending, rather than taxation. Rishi Sunak will be announcing the results of the long-awaited Spending Review for the next three years, which will set departmental budgets for 2022-23 to 2024-25.

Sunak will surely be reluctant to announce even more tax hikes on top of the substantial increases already in the pipeline. Lest we forget, these include hikes in both corporation tax and income tax (via the freezing of personal allowances and the basic rate limit at 2021-22 levels), to which we can now add the increases in National Insurance Contributions (NICs).

Nonetheless, we should still get some big clues about the outlook for taxation in the coming years. This is because the Office for Budget Responsibility (OBR) will publish updated economic and fiscal projections alongside the Budget. These will be much more optimistic than the numbers on which much of the Treasury’s recent thinking on taxation has been based.

Admittedly, the disappointing GDP data for July (when output increased by just 0.1% on the month) appeared to suggest that the recovery had stalled. But there are good reasons to think this was only a temporary pause.

The stagnation in July partly reflected renewed consumer caution over Covid (output in consumer-facing services fell by 0.3%). Indeed, the initial economic impact of the lifting of restrictions on ‘Freedom Day’ may even have been negative. Fortunately, more timely surveys, such as the CBI Distributive Trades, already suggest that spending picked up again in August. The news on the evolution of Covid itself has mostly been positive, too.

There are also many problems on the supply side. Some of these will be temporary as well, notably the ‘pingdemic’, which peaked in July. Others are global and likely to be longer lasting, though markets will be able to fix these over time.

Attempts to pin the weak July data on Brexit certainly fall at the first hurdle, because other economies in Europe are facing similar disruption to supply chains. Unfortunately, they do not publish monthly GDP data. But on other indicators, such as retail sales, car production, and activity in the construction sector, their recoveries also stalled in July.

More positively, the latest UK labour market data provide more reassurance on the health of the economy, and further vindication of the decision to wind down the furlough scheme. In particular, early estimates suggest that another 241,000 payroll jobs were added in August, taking the total back to pre-Covid levels. GDP may only be a month or two behind in reaching this milestone, which would be much sooner than the OBR was expecting.

The unemployment rate also fell to 4.6% in the three months from May to July, and was just 4.4% in July alone, again much lower than the OBR projections.

The tightening in the labour market was reflected in a pick-up in underlying pay growth, which the ONS now estimates at between 3.6% and 5.1%. For now, this may be a ‘Goldilocks’ rate: hot enough to boost spending power and tax revenues, keeping real wage growth positive despite higher consumer price inflation, but not so hot that it should seriously worry the Bank of England, especially if productivity recovers too.

Some concerns remain. In particular, the high level of vacancies and widespread reports of labour shortages could mean that skills mismatch is still a big issue. However, it may also be that lots of workers are still tied up on furlough, or reluctant to risk moving employer because of lingering concerns about Covid. These headwinds should be temporary.

The big picture is therefore that the OBR’s new forecasts should be much more upbeat. For a start, back in March the OBR was only expecting UK GDP to grow by around 4% this year, whereas a figure of at least 7% now looks likely.

More importantly, fears of significant long-term scarring to the economy – particularly via a sustained increase in unemployment – look increasingly overdone. This is crucial, because the OBR was suggesting that there would be a permanent ‘black hole’ in the public finances too, which the Treasury might have to fill with further tax increases.

In reality, a stronger recovery will help to repair the fiscal damage from Covid, reducing both the amount of borrowing, and the burden of debt relative to the size of the economy

It is perhaps a bit too much to hope that this will prompt the Chancellor to cancel the tax increases he has already announced. But he should soon be in a position to soften their impact, for example, by ending the freeze on the personal allowance earlier than planned (and, by happy coincidence, in good time for the next election).

At the very least, a stronger economic recovery and a buoyant labour market should save us from further tax rises.

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Julian Jessop is an independent economist.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.