5 November 2021

Rishi’s war chest? The economic data that could give Sunak room for tax cuts

By Ben Brittain

The recent Budget grew the size of both the state and the tax burden to historic levels. Tory members don’t seem best pleased about that, with Rishi Sunak falling to his lowest position to date on ConservativeHome’s Cabinet league table. But Conservatives disgruntled at a budget they consider ‘too left-wing’ may be reassured by data suggesting Sunak will have room for tax cuts before the next election.

Take October’s composite output PMI for manufacturing, which has recently been revised upwards from 56.8 to 57.8, indicating that the UK economy recovery is regaining momentum after a sluggish third quarter. Similarly, UK service providers have reported a sharp rise in business activity last month, driven by the strongest increase in new jobs since June. This means that business activity has expanded at the fastest pace since July, driven by the first acceleration in new order growth for five months. Taken together, those figures all point to the UK’s post-Covid recovery being back on track. 

This matters because subdued growth will ensure long-term scarring to the economy and lower tax receipts. However, the Office for Budget Responsibility (OBR) Budget outlook revised up real GDP, as it now expects post-pandemic scarring of potential output to be 2% – rather than the 3% they assumed in March. If the economy regains momentum, as indicated by revised PMI, then economic scarring will be reduced further, meaning tax-revenues could be higher than in the OBR’s forecast. PMI indicators for the Christmas period, when hospitality and retail can expect a big boost, will give a clearer picture the resilience of the UK economy.

A closer look at the OBR’s forecast modelling also gives room for optimism. Underpinning the figures is one core assumption: the re-introduction of restrictions during the winter months. It says the UK will be:

‘Requiring the reimposition of only relatively modest additional restrictions in order to keep hospital admissions under control.  In line with the Government’s plan, in our central forecast we assume that higher case numbers lead to either a modest tightening of public health restrictions or an increase in voluntary social distancing.’ 

This refers to the Government’s so-called ‘Plan B’, which according to the Cabinet Office’s Covid-19 taskforce would cause up to £18bn of economic damage, whilst mandatory home working could cost the economy £30bn – or 1% of GDP at 2019 levels. 

However, since the publication of the OBR’s economic and fiscal outlook and that Covid taskforce report, cases have started to fall. Growth in cases has largely been driven by children of school age, and with nearly 80% of that age group having had Covid, epidemiologists believe infections should start to level off without any need for more restrictions.

The assumption that underpin the OBR modelling are therefore unlikely to happen, which means their figures for both growth and tax revenue are probably unduly pessimistic. A further revision of the GDP numbers and a reduction in long-term scarring mean the Treasury can expect higher tax receipts down the line.

A tax-cutting Chancellor?   

If he does end up with larger tax receipts than previously anticipated, the Chancellor faces a tricky choice about how to spend that extra revenue. He could succumb to further pressure from an interventionist-minded No 10 and enlarge the state further with more public spending. However, the reaction to the Budget from both Conservative members and a number of MPs, as well as Sunak’s public statements about reducing the size of the state, strongly suggest he will use any headroom for tax cuts. That may well be a tricky political choice when the time comes, but at least the current data suggest it’s a choice Sunak will have the luxury of making.

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Ben Brittain is a policy and data analyst at the University of Birmingham's City-Region Economic Development Institute.

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