A year ago, the Chancellor promised that the £40 billion of tax increases announced in her first Budget would be a “one-off”. But it is now almost certain that her second Budget next month will deliver more of the same.
What’s gone wrong? The technical answer is that OBR is expected to predict that the current budget (day-to-day spending minus revenues) is on course for a deficit of as much as £20 billion in 2029-30, when the fiscal rules require it to be in surplus. What’s more, the last Budget had aimed for a surplus of nearly £10 billion (the ‘fiscal headroom’), so that makes a total shortfall of around £30 billion.
At least half of this shortfall is expected to reflect another downgrade in the OBR’s forecasts for productivity growth, which have been over-optimistic for many years.
The Government has tried to blame this on Brexit, claiming that the negative impact of leaving the EU has been even worse than the OBR had already assumed. But the evidence of a big hit here is remarkably flimsy.
The more plausible explanation is simply that the OBR’s forecasts will now give a larger weight to the UK’s poor performance on productivity all the way back to the Global Financial Crisis of 2008.
The rest of the £30 billion shortfall would mainly be due to higher than planned spending, especially on benefits and debt interest.
The upshot is that, if the Chancellor wants to restore the existing headroom of just under £10 billion, she may have to cut spending or raise taxes by a total of £30 billion. And if she wants to raise that headroom further, creating a larger buffer against future shocks, the final figure could be closer to £40 billion (once again).
Whatever the precise numbers, the Budget needs to be big and bold. It is essential to lift the uncertainty that is holding back activity in the private sector and keeping borrowing costs high. Consumers, businesses and investors all need to be reassured that the beatings in this year’s Budget really are going to be the last.
The best way to do this would, of course, be to tackle the problem at source. The bigger picture is that government spending is spiralling out of control.
Current (day-to-day) expenditure is already expected to increase by more than £200 billion between 2024-25 and 2029-30, to £1,351 billion. A saving of just 3% on that last figure would be worth £40 billion.
However, the Government appears determined to try to close the gap with more tax increases instead, despite the risk that this simply fuels the ‘doom loop’ of higher taxes and weaker growth which has already taken root.
The “big and bold” solution here would be to raise taxes in the broadest possible ways – including income tax and VAT – to minimise the additional distortions and disincentives to work, save and invest.
This should be combined with fundamental reforms, such as merging income tax and NI, and scrapping some of the worst taxes, starting with stamp duty. The Government should also rethink its approach to energy policy and to labour market regulation.
Unfortunately, political constraints and a lack of imagination mean that next month’s Budget is likely to be even more damaging than it has to be. Doubling down on higher spending, higher taxes, and ever more state intervention, cannot be the solution to the UK’s long-standing economic problems.
Plain-speaking Economics 