Budget 2018 – the fiscal landscape

The end of austerity?

In her speech at the Conservative Party Conference earlier this month, the Prime Minister signalled ‘the end of austerity’.

Economic commentators will no doubt continue to dispute whether the UK has yet fully recovered from the financial crisis of 2008. In part this is because they define ‘recovery’ differently. Some mean by that term that the country’s public finances are now back on a sound footing, while others will not pronounce the recovery complete until the country is back where they believe it would have been without the crisis.

However, ‘the end of austerity’ is not a precise analysis of the country’s economic position, but a declaration of fiscal policy based on the belief that the recovery has been achieved or is at least in sight. Mrs May’s key indicator appeared to be that "because of … the decisions taken by the Chancellor, our national debt is starting to fall for the first time in a generation." However, she also indicated that while "fixing our finances was necessary … there must be no return to the uncontrolled borrowing of the past. No undoing all the progress of the last eight years. No taking Britain back to square one." 

One might interpret this as a cautious, possibly even a tentative, end to austerity, rather than the beginning of a new age of luxury and extravagance. This appears prudent, given the fact that (using the latest data available at that time) the national debt did not fall but increased by £15.9 billion over the year to 31 August 2018 (though it did indeed fall as a percentage of GDP, by 1.8 percentage points). In addition, new Government borrowing fell from £45.5 bn in the year to 31 March 2017 to £39.9 bn in the year to 31 March 2018 [1].

The Chancellor’s conference speech delivered broadly the same message as that of the Prime Minister, even though he left her to deliver the ‘end of austerity’ soundbite. He acknowledged that the economic outlook would depend on whether the government reached a successful conclusion to the Brexit negotiations and indicated that, while he was confident of success, he would ‘maintain enough fiscal firepower’ to support the economy in the event of ‘no deal’. While the precise meaning of this was somewhat elusive, the general message was clearly that he intended to be prepared for all eventualities.

On the basis of a successful Brexit outcome, he predicted a ‘deal dividend’, a boost to economic growth, ‘which we will share, in line with our balanced approach, between keeping taxes low, supporting public services, reducing the deficit, and investing in Britain’s future’. 

The balanced approach

An early opportunity for Mr Hammond to indicate what this ‘balanced approach’ will mean in practice will be provided by the forthcoming Budget, to be presented on 29 October. If a Brexit deal has been struck by then, presumably this approach will be applied accordingly. If the outcome of negotiations is still uncertain the Chancellor will be faced with a choice of either producing two alternative Budgets or (perhaps more likely) proceeding on the basis of a successful outcome, but with a warning that in the event of ‘no deal’ he will be returning to Parliament with revised proposals. (The question of what exactly would constitute a successful outcome is not explored further here.)

It appears that the Chancellor expects to have increased funds at his disposal, arising from taxes on increased economic activity and perhaps from reduced demand for welfare payments. Assuming that the intention of ‘investing in Britain’s future’ is a rhetorical flourish rather than a separate application of the ‘deal dividend’, these available funds will be applied in three ways: in reducing projected borrowing; in increasing expenditure on public services; and in ‘keeping taxes low’. Strictly, of course, no funds are required to keep taxes low in an expanding economy, though they would be required if tax reductions were planned.

The tax burden under the balanced approach

Thus the Chancellor has effectively committed himself (Brexit permitting) to keeping tax rates at their current level (which he clearly considers to be low), with perhaps a hint that he will reduce them if he can.

That could be a pointer to a very uneventful Budget in terms of headline measures. Normally, even in such a ‘quiet’ Budget, there is no lack of technical changes to engross the tax specialist. In the present circumstances, however, whether the UK leaves the EU in triumph or disaster (and whether or not there are by then any recognised criteria to determine the difference between the two) officials at HMRC and the Treasury are likely to be fully occupied in disentangling the UK tax system from the EU, without looking for other major systemic changes to develop and implement.

An alternative view?

By contrast to this sanguine view from the Prime Minister and the Chancellor, the Institute for Fiscal Studies said in its ‘Green Budget’ issued on 16 October that the Chancellor would need to raise funds equal to a one penny rise in all income tax rates, national insurance rates and the VAT rate if it was to meet the commitment to end austerity while at the same time attaining the Chancellor’s existing target of eliminating the deficit (i.e. achieving a year with no net borrowing) by the mid 2020s [2]. This conclusion is based, of course, on the Institute’s assessment of what degree of government spending would constitute an end to austerity, taking into account commitments already made (for example in relation to the NHS). The Chancellor may perhaps have a more modest spending goal in mind. In addition, provided borrowing can be seen to be falling (as it is), so that the country’s finances cannot be said to be in crisis, he may well be relaxed about once again extending the target date for eliminating the deficit altogether, because the determination of that date involves making a balanced judgement rather than operating an iron law of economics.

Tax, be it low or high, will always be the balancing figure between spending and borrowing. If the Chancellor is sanguine about spending and relaxed about borrowing, then (given his clear statement about keeping taxes low) immediate increases in the tax burden still look unlikely and modest reductions may be a possibility.

A government that struggles to command a majority in the House of Commons and in the opinion polls will presumably look for tax reductions that will have a wide application, and thus be of political as well as economic benefit.

Click here for a detailed consideration of various possible Budget measures.

[1] Office for National Statistics statistical bulletin ‘Public sector finances, UK: August 2018’ Available here.
[2] Institute for Fiscal Studies ‘Green Budget, October 2018’ at https://www.ifs.org.uk/publications/13508

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