Economic focus: Can improving tax revenues survive the turbulence?

Loyal readers of these columns have lived with me through some difficult and frustrating times when it comes to the public finances. There have been occasions when it has seemed highly unlikely that deficit reduction could continue. There have been times when the budget deficit seemed stuck above £100bn, which I still find to be a pretty scary number. During these difficult times, George Osborne just about held his deficit reduction programme together; it was often touch and go, though, and progress was plainly slower than initially intended.

 

The problem during these episodes rested almost exclusively with disappointing tax revenues. Corporate tax revenues appeared to have suffered long term damage as a result of the crisis, and not just those from banking and financial services. Meanwhile, income tax and national insurance receipts were held down by the weak growth in wages; and, in the case of income tax, by the combination of those weak wage rises and the increases in the personal tax allowance. VAT and other indirect tax revenues suffered from subdued growth in spending. By and large, the chancellor stuck to his public spending programme and controlled his outlays – but his inflows fell short.

 

Now, however, that appears to be changing. We know that the growth in earnings has picked up, helping to perk up the recovery. And, for once, some tax receipts are exceeding expectations. In the first four months of 2015/16, April to July, tax receipts were up by 4.4% on a year earlier. That included a modest 2.5% increase in VAT receipts (largely a reflection of near zero inflation), but very healthy increases in income and capital gains tax (up 5.2%), corporation tax (up 7.3%) and NICs (up 4.8%).

 

Remember the debate about whether the coalition government had halved the budget deficit before the election? It had to resort to saying that it had done so, but only as a percentage of GDP, not in absolute terms. The deficit came down from 10.2% of GDP in 2009/10 to 4.9% in 2014/15. In cash, however, the reduction fell short of a halving, dropping from £153.5bn in 2009/10 to £88bn in 2014/15. 

 

Had the coalition had the benefit of foresight, it could have said with some confidence that the deficit was being halved, by any measure. Public sector net borrowing – the deficit – in 2015/16 is officially projected to be £69bn. Most analysts believe, however, on the strength of the first few months’ figures, that the outturn will be several billion pounds below that, and possibly as low as £60bn. Before too long, at this rate of improvement, the government will be able to say that it has reduced the budget deficit by two-thirds.

 

Now, there are lots of things happening in the public finances, including asset sales, transfers from the asset purchase facility (the Bank of England’s quantitative easing programme) and other adjustments. To understand these things fully, a degree in public finance would be useful.

 

The big picture, though, is straightforward enough. If revenues are growing faster than expenditure to a sufficient extent, then the deficit will come down; if not, it will go up. Dickens’s Mr Micawber had it right when he said: ‘Annual income twenty pounds, annual expenditure nineteen pounds, nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds, nought and six, result misery.’ It is all about income and outgoings.

 

 

The question is whether the picture so far this year – of revenues growing healthily and spending hardly growing at all – can last. We have had a summer of some turbulence on the global markets. Hardly had the Greek crisis been put to bed (and there is an election coming up which means it may not yet have been) when the China crisis, which had been quietly building, took over. At times in August, global stock markets almost became a parody of themselves, with dramatic and alarming plunges one day followed by euphoric rises the next. The talk was of a new crisis.

 

I think we all learned to be humble about these things a few years ago, but it seems to me there was quite a lot of overreaction happening in the markets over the summer. Yes, Greece is problematical, but there was always going to be a deal. Yes, China has slowed and may still be slowing further, but its economy is not falling off a cliff – and, anyway, the relationship between the Chinese stock market and the Chinese economy is a tenuous one.

 

There are some real effects from this market turbulence. Though the oil price has been as skittish as the stock markets over the summer, the trend has been down, which will reduce already very low North Sea oil revenues. It is one reason why I think the chancellor should be increasing fuel duty to compensate for the weakness of oil revenues, along with the fact that there is no better time to do so than when inflation is close to zero, and threatens to dip back into deflation.

 

Mostly, however, the forces that have produced an improvement in Britain’s public finances should last.

 

Recent wage growth will be reinforced by the introduction of the government’s new living wage of £7.20 an hour for those aged 25 and over next April. Economic growth is now well established and has reasonable momentum. Apart from a blip in the first quarter, GDP growth appears to have settled down at around 0.7% a quarter, nearly 3% a year. Inflation will gradually pick up, even without a fuel duty hike, boosting VAT revenues. The better news on the deficit will not last forever, but it has further to run.