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Economics focus: Why it’s too soon to celebrate victory in the public finances

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The scores are now in for Britain’s public finances in 2016/17. I was going to say the final scores but, like most official statistics, the revisions will continue for some time. What we know for now, however, is that it was a good year.
Not only was public sector net borrowing at £52bn in 2016/17, the lowest since 2007/08 – when the financial crisis had started but had yet to really bite, but there was also a big £20bn fall compared with the previous year, 2015/16. Given that the fear was that the immediate impact of the Brexit vote would be to push up the budget deficit, something the Office for Budget Responsibility embraced in its autumn statement forecast last November, this was good news indeed.
That £20bn fall means that the process of deficit reduction has accelerated. Only two full fiscal years ago, in 2014/15, borrowing was only a whisker under £95bn and thus, years on from the crisis, still uncomfortably close to £100bn. Now it is half of that and, at 2.6% of gross domestic product in 2016/17, back firmly in safer territory.
George Osborne’s original aim had been to eliminate the current budget deficit – the deficit excluding public investment – and his great regret was not doing that by the time of the 2015 general election. But at 0.7% of GDP in 2016/17, we almost got there, though Osborne had announced his decision to leave politics before the figures were released.
So as we wade through the treacle of yet another election campaign, why is this good news about the public finances not being used more aggressively by Theresa May? Why are the Conservatives, if anything, on the defensive over tax, as they grapple with what to do about one of the leftovers from the 2015 election and whether they should repeat the pledge not to raise VAT, income tax or national insurance?
There are a few reasons. One, which would not necessarily stop a politician, is that the latest figures flattered to deceive. One reason the OBR was caught out in November (though it revised down its forecast to a creditable £51.7bn in March) was that it failed to fully allow for one-off factors that brought down the deficit last year. These, to remind you, included changes in the timing of both EU contributions and corporation tax payments, and income shifting to beat the April 2016 rise in dividend taxation. As these factors fall away, the OBR expects a rise in borrowing to £58bn this year, 2017/18. This has happened before. A rise in borrowing in 2012/13 was widely but wrongly interpreted as the abandonment of austerity but was due to the transfer of the Royal Mail pension fund to the public sector.
For the Tories, there are other arguments for not prematurely celebrating the drop towards normality in the borrowing figures. When your opponents, however far behind in the polls they are, start promising big increases in public spending, it would be harder to persuade voters that this would be hugely risky while simultaneously celebrating victory in the battle to tame the public finances.
It also matters in the messages the Tories themselves send to voters. One reason they have been in difficulty over the 2015 tax pledge is that Philip Hammond fell foul of it in the Budget, when his attempt to raise class 4 NICs for the self-employed was seen to fall foul of the manifesto commitment. The Treasury had not spotted this, and neither had anybody else given an insight into the Budget prior to publication, including the prime minister. Hammond’s NI move, which he has indicated he would like to return to, was made because of his belief that any largesse should be fully funded by revenue raisers. The more restricted he is on raising revenue by pledges, the harder it is for him to be a responsible guardian of the public finances, which he sees as his duty.
This is a bugbear of mine. By the time Osborne and David Cameron left office, their freedom to raise tax was ridiculously constrained, not just by the 2015 pledge but also by the programme of corporation tax cuts, the pledge to raise the personal income tax allowance to £12,500 and the highest rate threshold to £50,000, and what looks like a permanent freeze on fuel duty. As it is, with plenty of time to go, May has already ruled out a rise in VAT in the next parliament.
Hammond wants more freedom on tax, notwithstanding the improvement in the public finances, which he knows has much further to go. He also knows that messaging is important when it comes to voter expectations. When May and Hammond first took over, there was a flurry of expectation that this would mean the end of austerity. He was keen to disabuse people of that, although his promised ‘reset’ of fiscal policy, which did not amount to very much when finally revealed, was allowed to hang around a bit too long.
Austerity has further to go. The four year cash freeze on most working age benefits, which Hammond inherited from Osborne, is still in place and is biting harder because of the rise in inflation. The National Health Service has just been through one of its worst winter crises and there is no pot of gold to ease the pain. Indeed, other parts of the public sector are feeling the squeeze they are under, and jealously eyeing the ring fencing the NHS enjoys.
The 2016/17 budget deficit, the smallest since the financial crisis, is a staging post, but we are still a long way from journey’s end. One day, the tough times will be over. But not for quite a few years yet. 
Issue: 1352
Categories: Analysis