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Hammond becomes a reluctant tax and spender

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The NHS has been given a £20bn-plus 70th birthday present, while the pressure for extra spending elsewhere in Whitehall is intensifying and will continue to do so. The government has yet to identify the additional sources of revenue needed to pay for this largesse. That unenviable task now falls to Philip Hammond.

And so it has come to pass. In my last column, I speculated about how much the government would award the National Health Service as a 70th birthday present. Now we know. The level of NHS spending in England will be £20.5bn higher than now in real terms by 2023/24, Theresa May announced, which translates into nearly £25bn for the NHS in the UK as a whole. Philip Hammond knew he would have to concede extra spending for the NHS but had hoped to restrict the increases to less than 3% a year. He had to concede a higher settlement than that, at 3.4% a year.

The chancellor is not one to let fiscal responsibility go without a fight. He has got the budget deficit down to less than 2% of gross domestic product – the latest figures show that public sector net borrowing was 1.9% of GDP in 2017/18, down from a peak of 9.9% in 2009/10. And he does not intend to let deficit reduction stop there.

That was why Hammond warned the rest of the cabinet that, in the light of the NHS settlement, there would be no extra money elsewhere. Indeed, other government departments remain on course for a real-terms cut in spending of £5bn by 2022/23. If the Treasury wanted to absorb the extra NHS spending without increasing taxes or borrowing, it could impose deeper cuts elsewhere. That, however, does not look feasible.

Indeed, now that other departments have seen the colour of the Treasury’s money, any overall reduction in non-NHS spending in coming years looks highly unlikely. Instead, the pressure will intensify for extra public spending across the board.

The Ministry of Defence, backed by the House of Commons defence committee, is first in the queue under Gavin Williamson, an erstwhile ally of the prime minister. He has called for a down payment of an extra £4bn a year for defence. Others, including Sajid Javid at the Home Office, will not be far behind. Jeremy Hunt, the health secretary, is said not to be quite finished with the Treasury, wanting more money for social care.

The chancellor, in his Mansion House speech in June, dealt only with the NHS commitment, not other spending demands, but he signalled higher taxes. ‘Taxpayers will have to contribute a bit more, in a fair and balanced way, to support the NHS we all use,’ he said. The government would ‘stick to our fiscal rules’. Many would say ‘a bit more’ is an understatement in the light of what some Treasury officials, referring to the NHS deal, were describing as the biggest ‘fiscal event’ in recent years.

There is a difficulty for a Tory government in raising taxes, not least because it was elected on a manifesto of reducing them, though the party’s 2017 manifesto removed its earlier commitment not to increase any of the main taxes. Hammond was caught out by that one when he tried to increase national insurance (NI) on the self-employed in his March 2017 Budget. Raising taxes also falls into the ‘you wouldn’t start from here’ category. The tax burden – tax receipts as a percentage of GDP – is at a 30-year high of 36.7%.

So what might the chancellor do?

He has promised to let us know in his Autumn Budget and economists, including those at the Institute for Fiscal Studies, have been examining some of the options. One would be to emulate Gordon Brown, who after the 2001 general election announced a percentage point increase in both employee’s and employer’s NI. Hammond could, in this context, return to the self-employed and raise their NI too, without falling foul of last year’s Conservative manifesto. There is money to be had, an extra £8.5bn a year, with most (£5.5bn) coming from employees and the self-employed. The government could supplement this if it chose to bite the pensioner bullet and either levy NI on those who continue working beyond state pension age or impose a reduced-rate NI on the incomes of all pensioners.

A second idea, which has been doing the rounds in Westminster, would be for the chancellor to achieve the manifesto target of increasing the income tax personal allowance to £12,500, and the higher rate threshold to £50,000, which should be by 2020, and then stop. This would bring in about £3.5bn by the time of the next election.

A third idea is not to proceed with the reduction in corporation tax, currently 19%, to 17%. Not doing so would be worth £5bn a year.

These are not, by any chalk, the only options for raising taxes, but it is a depressing fact for the Treasury that even combining them would not get to £20bn a year. That may not be strictly necessary for the NHS alone – the Treasury had assumed there would be some increases in spending in the years ahead – but it could easily become necessary once demands from other areas of government spending are taken into account. These tax increases, moreover, are not palatable politically. An across the board increase in NI, an increase in the tax on income, is not something a Conservative government is supposed to do. There would be little logic, similarly, in raising the personal allowance and higher rate threshold and then freezing it, so reducing it in real terms. Businesses, meanwhile, were promised the reduction in corporation tax. Depriving them of it, when Britain is desperate to attract inward investment and there is already bad blood between business and the Tories, would not look very clever.

Hammond did not want to be in this position. He is a fiscal conservative and the least likely chancellor to go on a tax and spending spree. And he knows as well as anybody that it is a lot easier to increase spending than it is to raise taxes.