In 2021, Sunak increased the rate of corporation tax from 19% to 25%, and froze income tax allowances and thresholds to begin paying back the public debt built up during the pandemic. At the same time, he announced the biggest tax cut for businesses in history, a temporary ‘super-deduction’ of 130% for expenditure on plant and machinery. He broke the Conservative Party’s election manifesto pledge not to increase personal taxation by introducing a new health and social care levy that increased NICs on employers and employees by 1.25 percentage point from April 2022. He has also broken the Conservative Party’s manifesto pledge to maintain the state pension ‘triple lock’.
The cumulative impact of these changes will result in Britain’s highest tax burden for more than 70 years. According to the Office of Budget Responsibility (OBR), the tax burden is set to increase from 33.5% of GDP in 2019/20 (before the pandemic) to 36.2% by 2026/27. The taxes borne by the average household will be £3,000 higher than they were in 2019, when Boris Johnson became prime minister. The poorest fifth of the population will be worse off, despite the changes to universal credit, and the increase in the national living wage. The changes to the triple lock on state pensions will hurt the nearly two million pensioners living in poverty.
Sunak delivered Budget 2021 against the backdrop of a resurgent economy with strong growth, high employment, and rising inflation. Having shrunk by 9.4% during 2020, the economy is now bigger than it was before the pandemic. Households have used the savings that they accumulated during the pandemic to increase their consumption of goods and services. But sustained future growth in the economy will require a step change in business investment which collapsed during the pandemic and remains amongst the lowest in the G7 countries. The temporary ‘super-deduction’ won’t counteract decades of inadequate investment.
The pandemic is expected to cast a shadow over the economy for years to come; economic growth is expected to fall to 2.1% in 2023, and then decline. The other drag anchors on Britain’s future prosperity include the rise in inflation and the increase in personal and corporate taxation.
The Bank of England (‘the Bank’) initially dismissed the rise in prices as merely ‘transitory’. But inflation shot up to 5.4% in December 2021. Prices are rising because of the shortages caused by supply chain constraints, and the rocketing cost of fuel, food, and used cars. The Bank now expects inflation to peak at 7.25% in April 2022, even though the Bank’s remit from the chancellor requires it to maintain inflation at 2%.
The increases in the base rate have shored up the credibility of the Bank’s determination to curb inflation and mitigated the risk of inflationary expectations taking hold. But they won’t have any direct impact on the main factors that have caused the current inflation. For example, supply-chain constraints are expected to continue until 2023 or 2024. Most economists believe that it would be counter-productive for it to attempt to use monetary policy to curb the rise in prices caused by supply shocks. In other words, it can’t do anything about changes in relative prices, such as the sharp rise in the cost of gas caused by supply and demand conditions in the international market for wholesale gas. Energy prices won’t begin to abate until more international supplies of gas become available; it is unlikely to happen soon. The sanctions introduced in the wake of Russia’s invasion of Ukraine have also taken a toll on the countries that imposed them. For example, there has already been a fresh spike in energy prices.
Wage rises are currently being outstripped by inflation. If the Bank doesn’t succeed in nipping inflation in the bud, there is a risk of a ‘wage-price spiral’, with workers continually demanding higher wages, and employers responding by repeatedly increasing their prices. The tightening labour market and higher wages of workers will give employers a greater incentive to economise on their use of labour by increasing their investment in plant and machinery, and by automating their operations.
Inflation arbitrarily redistributes income and wealth. People living on fixed incomes and low earners are the biggest losers from inflation. The government is the principal beneficiary of inflation because it erodes the real value of outstanding public debt. Inflation is a tax on cash balances. Inflation will also enable the exchequer to reap higher taxes through ‘fiscal drag’ because Sunak has frozen income tax personal allowances and thresholds. But it has also increased the cost of servicing public debt. The return on a quarter of all government securities is linked to changes in the retail price index. Increases in interest rates to curb inflation will make it more difficult for the chancellor to manage the economy because every one percentage point increase in inflation and interest rates adds around £25bn to the cost of servicing government debt.
The Budget was dominated by announcements about public spending measures. After announcing that the aggregate level of taxation was forecast to increase to more than £1 trillion in 2026/27, Sunak declared that he wanted to reduce taxation by the end of the parliament! The OBR’s pre-Budget forecast reflected the higher level of growth and tax receipts expected in 2021 and 2022. It created a short-term ‘windfall’ of £50bn for the exchequer. Sunak used it to announce large increases in government spending on the NHS, its levelling up agenda, and support for the less well off. Most of the increases in departmental allocations are likely to be swallowed up by public sector pay increases and inflation.
Sunak’s decision to increase public spending by £30bn was described as ‘a gamble with public finances’. His exaggeration of the increases he had announced in level of public spending was compared to former Labour chancellor Gordon Brown’s propensity for triple counting increases in spending on health and education. There has been ‘inflation in rhetoric since then’.
Sunak unexpectedly reduced the universal credit taper rate, i.e. the rate at which benefits are reduced when a claimant’s other income increases. His decision to reduce the taper, ‘a tax on work, and a high rate of tax at that’, from 63% to 55% will cost the exchequer £11bn over the parliament. But at 47%, the taper is above the highest rate of income tax faced by those earning more than £150,000. Full-time workers on the national living wage will gain more from the change than they will lose from the withdrawal of the temporary £20 increase in universal credit introduced as an emergency measure during the pandemic. But the reduction in the earnings taper will not help unemployed universal credit claimants for whom the temporary payment of £20 during the pandemic was a vital lifeline.
Polling data suggests that the Conservatives have lost their reputation as a low tax party. Some leading Conservative politicians, including former Treasury ministers, have claimed that the increases in public spending announced in Sunak’s Budget and his introduction of large tax increases has left the government with ‘an identity crisis’. They said that the government’s fiscal actions did not reflect long-standing Conservative philosophy and values; and that they marked a fundamental 'philosophical shift' in the party’s credo. They complained that Conservative MPs and party activists had not been consulted beforehand about the seismic change in party theology.
An early election seemed to be on the cards before the prime minister’s recent political difficulties engulfed him. The Conservative Party had reportedly started appealing to Party donors to increase contributions to fund the campaign after the Budget. Governments tend to go to the full term of the parliament only when they expect to lose the next election. If the election were to be held in the spring or autumn of 2023 or early in 2024, it would enable the government to take advantage of the constituency boundary changes, which are expected to give its Party up to an extra ten parliamentary seats.
It would be virtually impossible for the chancellor to fund tax cuts in the run-up to the next general election by reducing public spending or by generating additional economic growth in the short-term. Instead, Sunak is expected to use the £20bn that he put aside from the windfall created by the revised OBR forecast to reduce taxation without breaching his new fiscal rules. ‘Sources close to the chancellor’ have told the media that he is planning to reduce the basic rate of income tax before the election. Paul Johnson, the director of the IFS, has described the suggestion as ‘indefensible’, pointing out that it would favour wealthier taxpayers.
Any pre-election tax cuts are likely to be short-lived without increased economic growth. Future tax rises are inevitable whichever party is in power following the next election because of the inexorable rise in public expenditure. Inflation and rising interest rates have made it expensive for the government to continue to rely on borrowing to fund its current expenditures. Britain’s ageing population, the government’s promise to maintain public expenditure on the NHS in real terms, and its climate change commitments all mean that public expenditure will continue to increase.
The increase in the proportion of the population that is over 65 years of age will result in higher spending on state pensions and health and social care. A commentator has jocularly suggested that Britain is turning into ‘an elderly care system with a state attached to it’. To reduce the future cost of the state pension, the government has reneged on the commitment it made in its 2019 general election manifesto to maintain the state pensions ‘triple lock’. It has also withdrawn its promise to increase the state pension by the increase in earnings when it exceeds the increase in the rate of inflation and 2.5%. The earnings’ link makes little economic sense in an inflationary environment. It was politically courageous of the government to sever the earnings’ link because the Conservative Party relies heavily on the so-called grey vote. The government has also launched a consultation about bringing forward the increase in the state pension retirement age.
Without economic growth, the NHS will continue to absorb an ever-growing proportion of public resources. It currently swallows up about two-fifths of all day-to-day public spending, four times its allocation twenty years ago. Most of the annual yield of £12bn from the new health and social care levy for the next three years has been allocated to the NHS. It is unlikely that the NHS will be able to manage without this infusion being made permanent. The health service’s annual pressures have become a ‘permanent winter’ and it will continue to face challenges ahead with the backlog of postponed treatments, staff shortages, and the rising cost of medical technology.
As a political sacred cow, the NHS’s use of public expenditure is not subject to the same degree of challenge and scrutiny by Treasury officials as that faced by other government departments. The Conservative Party tends to ‘over-compensate’ in funding and coddling the NHS because opinion polls consistently show that ‘our NHS’ is perceived by voters to be safer under the Labour Party. But whichever party is in power, any chancellor intent upon improving public services must insist on efficiency and value for money for the billions being committed annually to the NHS.
Climate crisis is a global public externality. The government has made an international commitment that Britain will achieve net zero greenhouse emissions by 2050. The government’s independent Climate Change Committee has estimated that the gross cost of achieving the goal will amount to £1.4 trillion. Green investment in the rest of the decade will need to rise swiftly to £50bn a year, more than 2% of GDP. Businesses and individuals will have to bear these costs through taxation. The OBR has calculated that meeting the target will cost households an average of £1,700 a year. These costs could be somewhat mitigated with investment in improved insulation, solar panels and electrical vehicles that have lower greenhouse emissions.
The government has not explained the scale and distributional impacts of the fiscal consequences of its climate commitments to the public. Instead, the prime minister has downplayed the sacrifices necessary by saying that ‘the government will be making carbon-free alternatives cheaper’ and that it will create ‘good jobs, green jobs, well paid jobs’, but has not explained how this might happen. For the government to mandate that individuals and businesses must directly bear the cost of the economy’s transition to net zero emissions without government help would of course be electorally unpalatable.
Individuals and businesses whose activities generate greenhouse emissions are not always held accountable for controlling such pollution, or for bearing the cost of the damage they do to others in our mutual environment. These externalities are the result of a ‘market failure’: society bears these costs, rather than the polluters.
The government may have to introduce a carbon tax on those who are not already within the scope of the UK-wide emissions trading scheme. A carbon tax would impose a charge on their emission of greenhouse gases, and create an incentive for them to change their systems or replace the plant or equipment that create the pollution. The tax would be imposed directly on those who emit greenhouse gas under the principle that the ‘polluter pays’.
The government’s environmental policy changes will have other fiscal impacts. For example, the government will need to find new sources of revenue to replace its receipts from fuel and vehicle excise duty (about £40bn a year) because of its decision to ban the sale of vehicles with internal combustion engines by 2030. The lost revenues could be replaced by carbon taxes, or by introducing road user pricing (or both). But instead of sustaining the government’s environmental objectives by increasing the duty on fuel in line with the increase in prices, Sunak chose to announce in Budget 2021 that it would be frozen for the twelfth year in succession.
The Conservative Party unexpectedly won formerly safe Labour constituencies (the so-called ‘red wall’ seats) in the North of England in the 2019 general election. Boris Johnson promised the voters there that his government would ‘level up’ their areas, to enable them to enjoy the same degree of affluence and public services as London and the South East. Again, he did not tell his prospective voters the cost of doing so, or explain who would bear it. There was concern about the scale of the task and the increase in taxation that it might entail. It was suggested that the cost of levelling up might be comparable to the cost of the reunification of East and West Germany in the 1990s. But, in the event, the proposals for closing the geographical prosperity gap set out in the government’s recent white paper on levelling up were in the end relatively modest. Most of the policies had already been announced, funded from money already allocated.
2022 has been dubbed as ‘the year of the squeeze’. The average household will be at least £1,200 poorer because of the rise in energy prices, income tax, NICs, and council taxes, and inflation. For example, the rise in the global wholesale price of gas will result in annual household bills increasing by nearly £700 (with further increases to follow). The cost of fuel constitutes a large proportion of net income for low earners and people living on benefits and pensions: the poorest households must choose between ‘heating or eating’. Sunak has introduced a package of measures to mitigate the impact of the spike in energy costs on households.
There have been calls from MPs (and by some ministers) for the deferral or abolition of the health and social care levy to relieve the pressure on take home incomes. The levy was, rather unusually, announced by the prime minister himself, rather than the chancellor. It led to suggestions that the levy was the ‘prime minister’s tax’, and not supported by the chancellor, but, in a recent newspaper article, the prime minister and Sunak have confirmed that the levy will go ahead, arguing that the revenues raised by levy were necessary to clear the backlog of treatments in the NHS, and to integrate health and social care. Oblivious to the irony, they described themselves as ‘tax-cutting Conservatives’ in the article.
Sunak is said to have a picture of Nigel (Lord) Lawson behind his own desk in Downing Street to inspire him. Lawson was a reforming chancellor between 1983 and 1989 when Mrs Thatcher was prime minister. If Sunak wishes to join Lawson in the pantheon of chancellors, he needs to address Britain’s chronically inadequate investment, low productivity and economic growth, and ensure that the Treasury doesn’t neglect its traditional role of scrutinising and securing value for money in public spending.
Low business investment and flagging labour productivity have stunted Britain’s economic growth. Stimulating Britain’s lacklustre growth and productivity would boost profits and household incomes and tax receipts. It would enable the government to increase public spending without increasing the burden of taxation. The OBR has forecast that economic growth will decline to 1.2% per annum in the three years to 2026. That is, about a fifth lower than it was before the introduction of the lockdown to combat the pandemic. The IFS has noted that real average gross earnings would have been about 40% higher than they are now if the trend in growth prior to the financial crisis had not been interrupted.
Most countries experienced a slump in productivity during the financial crisis. But Britain’s productivity has languished in the doldrums while in other countries productivity and growth bounced back to trend a few years after the financial crisis. As the economist Paul Krugman has noted: ‘Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise [the level of] output per worker’.
Increased labour productivity results in higher economic growth because the economy creates a greater volume of goods and services for any given level of labour. American, German and French workers produce nearly a fifth more per hour than British workers partly because their employers invest up to 40% more in capital (software, plant and machinery). The government can stimulate productivity and growth by encouraging businesses to increase investment in new technology and research and development (R&D), and in the skills of their workforce.
The government’s approach to encouraging higher investment and R&D lacks urgency, focus and credibility. For example, Sunak has recently deferred its target of spending £22bn a year on R&D by two years to 2026/27. And his decision to increase corporation tax is likely to discourage business investment. At 1.7% of GDP, Britain’s spending on R&D is significantly below the OECD average of 2.4%. Britain’s business investment accounts for only 10% of GDP, compared with 13% in France, Germany and the US.
The government won’t be able to meet its climate change commitments without massive investment in new technology. There is an urgent need to increase tax incentives for investment and R&D to capitalise on the growth opportunities, particularly in the life sciences and climate change. The government should also heed the strong case for providing additional support for R&D conducted by the universities. For example, AstraZeneca developed its pioneering coronavirus vaccine in partnership with Oxford University. The Industrial Strategy Council’s (ISC) report on Astra Zeneca should be compulsory reading for ministers and officials in the Treasury and the business department.
Sunak’s decision to widen the scope of R&D tax relief to encompass cloud computing and data management was welcomed by businesses. But the changes didn’t go far enough. The Treasury could have taken a leaf out of the Singapore government’s book and extended the relief to cover expenditure on the design and automation of innovative processes, and the development of intangible assets. There is also a case for a wide-ranging review of the investment and capital allowances regimes to determine if they meet the needs of the modern British economy. Capital allowances were introduced over 70 years ago. The economy was dominated by the manufacturing sector when the reliefs were first introduced, whereas services sector now accounts for over 80% of GDP. Relief is primarily provided for plant and machinery, whereas businesses now invest a much larger proportion of their capital in intangible assets: on software, not hardware.
Britain has a ‘skills deficit’ vis-à-vis its trading competitors. The decision by John Major and Tony Blair’s governments to over expand higher education at the expense of further education and vocational training has had adverse long-term consequences. Some of the polytechnics and colleges of further education that formerly provided first class vocational training have become universities. Many students from these institutions graduate with degrees in subjects that aren’t valued by potential employers. They are unlikely ever to earn enough to repay the student loan debts that they built up whilst at university. The government needs to develop a credible long-term national plan to meet the economy’s requirements for skilled workers. It could, for example, offer free college education for adults without A-levels, and bursaries to those who are pursuing recognised vocational courses in science, technology, engineering, and mathematics.
The changes necessary to improve the performance of the economy won’t happen spontaneously. They must be planned and implemented in consultation with businesses and trades unions. There is no high-level institutional mechanism for driving forward measures to improve productivity and growth. Sunak should establish and chair a new tripartite body similar to the recently abolished ISC to help him develop and deliver the policies necessary to transform Britain into a ‘high wage, high productivity’ economy. The new body could advise Treasury on issues such as its policy of giving priority to infrastructure, government support to industry now that it doesn’t have to adhere to EU state aid rules, and the coordination of supply chain links between government, business and other sectors. The development and delivery of the covid vaccine has highlighted the importance of focusing on strategic sectors that have comparative advantage, and of innovating, manufacturing and distributing locally, rather than relying on foreign suppliers.
The Public Accounts Committee (PAC) has investigated fraud and error in the various covid relief schemes and the award of contracts for personal protective equipment (PPE). There was little public reaction when the PAC first reported that the losses might amount up to £30bn. But there has been increasing public disquiet as more details of individual cases and profiteering by PPE contractors have become available. In a recent court case, the judge said that the lack of basic checks and the ease with which even convicted fraudsters were able to access covid loans ‘defied belief’. A Treasury spokesman in the House of Lords has resigned because of the government’s ‘woeful’ efforts to tackle such fraud. The government has been accused of giving a ‘free pass’ to covid fraudsters.
The government had initially attempted to shrug off criticism for the loss of public money. It suggested that there hadn’t been time to introduce better safeguards because of the urgency with which relief had to be provided. And, that the amounts lost were small, in relation to the £400bn spent by the government in dealing with the pandemic. Although the government has belatedly started taking action, stripping some covid loans of their government guarantees, it is unlikely to have a material impact on the scale of losses. The horses have already bolted.
The Treasury is supposed to exercise economy and secure value for money for public spending. As chancellor, Sunak should have provided more visible leadership and resources to departments for investigating the loss of public money. As William Gladstone, perhaps one of Britain’s greatest chancellors, noted: ‘The chancellor of the exchequer should boldly uphold economy in detail; and it is the mark of a chicken-hearted chancellor when he shrinks from upholding economy in detail … he is not worth his salt if he is not ready to save what are meant by candle-ends and cheese-parings in the cause of the country’.
In 2021, Sunak increased the rate of corporation tax from 19% to 25%, and froze income tax allowances and thresholds to begin paying back the public debt built up during the pandemic. At the same time, he announced the biggest tax cut for businesses in history, a temporary ‘super-deduction’ of 130% for expenditure on plant and machinery. He broke the Conservative Party’s election manifesto pledge not to increase personal taxation by introducing a new health and social care levy that increased NICs on employers and employees by 1.25 percentage point from April 2022. He has also broken the Conservative Party’s manifesto pledge to maintain the state pension ‘triple lock’.
The cumulative impact of these changes will result in Britain’s highest tax burden for more than 70 years. According to the Office of Budget Responsibility (OBR), the tax burden is set to increase from 33.5% of GDP in 2019/20 (before the pandemic) to 36.2% by 2026/27. The taxes borne by the average household will be £3,000 higher than they were in 2019, when Boris Johnson became prime minister. The poorest fifth of the population will be worse off, despite the changes to universal credit, and the increase in the national living wage. The changes to the triple lock on state pensions will hurt the nearly two million pensioners living in poverty.
Sunak delivered Budget 2021 against the backdrop of a resurgent economy with strong growth, high employment, and rising inflation. Having shrunk by 9.4% during 2020, the economy is now bigger than it was before the pandemic. Households have used the savings that they accumulated during the pandemic to increase their consumption of goods and services. But sustained future growth in the economy will require a step change in business investment which collapsed during the pandemic and remains amongst the lowest in the G7 countries. The temporary ‘super-deduction’ won’t counteract decades of inadequate investment.
The pandemic is expected to cast a shadow over the economy for years to come; economic growth is expected to fall to 2.1% in 2023, and then decline. The other drag anchors on Britain’s future prosperity include the rise in inflation and the increase in personal and corporate taxation.
The Bank of England (‘the Bank’) initially dismissed the rise in prices as merely ‘transitory’. But inflation shot up to 5.4% in December 2021. Prices are rising because of the shortages caused by supply chain constraints, and the rocketing cost of fuel, food, and used cars. The Bank now expects inflation to peak at 7.25% in April 2022, even though the Bank’s remit from the chancellor requires it to maintain inflation at 2%.
The increases in the base rate have shored up the credibility of the Bank’s determination to curb inflation and mitigated the risk of inflationary expectations taking hold. But they won’t have any direct impact on the main factors that have caused the current inflation. For example, supply-chain constraints are expected to continue until 2023 or 2024. Most economists believe that it would be counter-productive for it to attempt to use monetary policy to curb the rise in prices caused by supply shocks. In other words, it can’t do anything about changes in relative prices, such as the sharp rise in the cost of gas caused by supply and demand conditions in the international market for wholesale gas. Energy prices won’t begin to abate until more international supplies of gas become available; it is unlikely to happen soon. The sanctions introduced in the wake of Russia’s invasion of Ukraine have also taken a toll on the countries that imposed them. For example, there has already been a fresh spike in energy prices.
Wage rises are currently being outstripped by inflation. If the Bank doesn’t succeed in nipping inflation in the bud, there is a risk of a ‘wage-price spiral’, with workers continually demanding higher wages, and employers responding by repeatedly increasing their prices. The tightening labour market and higher wages of workers will give employers a greater incentive to economise on their use of labour by increasing their investment in plant and machinery, and by automating their operations.
Inflation arbitrarily redistributes income and wealth. People living on fixed incomes and low earners are the biggest losers from inflation. The government is the principal beneficiary of inflation because it erodes the real value of outstanding public debt. Inflation is a tax on cash balances. Inflation will also enable the exchequer to reap higher taxes through ‘fiscal drag’ because Sunak has frozen income tax personal allowances and thresholds. But it has also increased the cost of servicing public debt. The return on a quarter of all government securities is linked to changes in the retail price index. Increases in interest rates to curb inflation will make it more difficult for the chancellor to manage the economy because every one percentage point increase in inflation and interest rates adds around £25bn to the cost of servicing government debt.
The Budget was dominated by announcements about public spending measures. After announcing that the aggregate level of taxation was forecast to increase to more than £1 trillion in 2026/27, Sunak declared that he wanted to reduce taxation by the end of the parliament! The OBR’s pre-Budget forecast reflected the higher level of growth and tax receipts expected in 2021 and 2022. It created a short-term ‘windfall’ of £50bn for the exchequer. Sunak used it to announce large increases in government spending on the NHS, its levelling up agenda, and support for the less well off. Most of the increases in departmental allocations are likely to be swallowed up by public sector pay increases and inflation.
Sunak’s decision to increase public spending by £30bn was described as ‘a gamble with public finances’. His exaggeration of the increases he had announced in level of public spending was compared to former Labour chancellor Gordon Brown’s propensity for triple counting increases in spending on health and education. There has been ‘inflation in rhetoric since then’.
Sunak unexpectedly reduced the universal credit taper rate, i.e. the rate at which benefits are reduced when a claimant’s other income increases. His decision to reduce the taper, ‘a tax on work, and a high rate of tax at that’, from 63% to 55% will cost the exchequer £11bn over the parliament. But at 47%, the taper is above the highest rate of income tax faced by those earning more than £150,000. Full-time workers on the national living wage will gain more from the change than they will lose from the withdrawal of the temporary £20 increase in universal credit introduced as an emergency measure during the pandemic. But the reduction in the earnings taper will not help unemployed universal credit claimants for whom the temporary payment of £20 during the pandemic was a vital lifeline.
Polling data suggests that the Conservatives have lost their reputation as a low tax party. Some leading Conservative politicians, including former Treasury ministers, have claimed that the increases in public spending announced in Sunak’s Budget and his introduction of large tax increases has left the government with ‘an identity crisis’. They said that the government’s fiscal actions did not reflect long-standing Conservative philosophy and values; and that they marked a fundamental 'philosophical shift' in the party’s credo. They complained that Conservative MPs and party activists had not been consulted beforehand about the seismic change in party theology.
An early election seemed to be on the cards before the prime minister’s recent political difficulties engulfed him. The Conservative Party had reportedly started appealing to Party donors to increase contributions to fund the campaign after the Budget. Governments tend to go to the full term of the parliament only when they expect to lose the next election. If the election were to be held in the spring or autumn of 2023 or early in 2024, it would enable the government to take advantage of the constituency boundary changes, which are expected to give its Party up to an extra ten parliamentary seats.
It would be virtually impossible for the chancellor to fund tax cuts in the run-up to the next general election by reducing public spending or by generating additional economic growth in the short-term. Instead, Sunak is expected to use the £20bn that he put aside from the windfall created by the revised OBR forecast to reduce taxation without breaching his new fiscal rules. ‘Sources close to the chancellor’ have told the media that he is planning to reduce the basic rate of income tax before the election. Paul Johnson, the director of the IFS, has described the suggestion as ‘indefensible’, pointing out that it would favour wealthier taxpayers.
Any pre-election tax cuts are likely to be short-lived without increased economic growth. Future tax rises are inevitable whichever party is in power following the next election because of the inexorable rise in public expenditure. Inflation and rising interest rates have made it expensive for the government to continue to rely on borrowing to fund its current expenditures. Britain’s ageing population, the government’s promise to maintain public expenditure on the NHS in real terms, and its climate change commitments all mean that public expenditure will continue to increase.
The increase in the proportion of the population that is over 65 years of age will result in higher spending on state pensions and health and social care. A commentator has jocularly suggested that Britain is turning into ‘an elderly care system with a state attached to it’. To reduce the future cost of the state pension, the government has reneged on the commitment it made in its 2019 general election manifesto to maintain the state pensions ‘triple lock’. It has also withdrawn its promise to increase the state pension by the increase in earnings when it exceeds the increase in the rate of inflation and 2.5%. The earnings’ link makes little economic sense in an inflationary environment. It was politically courageous of the government to sever the earnings’ link because the Conservative Party relies heavily on the so-called grey vote. The government has also launched a consultation about bringing forward the increase in the state pension retirement age.
Without economic growth, the NHS will continue to absorb an ever-growing proportion of public resources. It currently swallows up about two-fifths of all day-to-day public spending, four times its allocation twenty years ago. Most of the annual yield of £12bn from the new health and social care levy for the next three years has been allocated to the NHS. It is unlikely that the NHS will be able to manage without this infusion being made permanent. The health service’s annual pressures have become a ‘permanent winter’ and it will continue to face challenges ahead with the backlog of postponed treatments, staff shortages, and the rising cost of medical technology.
As a political sacred cow, the NHS’s use of public expenditure is not subject to the same degree of challenge and scrutiny by Treasury officials as that faced by other government departments. The Conservative Party tends to ‘over-compensate’ in funding and coddling the NHS because opinion polls consistently show that ‘our NHS’ is perceived by voters to be safer under the Labour Party. But whichever party is in power, any chancellor intent upon improving public services must insist on efficiency and value for money for the billions being committed annually to the NHS.
Climate crisis is a global public externality. The government has made an international commitment that Britain will achieve net zero greenhouse emissions by 2050. The government’s independent Climate Change Committee has estimated that the gross cost of achieving the goal will amount to £1.4 trillion. Green investment in the rest of the decade will need to rise swiftly to £50bn a year, more than 2% of GDP. Businesses and individuals will have to bear these costs through taxation. The OBR has calculated that meeting the target will cost households an average of £1,700 a year. These costs could be somewhat mitigated with investment in improved insulation, solar panels and electrical vehicles that have lower greenhouse emissions.
The government has not explained the scale and distributional impacts of the fiscal consequences of its climate commitments to the public. Instead, the prime minister has downplayed the sacrifices necessary by saying that ‘the government will be making carbon-free alternatives cheaper’ and that it will create ‘good jobs, green jobs, well paid jobs’, but has not explained how this might happen. For the government to mandate that individuals and businesses must directly bear the cost of the economy’s transition to net zero emissions without government help would of course be electorally unpalatable.
Individuals and businesses whose activities generate greenhouse emissions are not always held accountable for controlling such pollution, or for bearing the cost of the damage they do to others in our mutual environment. These externalities are the result of a ‘market failure’: society bears these costs, rather than the polluters.
The government may have to introduce a carbon tax on those who are not already within the scope of the UK-wide emissions trading scheme. A carbon tax would impose a charge on their emission of greenhouse gases, and create an incentive for them to change their systems or replace the plant or equipment that create the pollution. The tax would be imposed directly on those who emit greenhouse gas under the principle that the ‘polluter pays’.
The government’s environmental policy changes will have other fiscal impacts. For example, the government will need to find new sources of revenue to replace its receipts from fuel and vehicle excise duty (about £40bn a year) because of its decision to ban the sale of vehicles with internal combustion engines by 2030. The lost revenues could be replaced by carbon taxes, or by introducing road user pricing (or both). But instead of sustaining the government’s environmental objectives by increasing the duty on fuel in line with the increase in prices, Sunak chose to announce in Budget 2021 that it would be frozen for the twelfth year in succession.
The Conservative Party unexpectedly won formerly safe Labour constituencies (the so-called ‘red wall’ seats) in the North of England in the 2019 general election. Boris Johnson promised the voters there that his government would ‘level up’ their areas, to enable them to enjoy the same degree of affluence and public services as London and the South East. Again, he did not tell his prospective voters the cost of doing so, or explain who would bear it. There was concern about the scale of the task and the increase in taxation that it might entail. It was suggested that the cost of levelling up might be comparable to the cost of the reunification of East and West Germany in the 1990s. But, in the event, the proposals for closing the geographical prosperity gap set out in the government’s recent white paper on levelling up were in the end relatively modest. Most of the policies had already been announced, funded from money already allocated.
2022 has been dubbed as ‘the year of the squeeze’. The average household will be at least £1,200 poorer because of the rise in energy prices, income tax, NICs, and council taxes, and inflation. For example, the rise in the global wholesale price of gas will result in annual household bills increasing by nearly £700 (with further increases to follow). The cost of fuel constitutes a large proportion of net income for low earners and people living on benefits and pensions: the poorest households must choose between ‘heating or eating’. Sunak has introduced a package of measures to mitigate the impact of the spike in energy costs on households.
There have been calls from MPs (and by some ministers) for the deferral or abolition of the health and social care levy to relieve the pressure on take home incomes. The levy was, rather unusually, announced by the prime minister himself, rather than the chancellor. It led to suggestions that the levy was the ‘prime minister’s tax’, and not supported by the chancellor, but, in a recent newspaper article, the prime minister and Sunak have confirmed that the levy will go ahead, arguing that the revenues raised by levy were necessary to clear the backlog of treatments in the NHS, and to integrate health and social care. Oblivious to the irony, they described themselves as ‘tax-cutting Conservatives’ in the article.
Sunak is said to have a picture of Nigel (Lord) Lawson behind his own desk in Downing Street to inspire him. Lawson was a reforming chancellor between 1983 and 1989 when Mrs Thatcher was prime minister. If Sunak wishes to join Lawson in the pantheon of chancellors, he needs to address Britain’s chronically inadequate investment, low productivity and economic growth, and ensure that the Treasury doesn’t neglect its traditional role of scrutinising and securing value for money in public spending.
Low business investment and flagging labour productivity have stunted Britain’s economic growth. Stimulating Britain’s lacklustre growth and productivity would boost profits and household incomes and tax receipts. It would enable the government to increase public spending without increasing the burden of taxation. The OBR has forecast that economic growth will decline to 1.2% per annum in the three years to 2026. That is, about a fifth lower than it was before the introduction of the lockdown to combat the pandemic. The IFS has noted that real average gross earnings would have been about 40% higher than they are now if the trend in growth prior to the financial crisis had not been interrupted.
Most countries experienced a slump in productivity during the financial crisis. But Britain’s productivity has languished in the doldrums while in other countries productivity and growth bounced back to trend a few years after the financial crisis. As the economist Paul Krugman has noted: ‘Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise [the level of] output per worker’.
Increased labour productivity results in higher economic growth because the economy creates a greater volume of goods and services for any given level of labour. American, German and French workers produce nearly a fifth more per hour than British workers partly because their employers invest up to 40% more in capital (software, plant and machinery). The government can stimulate productivity and growth by encouraging businesses to increase investment in new technology and research and development (R&D), and in the skills of their workforce.
The government’s approach to encouraging higher investment and R&D lacks urgency, focus and credibility. For example, Sunak has recently deferred its target of spending £22bn a year on R&D by two years to 2026/27. And his decision to increase corporation tax is likely to discourage business investment. At 1.7% of GDP, Britain’s spending on R&D is significantly below the OECD average of 2.4%. Britain’s business investment accounts for only 10% of GDP, compared with 13% in France, Germany and the US.
The government won’t be able to meet its climate change commitments without massive investment in new technology. There is an urgent need to increase tax incentives for investment and R&D to capitalise on the growth opportunities, particularly in the life sciences and climate change. The government should also heed the strong case for providing additional support for R&D conducted by the universities. For example, AstraZeneca developed its pioneering coronavirus vaccine in partnership with Oxford University. The Industrial Strategy Council’s (ISC) report on Astra Zeneca should be compulsory reading for ministers and officials in the Treasury and the business department.
Sunak’s decision to widen the scope of R&D tax relief to encompass cloud computing and data management was welcomed by businesses. But the changes didn’t go far enough. The Treasury could have taken a leaf out of the Singapore government’s book and extended the relief to cover expenditure on the design and automation of innovative processes, and the development of intangible assets. There is also a case for a wide-ranging review of the investment and capital allowances regimes to determine if they meet the needs of the modern British economy. Capital allowances were introduced over 70 years ago. The economy was dominated by the manufacturing sector when the reliefs were first introduced, whereas services sector now accounts for over 80% of GDP. Relief is primarily provided for plant and machinery, whereas businesses now invest a much larger proportion of their capital in intangible assets: on software, not hardware.
Britain has a ‘skills deficit’ vis-à-vis its trading competitors. The decision by John Major and Tony Blair’s governments to over expand higher education at the expense of further education and vocational training has had adverse long-term consequences. Some of the polytechnics and colleges of further education that formerly provided first class vocational training have become universities. Many students from these institutions graduate with degrees in subjects that aren’t valued by potential employers. They are unlikely ever to earn enough to repay the student loan debts that they built up whilst at university. The government needs to develop a credible long-term national plan to meet the economy’s requirements for skilled workers. It could, for example, offer free college education for adults without A-levels, and bursaries to those who are pursuing recognised vocational courses in science, technology, engineering, and mathematics.
The changes necessary to improve the performance of the economy won’t happen spontaneously. They must be planned and implemented in consultation with businesses and trades unions. There is no high-level institutional mechanism for driving forward measures to improve productivity and growth. Sunak should establish and chair a new tripartite body similar to the recently abolished ISC to help him develop and deliver the policies necessary to transform Britain into a ‘high wage, high productivity’ economy. The new body could advise Treasury on issues such as its policy of giving priority to infrastructure, government support to industry now that it doesn’t have to adhere to EU state aid rules, and the coordination of supply chain links between government, business and other sectors. The development and delivery of the covid vaccine has highlighted the importance of focusing on strategic sectors that have comparative advantage, and of innovating, manufacturing and distributing locally, rather than relying on foreign suppliers.
The Public Accounts Committee (PAC) has investigated fraud and error in the various covid relief schemes and the award of contracts for personal protective equipment (PPE). There was little public reaction when the PAC first reported that the losses might amount up to £30bn. But there has been increasing public disquiet as more details of individual cases and profiteering by PPE contractors have become available. In a recent court case, the judge said that the lack of basic checks and the ease with which even convicted fraudsters were able to access covid loans ‘defied belief’. A Treasury spokesman in the House of Lords has resigned because of the government’s ‘woeful’ efforts to tackle such fraud. The government has been accused of giving a ‘free pass’ to covid fraudsters.
The government had initially attempted to shrug off criticism for the loss of public money. It suggested that there hadn’t been time to introduce better safeguards because of the urgency with which relief had to be provided. And, that the amounts lost were small, in relation to the £400bn spent by the government in dealing with the pandemic. Although the government has belatedly started taking action, stripping some covid loans of their government guarantees, it is unlikely to have a material impact on the scale of losses. The horses have already bolted.
The Treasury is supposed to exercise economy and secure value for money for public spending. As chancellor, Sunak should have provided more visible leadership and resources to departments for investigating the loss of public money. As William Gladstone, perhaps one of Britain’s greatest chancellors, noted: ‘The chancellor of the exchequer should boldly uphold economy in detail; and it is the mark of a chicken-hearted chancellor when he shrinks from upholding economy in detail … he is not worth his salt if he is not ready to save what are meant by candle-ends and cheese-parings in the cause of the country’.
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