Sunak's budget judgment was right - but the economy still needs fixing Posted by David Smith at 09:00 AMCategory: David Smith's other articles My regular column is available to subscribers on www.thetimes.co.uk This is an excerpt. Budgets are a bit like Christmas, a huge amount of anticipation followed by the event itself, which can be a bit of a let-down, particularly if you know beforehand most of what you are going to get. Christmas, of course, is not all about presents. Four days on, however, the kids have got bored with or broken their toys, and I have to try to conjure something up from the leftovers. Fortunately, there is plenty to say. This was a big budget, a big moment, and the first thing to say is that I have to applaud a budget that precisely met the central
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Sunak's budget judgment was right - but the economy still needs fixing
My regular column is available to subscribers on www.thetimes.co.uk This is an excerpt.
Budgets are a bit like Christmas, a huge amount of anticipation followed by the event itself, which can be a bit of a let-down, particularly if you know beforehand most of what you are going to get. Christmas, of course, is not all about presents. Four days on, however, the kids have got bored with or broken their toys, and I have to try to conjure something up from the leftovers.
Fortunately, there is plenty to say. This was a big budget, a big moment, and the first thing to say is that I have to applaud a budget that precisely met the central recommendation set out here in recent weeks. Last Sunday’s column had the headline “Sunak must support us now and make us pay later” and that is exactly what the chancellor did.
There was plenty of pre-briefing about corporation tax rises and freezing personal income tax allowances and some of it implied that it would happen immediately. Delaying the tax allowance freeze for a year and the corporation tax hike for two years made perfect sense, though in the case of corporation tax, the expectation was of a gradual rise over time, not that the rise from 19 to 25 per cent would be done in one fell swoop.
Meanwhile, we should note the tax dog that did not bark. Tory donors, entrepreneurs and landlords, some of whom fell into all three categories, got very excited in the run-up to the budget about an increase in capital gains tax. It did not happen and, indeed, it was not mentioned. Sunak may have had it in mind to do something but he was persuaded against it, though he will say something more on tax reform on “tax day”, March 23.
The general shape of the budget was, therefore, one that I have no hesitation in applauding. The chancellor did not repeat the prescription of Geoffrey Howe in 1981 and raise taxes immediately with the economy in recession. His support for the economy went further than expected, with the furlough scheme extended to the end of September, not June, and more self-employed people brought into the support net. The budget judgment was right. I’ll come on to the other big support measure in a moment.
Second, and I don’t think this is generally appreciated, if all goes according to plan, the chancellor will have at a stroke set in train a process that will fix the public finances. By 2025-26, according to the Office for Budget Responsibility (OBR), the current budget deficit will have been eliminated. It is a huge 13.3 per cent of gross domestic product (GDP) this year.
The current budget deficit, to explain, is the difference between day-to-day government spending and tax revenues. It means that the government, which intends to devote nearly 3 per cent a year to capital spending, would only then be borrowing to invest, a long-held ambition of chancellors.
Fixing the public finances is a relative term. In five years public sector debt will still be more than 100 per cent of GDP, £2.8 trillion, and public borrowing, in cash terms, will be around £74 billion, according to the OBR. But it would still represent considerable progress.
“If all goes according to plan” is doing quite a lot of work in the paragraphs above. There are serious questions about whether the future tax increase announced in the budget can deliver the expected revenues and whether the economy can sustain a tax burden which has only been achieved once, and very briefly, over the past 70 years. The Institute for Fiscal Studies points out the “sad truth” that it will require the highest sustained tax burden in UK history.
There is also a question of whether the chancellor, whose future plans depend on tight control of public spending after pandemic support is withdrawn, can constrain a fiscally incontinent, big spending prime minister. Already the government is embroiled in a row over a 1% recommendation for the increase in NHS pay. That is one of the many challenges ahead.
Third, I have to try to answer the question about whether the budget addresses any of the issues about Britain’s future economic performance and, in particular, productivity. Will it raise our game?
Exactly a year ago, drawing on hints from the former chancellor Sajid Javid about what he would liked to have done had he remained in office and research led by Professor Peter Spencer at the University of York, I wrote about “full expensing”, allowing firms to immediately deduct the entire cost of new investment from their tax bill.
Sunak, as you will know, went further, announcing a “super deduction” which will allow firms to deduct 130 per cent of the cost of investment in eligible plant and machinery from their tax bill. It will last for two years, starting next month, 2021-22 and 2022-23, and be quite expensive, £12 billion a year.
It should stimulate business investment, on which the UK’s record has been pretty terrible, and this contribute to a revival in productivity, the holy grail of the economy’s supply side. The OBR predicts that after a small fall this year, business investment will jump by 16.6 per cent in 2022.
Unfortunately, however, it is a flash in the pan. Business investment then tails off and falls as the stimulus ends and higher corporation tax kicks in. The incentive’s effect is merely to bring business investment forward, not raise it overall. The supply-side signals being sent out by the government are all over the place. Kwasi Kwarteng, the new business secretary, is scarring the industrial strategy council chaired by the Tiggerish Andy Haldane, the Bank of England’s chief economist, which has been doing good work.
We are left with a familiar picture. Brexit will reduce the UK’s long-run productivity by 4 per cent, according to the OBR. “Scarring” as a result of the pandemic will leave the economy 3 per cent smaller than it otherwise would have been by the end of the parliament. After a strong bounce this year and next, with growth of 4 per cent and 7.3 per cent respectively, the economy slows to a dull rate of growth of just over 1.5 per cent a year.
The story is also a familiar one on productivity. It will also be lower than feared before the pandemic. It will be lower than expected before the pandemic over the medium term, and its growth will average just 0.9 per cent a year over the next five years according to the OBR. Normally these forecasts are too optimistic. Sunak could not do everything in a single budget. Fixing productivity is still on his “to do” list.