Autumn Statement 2023 – The Election Campaign Begins

Backdrop

When Jeremy Hunt stood up in the House of Commons at 12:36pm on Wednesday 22 November, he presided over a tax code which runs to 21,000 pages of text and 10 million words. By the time he stood down an hour later, he had added several thousand new words to those voluminous texts and had done precious little to simplify them. But he had given some hope that the unremitting economic gloom of recent times might lift.

On Monday, the prime minister had told us that, now that the dragon of rampant inflation was slain (though it is still running at a not insignificant 4.6 percent), it was time to cut taxes. But was that complacency? Bank of England Governor Andrew Bailey seemed to think so on Tuesday. Nevertheless, rumours circulated that Mr Hunt would have enough “fiscal headroom” to cut national insurance contributions (NICs – which Johnson-Sunak were so keen to raise just 18 months ago) and to raise the thresholds for the higher rate of income tax and for inheritance tax. The £325,000 inheritance tax threshold has not been raised since the Brown-Darling fiscal duo was in charge in 2009.

In the event, the rabbit plucked from the top hat came towards the end of a jaunty oration. NICs for employees will be cut from 12 percent to 10 percent on 06 January next year. About 27 million working people will see an increase in their pay packets thereafter. That will cost the government about £9 billion. Moreover, Britain’s 12.6 million pensioners will get the full triple lock 8.5 percent uplift, worth an additional £900 a year – but then they don’t pay NICs, so will not benefit from the cut in NIC rates. Philip Hammond, when Mrs May’s Chancellor, wanted to align NICs paid by the self-employed with those paid by employees; Mr Hunt has maintained most of the differential by cutting Class 4 NICs from nine to eight percent. But then Britain’s band of self-employed people – the model army of our supposedly flexible labour market – has reduced in number by about 700,000 since the pandemic.

There was not much on Wednesday about expenditure – but there will have to be spending cuts of between two and four percent going forward. In the age of polycrisis, governments are under constant pressure to splash the cash whenever problems arise. During the pandemic, the temporary Test and Trace apparatus cost more than the Royal Navy. And we clearly need a more robust defence budget. (Why do our two spanking aircraft carriers have so few serviceable combat aircraft?).

Over the last year, the UK government has been called upon to pay people’s gas bills – and it has generously obliged. The state has become a kind of emergency cash machine. At the same time, there are swathes of government, such as courts, prisons and probation, that are desperate for cash. Consider that 11 local authorities in England have gone bankrupt since 2018. No doubt the scope of government spending cuts will become clearer in the spring budget, expected next March.

Messrs. Sunak and Hunt do not believe, as proponents of the Laffer Curve do, that tax cuts pay for themselves. Generally, if they cut taxes, they must cut spending. But when tax revenues are more robust than expected, there are ways to ease the pain for taxpayers – at least temporarily.

Debt

On Tuesday we learnt that government interest costs for October amounted to £7.5 billion – about half as much again as the bill of £4.5 billion in October last year. Money is no longer available for free or nearly-free as rates revert to historically “normal” levels – as was always going to happen. The cost of servicing the government’s stock of debt will exceed £90 billion this year – more than the cost of any government spending department except health and pensions.

Despite Mr Hunt’s upbeat delivery, the real story is that government finances across the west are under pressure as debt service costs rise – as I discussed last week. BlackRock, one of America’s largest asset managers, thinks that benchmark US borrowing costs will hover around 5.5 percent for the next five years. Government bond prices have dropped on both sides of the Atlantic of late (and thus bond yields have risen) as investors have decided that interest rates will have to remain at least at current levels for longer to dampen stubbornly entrenched inflation.

That said, the OBR believes that the UK debt-to-GDP ratio is on a gently downward trajectory, though it will remain above 90 percent until at least the end of the decade. Estimates for economic growth have been downgraded for 2024 and 2025. Next year, the economy will grow by just 0.7 percent, the OBR thinks. That is the real challenge: the higher the growth number, the easier it is to reduce debt.

Welfare

The number of people classified as economically inactive rose by 63,000 in Q2 2023 and has climbed by nearly half a million since the onset of the pandemic in the first quarter of 2020. There are 2.6 million people in the UK who are outside the labour market because of long-term sickness or disability. And yet there are still nearly a million unfilled job vacancies across the economy. It has been glaringly obvious for some time that public finances demand that health-related economic inactivity be reduced. But how?

Mr Hunt offered some tough love. The minimum wage will rise next year by more than one pound to £11.44 an hour. Universal credit will rise by inflation. But people who refuse job offers and who have been out of work for 18 months or more could lose their entitlement to universal credit altogether. Over the next five years, the government will spend £3.2 billion on five measures designed to encourage economically inactive people back into the workforce.

The OBR actually expects welfare spending as a share of GDP to be higher in five years’ time than it is today, despite the widespread use of work capability assessments (WCAs), which will apply from September 2025. That is because an ageing population is driving higher sickness payments and creating more pensioners who tend to work part-time, if at all.

Business

Much of Mr Hunt’s Statement concerned initiatives to incentivise business investment. The Chancellor boasted about 110 new measures, most of which were buried in the texts issued as he stood down.

“Full expensing”, temporary until now, now becomes a permanent feature of the UK business tax regime. (Though old hands know that nothing is permanent in the world of taxation). That means that businesses can write off all new capital investment against current year taxation. Given a corporation tax rate of 25 percent (introduced by Sunak-Hunt last year) businesses can recoup 25 pence of tax against every one pound of new investment.

Thus far, Sunak-Hunt have offered few supply-side reforms to widen the bottlenecks in the British economy. Britain has one of the lowest levels of business investment in the OECD. Full expensing could be part of the solution. As I have written here before, the headline rate of corporation tax is only part of the story: the real substance lies in the regime of capital allowances – capital expenditure that can legitimately be offset against tax.

Impediments

The British tax system has grown like Topsy over the last century or more, cultivated by chancellors who calculated what they could get away with at the time. There is a lack of coherence in the tax system and some of the taxes that we pay are downright detrimental to the economy as a whole.

The Institute for Fiscal Studies (IFS) reckons that charging stamp duty on primary homes is one example. It renders the housing market less efficient in matching people with the homes they need. Retired homeowners are discouraged to downsize, as many wish to do, as they have more bedrooms than they need – which would benefit a young family. Moreover, it should be easier for people to relocate to find a job in another part of the country, as happens commonly in the USA.

Further, the tax system together with the benefits system creates “cliff edges” whereby the effective marginal tax rate can spike. For example, the High Income Child Benefit Charge claws back child benefit from a household where one parent earns more than £50,000 at a rate of one percent for every additional £100 that they earn. Child Benefit is lost completely when one earner’s income exceeds £60,000. This equates to a marginal tax rate of 63 percent for a family with two children and one of 79 percent for a family with four children. And you thought the maximum tax rate was 45 percent?

Or again, if you are fortunate enough to earn £100,000 (and a lot of City-types do) you are paying the higher income tax rate of 40 percent on half of your income. But once you start to earn £100,001 a year or more, you begin to lose your personal allowance (the amount on which you pay no income at all, currently £12,570). The personal allowance drops by £1 for every £2 earned above £100,000, until it entirely disappears at £125,140. Additionally, you lose your entitlement to free childcare. (From September 2025, parents of children under the age of five will be entitled to 30 hours of free childcare per week). Thus, someone earning £99,000 a year takes home more cash than someone earning £101,000. In fact, if you earn £100,00 and then get a £25,000 bonus, assuming you have two children, you will need an additional pay rise of more than £26,000 to compensate for the additional tax and childcare costs, according to AJ Bell.

Then there is the VAT threshold. Currently, all businesses which turn over £85,000 or more in sales must register for VAT. This has unintended consequences. If you run a café or a florist and you generate sales of £84,000 a year – well done. But if you raise your prices by less than one percent and start making £85,000 a year, you will have to pay output VAT of £14,167ⁱ – less, of course, any input VAT that you can reclaim on your supplies and overheads. In practice, you would probably be better off closing your shop one day a week and spending quality time doing the things you like. So much for Mrs Thatcher’s vision of an entrepreneurial Britain.

None of these “cliff edges” were removed on Wednesday. Nor were income tax, NIC or inheritance tax thresholds raised, so that “fiscal drag” continues as millions of earners are sucked into the 40 percent income tax band. Even people who don’t feel well off have to pay inheritance tax when they inherit their parents’ modest homes. The total tax take is still scheduled to reach a post-WWII record high of 37.7 percent by 2028, according to the OBR. Moreover, the personal allowance will soon be lower than the state retirement pension for many pensioners, hence many will have to pay income tax on their state pensions for the first time.

Politics

The irony is that, despite the bucket of iced water that Rachel Reeves, the shadow Chancellor, poured over Mr Hunt’s head, so to speak, there is now actually very little difference between Labour and the Tories in so far as fiscal policy is concerned. Mr Hunt is boxed in by spending commitments and cannot cut taxes to the extent he would like. Indeed, he campaigned for the premiership in the summer of 2019 on a manifesto of slashing corporation tax to sub-Irish levels and yet became the Chancellor who raised corporation tax from 19 to 25 percent. And for her part, Rachel Reeves cannot promise to raise taxes on “the rich”, as so many Labour backbenchers devoutly wish, for fear of scaring the horses before a general election. She has already said she would keep the two percent cut in NICs.

Labour is going to tamper with the tax system at the margin by slapping VAT on private school fees and by abolishing the non-dom tax status (by terms of which wealthy people of overseas heritage do not pay UK taxes on their overseas income). But these measures will not be enough to finance more than a modest increase in state expenditure. Rachel, like Jeremy, wants to reduce the national debt, but does not want to cut spending. Labour says it will only borrow in future to finance infrastructure spending – much as Gordon Brown promised more than 25 years ago. That sounds fine; but in practice it does not work. You borrow money to build a hospital – but then how do you pay for all the clinicians and nurses?

Mr Sunak’s plan to re-launch his government and party this autumn was fourfold. First there was the party conference in Manchester (now largely forgotten, except that the high-speed train to Manchester was cancelled); then there was the King’s Speech (mostly about getting tough on crime); then there was the cabinet reshuffle in which Suella Braverman was vaporised and David Cameron re-imagined; and now the Autumn Statement. Only the last of these events might have shifted the electoral calculus even slightly.

This was a blatantly political statement – as we would have expected. We are now in the preliminary stages of the next general election, which, because the cut in NICs will be dated from early January, could come as early as next spring. Or so the fevered speculation goes. It is true that politicians prefer campaigning in the spring or summer to the winter – which is why historically most British general elections have taken place in May or June. The December 2019 “Get Brexit Done” election was the first December poll since 1911.

Rachel Reeves was right to underline that voters will go to the polls next time round feeling worse off. Living standards are still falling. The Resolution Foundation reckons that the average British household will be £1,900 worse off at the end of this parliament than it was at the beginning. Because the growth outlook is bleak, that is not likely to change anytime soon. Even though the economy is 1.8 percent larger than before the pandemic, GDP per head is shrinking. And, as Rachel Reeves said, the perception is that public services are “on their knees”.

We are now in a place of post-Brexit, post-pandemic and post-inflationary precarity. The British economy has a chronic growth problem, a productivity problem and unwieldy national finances. But Labour, if elected, would face these same challenges – and most electors understand that there is no quick fix.

Afterword

Why was the “shock victory” of Geert Wilders in the Netherlands’ general election such a shock? He desires to restrict immigration and to hold a referendum on Dutch membership of the EU. As I have discussed here, Europe has been trending to the right (call it “populism” if you will, though that label is hollow) for some time – despite the defeat of the Law and Justice Party in the Polish general election last month. The overwhelming cause of this political trend across Europe is not the decline in living standards – though that is potent – but the scale of immigration that the entire continent faces.

On Thursday (23 November) we learned in the UK that the Home Office (under the control of supposedly “anti-migrant” Suella Braverman until early last week) had granted 1.2 million work visas over the last year to new residents – most of whom come from outside the EU. The UK population has grown by 3.7 million – that is half a London – in less than decade. That puts massive pressure on public services, and indeed on our environment. It is not what people voted for in 2019.

Did we “take back control” on 23 June 2016? It certainly doesn’t look like it now. I argued for Brexit in these pages back then – and now I regret that; though I still believe that the post-monetary union European agenda pursued by the Franco-German elites was anti-market and undemocratic. A British Gaullist, I believe in une Europe des patries. We should have remained in and headed up the awkward squad.

Europe will only be able to control and manage the migration challenge collectively. Suella and Georgia Meloni (plus Wilders and the rest) are on the same page. It almost makes you want to vote Labour. Because only Sir Keir Starmer will be able to re-set our fractured relationship with our giant trading partner. And in an emerging world of civilisation-states, we need to stick close to the civilisation of which we are an integral part.

I admit it’s confusing: in order to get it right, we might have to vote left.

i^ Given a VAT rate of 20 percent, the “VAT fraction” is 1/6.