Mr Sunak’s budget on Wednesday (03 March), as expected, paved the way for higher taxes, especially on business, and spending than many Tories would like. But the Chancellor had to do something drastic to repair national finances, writes Victor Hill.
The spotlight on Rishi
For Chancellors of the Exchequer, budget day is like an A-list entertainer’s night at the London Palladium – they strut their stuff for an hour or more to popular acclaim – or otherwise. And the initial applause is sometimes at variance with how the critics respond in the days that follow.
How does one evaluate a budget? Most of the policy detail is contained not in the Chancellor’s address to the House of Commons, but in the Red Book which is released after he has sat down and which often takes a long time to unpack. The consequences of fiscal policy do not manifest themselves for years; and those calculations so beloved of the tabloids about how much more (or less) tax Mr & Mrs Average with two point one children will have to pay are based on assumptions and counterfactuals. (They will pay more because the personal allowance would otherwise have risen as it has in recent years – but that was never guaranteed.)
Investors are best advised to evaluate a budget by looking at the reaction of the financial markets, even if most of the knee-jerk buy-sell decisions are driven by non-economists. Well, on Wednesday the pound edged up marginally against both the dollar and the euro; and the FTSE-100 nudged up by a few pips. We may say that the markets were – and remain – agnostic. The future is an undiscovered country, and we grope our way towards it in the dark.
It is a cliché to say that Mr Sunak’s budget on Wednesday marked a seminal moment in the history of Britain’s national finances – though clichés often contain much truth. Mr Sunak’s first budget, delivered on 11 March last year was something of a non-event: within hours of his statement, with exquisite timing, the WTO formally declared that a global pandemic raged around us. And immediately we knew that all Mr Sunak’s numbers were up the spout – though we did not imagine quite by how much then. 51 weeks ago, Mr Sunak envisaged a fiscal deficit of £42 billion. On Wednesday, he gave us the actual near-final number: £352 billion. That disparity, driven by the exigences of the pandemic (about £400 billion of unforeseen expenditure), was the single most pressing factor behind the matrix of tax and spend proposals he advanced this week.
I assume that my canny readers are au fait with the main provisions of this budget so I shall just alight on a few measures that are most likely to impact their wealth.
If the Chancellor had not provided for an overall increase in the tax burden, he would quite rightly have been accused of playing fast and loose with the national debt. The question was where those increases would fall, and when. This is economics but it is also politics: politicians can risk unpopularity short-term, but in the medium-term they want to get re-elected. At least it seems that Mr Sunak is intent on sticking to the Tories’ election pledge not to hike income tax rates, NICs or VAT.
The long run of increases in the personal allowance (below which level no income tax applies) and the higher rate threshold is over. In 2009-10, Gordon Brown’s last year as PM, the personal allowance was £6,475; this year it is £12,500 – an increase of 93 percent, so much more than inflation. That reform absolved a lot of part-time, self-employed and low wage earners from paying any income tax – in fact, last year only six adults in ten paid income tax at all. The higher rate income tax threshold in 2009-10 was £34,800; this year it is £50,000 – an increase of 44 percent. So personal taxes have been modestly reduced under the Coalition (2010-15) and subsequent Tory governments.
Mr Sunak also froze the thresholds for inheritance tax (£325,000), the capital gains tax exemption (£12,300), the lifetime allowance on pensions (the LTA, at £1.073 million) and the turnover threshold for VAT registration from April 2022 (currently £85,000). The furlough scheme and the business rates holiday will persist until the end of September. The stamp duty holiday (on house purchases up to £500,000) will continue until June. Duties on booze and petrol are also frozen. Revenues from alcohol duties actually surged by £800 million this year – despite the closure of pubs, restaurants and nightclubs – as people drowned their sorrows at home. The question is whether people will flock back to the pubs when they re-open.
The deeply troubled aviation industry will resent the increase in air passenger duty (APD) by £2 to £82 for a long-haul economy ticket, and by £5 to £181 for those in business and first class. Taxes on short-haul flights will remain frozen at £13/£26.
There was nothing here to frighten the horses; but a dream has been abandoned. Sir John Major (PM 1990-1997) aspired to a Tory government scrapping inheritance and capital gains tax altogether. That aim seems more distant than ever. For all that, the budget has scored well in the opinion polls – most people don’t fret about IT and CGT, believing them to be paid only by the rich.
Corporation Tax (CT)
Corporation tax – the tax on company accounting profits – is charged with more ideology than any other tax. Pro-market zealots regard corporation tax as anathema – the lower a company’s after-tax profits, the less money it commands to reinvest and/or reward shareholders. They think that the lower a country’s rate of CT, the more pro-business it is. Socialists believe that corporations should be punished for making money; indeed some regard profits as a dirty word. Pragmatists believe that in a still-globalised (though de-globalising) world, nations must compete with one another for investment – and that means maintaining a competitive level of CT.
In practice, as I have pointed out in these pages numerous times in the past, the headline rate of corporation tax is much less important than the regime of write-downs that companies are allowed to offset against profits in any given jurisdiction. That is why any comparison of headline rates between countries is at best superficial and at worst misleading. What Mr Sunak unpacked on Wednesday was a CT regime which would look familiar to German businessmen – a higher headline rate but with more scope for capital deductions. More complex and more obscure – quite the opposite to what previous Tory governments (and the Trump administration) believed in.
By raising the rate of CT for larger companies from the current 19 percent to 25 percent in 2023 (something Mr Corbyn promised just 16 months ago) the Treasury hopes to rake in an additional £17 billion of revenues a year. That is the first rise in the headline rate since Denis Healey’s first budget of 1974. Lowering the rate of CT to near-Irish levels (it is 12.5 percent in the Republic) was one of the main themes of George Osborne’s tenure at Number Eleven. This is therefore a major about-turn.
My problem with the concept of super deductions (of 130 percent) is that well-meaning incentives can transmogrify into perverse ones. If a capital investment can be justified in terms of its IRR (internal rate of return) it does not need a 30 percent kick-back to make it happen. Rather, this will incentivise companies to invest in marginal projects (such as HS2 if I may say so) – one of the reasons behind our lagging productivity. This is the lamentable Eat-out-to-Help-outsyndrome applied to capital allocation. It is a dodgy gimmick and will hopefully be unwound before it is abused. Generally, governments should avoid getting involved in investment decisions in the private sector. (I know that makes me sound like a Thatcherite.)
That is the most worrying thing about Mr Sunak. Deep down, with his Goldman Sachs hat on, he would probably agree with the above paragraph. But as a politician who is effectively number two on the board of UK PLC, he just can’t resist histrionic flourishes. Loss-making businesses, by definition, do not pay CT, so it cannot be said to be a tax on jobs and is therefore perceived as “fair”.
Mr Sunak pledged to splash the cash on a litany of worthy causes. Domestic abuse, mental health and small business will receive new funding. There will be grants for retail and hospitality businesses. A swathe of regions from Ayrshire to Rochdale will receive largesse. (Naturally, those not in receipt of such largesse are claiming the Tories are throwing money at their northern satrapies. 40 of the 45 constituencies to benefit from the £1 billion regeneration fund are Tory seats.) Eight freeports will be operational in England by the end of the year. The precise tax dispensation obtaining in these freeports is yet to be unveiled.
Day-to-day spending on public services by the main spending departments will fall by £4 billion next year, prompting accusations of a return to austerity. We can expect much gnashing of teeth about inadequate funding for the NHS. And if local councils are squeezed, then they are likely to resort to an increase in council tax on local residents – something already in view. Council tax is the one that ordinary people resent the most.
The national debt
The deficit this year will have been equal to 17 percent of GDP – an unprecedented number in peacetime. Debt will continue to rise and will hit 97.1 percent of GDP before falling somewhat in the following two years. Though for now, the cost of servicing that debt is relatively modest, given ultra-low interest rates. But, as the OBR pointed out, a one percent rise in rates could add another £21 billion to interest costs by 2026. The national debt will soar to £2.75 trillion in 2023-24. That’s about £40,000 per man, woman and child.
The total tax-take
On a morbid note, a rise in excess deaths by pensioners from Covid-19 apparently saved the Treasury £1.5 billion in state retirement pension payments. Grimly, these coronavirus deaths also contributed to inheritance tax receipts. Overall, the slump in tax revenues is not quite as catastrophic as many feared.
The OBR decreed on Wednesday afternoon that the UK will have a higher tax-take than at any time since the 1960s. That’s based on the calculation that the total tax burden will be 35 percent of GDP in 2025-26. That is still low by European standards. Total government expenditure (Total Managed Expenditure or TME in the trade) will be £1.14 trillion or 54.4 percent of GDP in the current fiscal year. That will be the highest level since fiscal 1945-46 at the close of WWII.
Thatcherites fear that the pandemic and its financial aftermath will have given a centre-right Tory government a license to maintain a much bigger state from hereon in. Those who advocate free markets and a slimmer state are outnumbered. On the other hand, the Chancellor stressed that these are temporary measures for exceptional times, suggesting that one day not too far off the Tories will be able to resume their instinctively tax-cutting, free-wheeling agenda. The question is: how long will it take to recover? And the most reasonable answer to that question is: a long time. In fact, probably longer than the hiatus before the next catastrophe strikes.
Be that as it may, there is a sense that the crisis is coming to its natural conclusion and that the numbers will soon slowly improve over time. After a ten percent fall last year, UK GDP will grow by four percent this year. The OBR is forecasting that the UK economy will regain its 2019 level by the middle of next year. Unemployment will peak at 6.5 percent – that’s much better than feared. The UK looks set to become the first major nation to have vaccinated its entire adult population, so there could be a consumer boom in Q3 when the restrictions are undone.
History will not regard this budget as Mr Sunak’s greatest achievement; but it will credit him with massive success in damage limitation by keeping the body of the economy intact at a time of extreme turbulence, thanks to judicious interventions of which the furlough scheme was paramount.
For some, the furlough scheme was a foretaste of the universal basic income (UBI) to which many idealists aspire. For most of us, however, the cost of the furlough scheme demonstrates precisely why UBI is unaffordable – and will remain so until such time as robotisation and AI have increased productivity dramatically beyond current levels. (I’m thinking another 25-30 years.) It’s a pity that Mr Sunak didn’t proclaim that on Wednesday. The real test of leadership is to make clear that the beneficent state has limits.
There are still many unknowns. My hunch is that we shall all require periodic coronavirus vaccine boosters. That will entail huge additional spending on the NHS going forward – not to mention the elephant in the room of how to pay for the care of the elderly. (I’ll write about social care soon. I’m a pragmatist. I believe that if people lose their marbles in old age and still have assets, they should use them for top-level care. Why should the state pay so that middle-class children can inherit more?)
Another unknown is monetary policy, which, since the elevation of the priestly caste of central bankers to sacred status, is beyond the purview of mere finance ministers. Will the Bank of England continue to hoover up gilts? Does the government have any view about that? Is there a limit to monetary profligacy at a moment when interest rates and inflation might be about to turn north? I think we should be told – though I fear we won’t.
We would devoutly wish not to be where we are; but given that we are where we are, Rishi is a good man to have at the helm. Whether you think Boris is a decent captain, as I do, is another conversation – though he must accelerate the ending of the restrictions in line with declining health risks. On the morrow of this budget, I think that Jim Mellon’s recent bullish prognosis for sterling and the FTSE are as sound as ever.