Mr Hammond’s good news

The outlook for UK government finances has improved (mildly) – that is good news. But the debate about “austerity” will remain with us for many more years.

Moderately encouraging numbers

Until Mr Hammond’s arrival at 11 Downing Street, March was the month of the budget when tax rates and bands were announced for the forthcoming fiscal year; while the Autumn Statement, delivered in November, was the occasion on which the government’s spending plans were unveiled. Now, the budget takes place in November and incorporates spending proposals: the Spring Statement is just an occasion on which the Chancellor reports the state of the nation’s finances to the House of Commons.

But in these days of castrated government (regular readers will be familiar with my theme that the politicians have needlessly given away the powers accorded to them by the People to unaccountable agencies) the Chancellor is obliged to sing to the tune, not of the Treasury, but to that of the Office of Budget Responsibility (OBR) – which is supposedly manned by independent economists. So the so-called Spring Statement is not really the Chancellor’s overview of the economy – but rather the Chancellor’s review of the latest OBR forecasts. But, as the Chancellor declared on Tuesday (13 March): Forecasts are there to be beaten.

The OBR has upgraded its growth forecast for 2018 from 1.4 percent to 1.5 percent and has reduced its estimate for government borrowing by £4.7 billion from £49.9 billion to £45.2 billion thanks to robust tax revenues. (Less than I for one had expected.) The OBR thinks that borrowing over the next five years will come in at £15.6 billion less than forecast last November. (This under-borrowing, in the current lingo, is now called headroom.) British manufacturing is enjoying its longest unbroken run of growth for 50 years. Employment is at a record high.


But for all that, according to the OBR, Britain’s growth is likely to be the lowest amongst the G-7 leading economies this year. That is largely because we are at a different stage in the business cycle, having topped the G-7 growth chart over 2013-16. There is also the issue that different measures of GDP tell different stories. For example, the Office of National Statistics (ONS) measure of GDP based on earnings data yields lower growth numbers even than the OBR’s estimates which are based on output data.

UK business order books are full and businesses are struggling to recruit skilled staff. This puts capacity constraints on an economy that is growing well below its long-term trend growth rate. Productivity growth, however, which was the main issue of the November budget last year, has been revised upwards.

The Statement that Mr Hammond delivered on 13 March was devoid of surprises. The much trailed good news about the improvement in public finances was, nonetheless, important. For the first time since the Financial Crisis of 2008 there is light at the end of the tunnel. We shall still incur a fiscal deficit but it will not be more than two percent of GDP in 2020-21. The blissful day when the national Debt-to-GDP ratio begins to decline is now at hand. But we are still in that financial tunnel.

The end of austerity has been postponed

The Chancellor told the House that he would take a “balanced approach” using any increased fiscal headroom to bear down on the national debt and to “keep taxes low”. This was a signal to the big spending departments – Health, Work & Pensions, Education, Defence – that there would be only modest room for spending increases come November. Austerity, or more accurately, frugality, will continue to prevail.

The Defence Secretary, Mr Williamson, has been banging the table (quite literally, so it is said) for more money for the armed forces. Given the deteriorating relationship with Russia, defence may be seen as a top priority hereon in. But all sides regard the NHS as in desperate need of more funding too – especially since the public sector pay cap of one percent was scrapped last year. And the huge matter of social care (how vulnerable old people are to be cared for) which loomed so large in the general election last year, has still not been resolved though everyone knows it will require money.

For Labour’s Mr McDonnell, austerity is a “political choice, not an economic necessity” – the Tories have adopted austerity out of spite against the poor. But the Chancellor knows that if he gives in to demands to ramp up spending, the real prize – that of finally eliminating the deficit and starting to pay down the national debt – will be lost.

The Chancellor knows that if he gives in to demands to ramp up spending, the real prize – that of finally eliminating the deficit and starting to pay down the national debt – will be lost.

One of the key issues is that the OBR apparently thinks that this year’s bumper tax revenues – especially the more-than-expected self-assessment payments from the self-employed – will not be repeated in future years. It should be noted that the OBR has consistently under-estimated the economic contribution of Britain’s cohort of around five million self-employed people. It probably thinks that they are all white van men (and women) of one kind or another. But then, how would lifelong civil servants and quango-fodder possibly understand the gig economy?

It is true that the demographics are challenging. During the 2020s not only will longevity continue to rise but a balloon of post-war baby boomers will hit state retirement age (despite recent increases in that threshold). This will mean a much higher state pensions bill. On Wednesday (14 March) the Institute for Fiscal Studies (IFS) came up for air, saying that taxes would have to be raised going forward in order to sustain even existing levels of public expenditure.

Next year, Mr Hammond revealed, there will be a multi-year Whitehall spending review. That will mean more banging fists on tables (justifiably, in my view) by Mr Williamson.

Taxing the un-taxables

In order to square this circle – to fund higher expenditure on ‘goodies’ without taxing nice people more – the solution is obviously to tax ‘baddies’. These are the obscenely wealthy corporations – mostly American technology companies – which hide their massive cash piles offshore.

So, at last, the Chancellor signalled that he would discuss a possible measure with his G-20 peers over the weekend of 16 March. The idea – one I have advanced in these pages – is to tax multi-national technology companies on revenues (which are a matter of accounting record) generated in-country rather than on profits (which can be easily manipulated).

As things stand, Facebook (NASDAQ:FB) and Google (NASDAQ:GOOGL) can harvest data from users in the UK and then use it to pitch an ad that generates revenue in Panama (or Ireland). Facebook paid £2.6 million of UK corporation tax on £842.4 million of revenues in 2015-16. In the same year Alphabet/Google paid £25.1 million tax to the UK exchequer on revenues of £1 billion. If Mr Hammond’s initiative is pursued – and he will lose political capital if it isn’t – this could also cost other tech giants such as Uber (private), Netflix (NASDAQ:NFLX), Amazon (NASDAQ:AMZN) and Apple (NASDAQ:AAPL).

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The beauty of the revenue tax is that, even if other G-20 countries do not cooperate, there is little that the tech companies could do about it bar close down their operations. Nor is it just the tech giants. The international coffee chains also have a reputation as dodgy corporate citizens. It was revealed on 27 February that Caffè Nero (private) has not paid any UK corporation tax for ten years[i]. It is curious that the government is still agonising about a tax on non-reusable coffee cups at a time when public opinion seems to be in favour of such a measure.

On 15 March the Financial Times revealed[ii] that the European Commission is planning a revenue tax on tech companies with a headline rate of three percent. This will require the support of all EU members – expect dissent from Ireland and Luxembourg.

Separately, HMRC on Tuesday issued guidance for VAT compliance for businesses and individuals using platforms provided by tech companies such as eBay (NASDAQ:EBAY) and Airbnb (private) to generate revenues. HMRC thinks that about one quarter of people engaged in the sharing economy do not understand their tax obligations. It believes that illegal sales of tax-free goods over the internet cost the Treasury £1-£1.5 billion in 2015-16.

The Brexit factor

Mr Hammond said that he was optimistic about the outcome of the meeting of the European Council of 22-23 March when the next stage of the Brexit negotiations will be deliberated by the EU-27. Maybe he knows something we don’t. What we do know is that the Council is likely to pronounce upon the likely arrangements for the implementation period – which will most probably run from 29 March 2019 to 31 December 2020. During this period the UK will be a kind of naughty schoolboy in detention – he will still have to obey all the school rules and pay his tuck shop bill, but none of the other children will be allowed to speak to him.

The UK will then have to pay most of the Brexit Bill, estimated at €41.1 billion (£37 billion) over 2019-2026: after that there will be relatively minor pension liabilities payable up to 2064. So there will be no Brexit dividend – as the Brexiteers call the much-contested £350 million a week – until the 2024-25 fiscal year at the very earliest. And Mrs May has already confirmed in her Mansion House speech of 02 March that the UK will still continue to pay into all those satellite agencies of which we shall remain a member – Europol, the European Space Agency, the European Medicines Agency and those dealing with chemicals, air safety atomic energy and so forth.

Meanwhile, implementation period or not, there is a cost to implementing Brexit. Mr Hammond announced an extra £395 million for the Department for Exiting the European Union and an extra £310 million for DEFRA, which is planning a staff increase of 65 percent in the run-up to Brexit. HMRC will receive an additional £260 million to inaugurate new customs arrangements.


There will also be costs in connection with preparing the UK Border Force for Brexit and rolling out a scheme for the 3.2 million EU nationals currently living in the UK. We know that freedom of movement will persist during the implementation period. Any EU citizens who come to the UK during the implementation period will have to register with the Home Office but they will gain permanent leave to remain after five years of continuous residence.

Talk of a Brexodus – the mass de-migration of European workers out of Britain to more welcoming European countries – is nonsense, by the way. An estimated 220,000 EU citizens came to work in the UK in the year to September 2017 as against 130,000 who left[iii]. It is true that certain fields of employment – nursing, for example – may have been impacted harder than others. But this is overwhelmingly due to the recently improved economic strength of the continental economies – rather that the beastly attitude of chauvinistic English Brexiteers to Johnny Foreigner – plus the fact that, with a 14 percent or so devaluation in the value of sterling against the euro since the Brexit referendum, wages paid in the UK look much less attractive in euro terms.

Negotiations could still break down spectacularly, however. Or – as I wrote last week – an alliance of the fifteen or so Tory disciples of Mrs Soubry with Labour could force through an amendment to the forthcoming Trade Bill requiring the UK to remain in a Customs Union.

Just one clarification of this important issue. By leaving the EU on 29 March 2019 stroke 31 December 2020 the UK ipso facto leaves the EU Customs Union. So the intention to join a Customs Union is entirely aspirational since no one knows what a Customs Union might look like. Would it be the one with Turkey (since 1995) or the one with Ukraine (since last year)? Or something entirely different? Labour and the Soubrinis have not told us. That is why I think the Trade Bill will pass without amendment – and possibly with the support of such Labour Brexiteers as the veteran Frank Field MP and the gutsy Kate Hoey MP.

There is little evidence that Brexit has tangibly damaged the British economy to date.

What seems most likely by my reading is that (1) the May government will decline any future customs union despite the very tight House of Commons arithmetic; (2) the implementation period will be granted on the basis of broad-brush principles and diplomatic language so elastic in meaning that all sides will read into it what they wish (regulatory alignment and the rest); (3) the real meat of the Free Trade Agreement (FTA) will not become apparent until the eleventh hour – in late 2020. Bespoke – probably. Frictionless – probably not. And passporting rights for British banks will go – though Swiss banks manage pretty well without them.

But there is little evidence that Brexit has tangibly damaged the British economy to date. The government’s own Brexit impact report made public last week (prepared of course by a group of die-hard Remainers within the Treasury) suggests that moving to a free trade agreement with the EU could cost the public finances as much as £60 billion a year due to the impact of non-tariff barriers.

But this report makes a number of assumptions which are highly questionable. Moreover, it does not consider the potential benefits to the economy of, for example, cheaper food imports from non-EU states. And it does not quantify the costs of welfare and healthcare for low-skilled, low-waged EU migrants whom we know receive more benefits than they pay in taxes…But let’s not go there for now.

Tigger or Eeyore?

If Mr Hammond was chipper, though not exuberant, Mr McDonnell was ghoulishly downbeat. Who is more realistic? It depends on your point of view, as ever. Opponents of the government – Labour, Sir Vince, the Tartan Army – have been saying that the figures confirm that Britain has “the lowest growth rate in the G-20”. Even the hallowed BBC has repeated this claim – which is not true. The UK is in fact in fourteenth position[iv].

Andrew Goodwin, lead UK economist at Oxford Economics, opined that the OBR’s figures are “unduly gloomy”. There is now a permanent tension between the Treasury and its live-in Victorian chaperone, the OBR – which is unhealthy for national economic policy, in my view.

Mr Hammond is unlikely to turn spendthrift in the Autumn Budget. In fact, we can expect more of what the government’s opponents call austerity. Happily though, he looks far more assured in the House of Commons than the I, Daniel Blake figure he cut in his first budget. And the markets have responded with polite, though not fulsome, applause.

For all that, there is a sense of a lack of ambition about this government. Managerialism reigns. Mr Hammond may well not fail like most of his recent predecessors. The UK will not become a financial basket case like some of our European neighbours. Indeed, his epitaph might well be the one the late, great Ken Dodd desired on his gravestone: He tried, and did his best.

[i] See: http://www.dailymail.co.uk/news/article-4266122/Caffe-Nero-pays-no-corporation-tax-25m-profit.html

[ii] See: https://www.ft.com/content/e38b60ce-27d7-11e8-b27e-cc62a39d57a0?emailId=5aa9a573768ad90004ebabc2&segmentId=488e9a50-190e-700c-cc1c-6a339da99cab

[iii] See: https://fullfact.org/immigration/eu-migration-and-uk/

[iv] See the table provided by Trading Economics at: https://tradingeconomics.com/country-list/gdp-growth-rate?continent=g20