The New Prime Minister’s Fiscal Challenge

So it is to be Boris Johnson versus Jeremy Hunt. Both contenders for the office of UK prime minister have promised un-costed tax cuts. But the winner will inherit Mrs May’s new spending commitments and the Brexit endgame is unclear. Victor Hill reflects.

Tuesday’s TV debate: a clash of titans or midgets?

At the BBC TV debate on Tuesday evening (18 June), none of the prime ministerial candidates, perched on bar stools, excelled. Boris looked tired and vacillated. Rory spent much of the time staring at his shoes or at the ceiling, removed his tie midway and generally looked like an emaciated whippet straining at the leash. Jeremy was redolent of a slightly put-out Thunderbird puppet. Michael looked peeved and was uncharacteristically shouty. Sajid was sincere but dull.

Boris was always certain of a place in the final two. The big surprise was the man whom he now has to beat. It’s not an inspiring choice. The next PM will have to make decisions for which neither candidate is well prepared.

The new prime minister’s fiscal challenge

Mrs May is certainly determined to go out with a bang and not a whimper. In the final weeks of her premiership she has committed the UK to go carbon neutral by 2050 – with un-costed consequences; she is pushing through an increase in the education budget of £27 billion over three years by building new schools and raising teachers’ salaries; and, reportedly, she has more legacy projects in store.

Not everyone is impressed. ITV News reported on Tuesday (18 June) that Mr Hammond, the Chancellor, was minded to resign over Mrs May’s “vanity projects”. It reported that tensions between Treasury and Number Ten officials had reached “boiling point”.

It is true that we have had nearly ten years of “austerity”. After the financial crisis governments were forced to cut back in order to control a fiscal deficit which reached 10 percent of GDP in Gordon Brown’s final year as PM. The coalition government, with the Cameron-Osborne pantomime horse in control of the purse strings, was committed to achieving a balanced budget sooner rather than later.

Under Mrs May, the purse strings were relaxed somewhat – with another £20 billion a year allocated to the NHS. True, the fiscal framework has broadly improved over the last year with the deficit down to just over 1 percent of GDP thanks to robust tax revenues. But we are still borrowing over £20 billion of net new debt every year so the total national debt outstanding is rising even if (at current levels of GDP growth or around 1.6 percent) the debt-to GDP ratio is falling. That said, largely because of demographics, the long-term demands of Britain’s state pension system and the NHS entail that state spending is likely to creep up inexorably as time goes by.

There is huge pent-up demand, however, for additional spending on the police, the criminal justice system, social care and on new infrastructure – all the prime ministerial candidates conjured with these. Only one candidate, Mr Stewart, declared boldly that you can have either tax cuts or spending hikes – but not both.

In his (probably final) Mansion House speech last night (20 June), Mr Hammond took the opportunity to flesh out the negative economic consequences of Johnsonian delusional thinking. He said:

A damaging no-deal Brexit would cause short-term disruption to our economy, soaking-up all the fiscal headroom we have built…and while fiscal and monetary policy interventions could help to smooth our path to a post-no-deal Brexit economy, both could only be temporary…and neither could prevent the economy being permanently smaller than if we leave with a Deal.

Mr Johnson’s proposition

Mr Johnson has declared his intention to pursue a “blue collar conservatism agenda” in government, “particularly in relation to supporting schools, police and other public services”. But his proposals to cut taxes, announced in his column in the Daily Telegraph on Monday of last week (10 June), were typically ill thought out. He wants to raise the income threshold at which the higher rate of income tax of 40 percent becomes payable from £50,000 to £80,000.

This is because a lot of middle class earners have, over time, become ensnared by the higher tax band though it was traditionally something to be applied to “the rich” (though who “the rich” are these days is an open question). The number of people paying the higher rate of income tax in the UK has risen from around 2.5 million in 2000 to 4.3 million in 2019. So someone earning £80,000 would be £6,000 a year better off under Mr Johnson – a considerable boon to the top ten percent or so of earners in the UK – though of no benefit at all to the other 90 percent.

One thing Mr Johnson doesn’t seem to have considered is that the upper rate tax bracket is a devolved matter in Scotland (though NIC thresholds are not!). So it would be up to Ms Sturgeon & Co. to match his largesse in Scotland. Mr Raab expressed the view that the Boris proposition amounted to a caricature of the Tories as “the party of privilege”. Mrs Leadsom doubted even that such a tax reform would get through the House of Commons. Nor did he address the anomaly introduced by Mr Osborne by means of which the Personal Allowance is tapered out for people earning over £100,000.

The counter-argument is that the top 10 percent pay something like half of all taxes and it is time that they got a break. While it is widely believed that “austerity” has largely disadvantaged the least well-off since the financial crisis of 2008-09, it is clear that the better-off carried the burden of additional taxes as the Coalition government of 2010-15 and then its two Tory successors continued to raise the Personal Allowance above inflation to its current level of £12,500. This policy has liberated millions of people (mostly part-time workers and the lower end of the self-employed) from paying income taxes altogether. That is a progressive achievement that these candidates for Tory leader should have celebrated.

Under Cameron-Osborne, child benefit for higher earners was axed, pension tax breaks were curtailed and middle class people who thought buy-to-let might be an alternative to stock market-biased provision for their old age were eviscerated with punitive stamp duty increases and less favourable tax write-offs.

Mr Johnson has also said that if there is a no-deal Brexit then Brussels will not get the £39 billion promised under the May-Barnier Withdrawal Agreement. Some commentators claimed that this would constitute sovereign default – a disgrace that has not befallen England since the middle ages. Standard & Poor’s confirmed that this would not constitute a sovereign default as its ratings only address “commercial debt obligations” and not, by inference, treaty commitments. In any case, the Withdrawal Agreement cannot be deemed a treaty commitment because it (so far) has not been ratified. The House of Lords determined that the actual legal obligation is only £9 billion – mostly in respect of pension liabilities.

£15.9 billion of the £39 billion relates to EU budget contributions for 2019 and 2020 during which the UK was supposed to be in the transition period (i.e. still a de facto member of the EU). Since we didn’t leave on 29 March this liability is already depleting. But if we refused to pay the balance the EU would very probably be reluctant to offer any Canada-style free trade agreement. That would not do the gilts market or the pound much good.

Mr Johnson also believes that every home should be guaranteed a fast internet connection by 2025. At the moment full-fibre internet coverage is available only to about 2 million homes in the UK – so he is right to be concerned. The official target today is to get 15 million homes connected by 2025 which Mr Johnson describes as “laughably unambitious”. But the most recent official estimate suggested that it would cost £5 billion of government subsidy to roll out a comprehensive full-fibre network by 2033. In any case, by 2025 the 5G wireless network is likely to offer most of the benefits of full-fibre in the countryside without costly taxpayer support.

A range of priorities

Mr Hunt thinks that we should radically increase our defence expenditure in a more dangerous world – to be by far Europe’s pre-eminent military power. The 2 percent of GDP target has hitherto obtained; but he thinks that should be the floor and would like to see defence expenditure at nearer 4 percent.

He also believes that the UK should cut corporation tax drastically – at least to equal the Republic of Ireland’s 12.5 percent. That would be both a symbol of Britain’s open economy and an incentive for overseas investors to remain here post-Brexit. But it would cost the Treasury an estimated £19.5 billion a year.

Michael Gove wanted to scrap VAT and to replace it with an American-style sales tax. I don’t know anyone in business who favours this. VAT levies a charge at each point in the value chain (where net VAT payable to HMRC is output VAT minus input VAT – so it is manageable). A sales tax is levied only at the end of the value chain – that is, to the final consumer. This kind of tax is also much more vulnerable to evasion. Moreover, no country has been able to sustain a sales tax at rates of above 10 percent or so – so the move would entail a significant loss of revenue.

Mr Javid wanted to scrap the top rate of 45 percent (applied on incomes above £150,000). Mr Hancock advocated an un-delineated digital sales tax to save the high street by scrapping business rates on small shops. Mr Raab aspired to a cut of 5 pence in the basic rate of income tax to 15 percent over the five years of the next parliament as well as a shake-up in National Insurance Contributions (NICs). That would cost about £30 billion in lost revenues.

This kind of open-skies thinking on tax is to be welcomed. We have not had a tax-reforming Chancellor since Nigel (Lord) Lawson in the 1980s when Thatcherism was given strong fiscal legs. Most Chancellors since then – Mr Osborne above all – have set out to complicate the British tax system by convoluted tinkering. As Matthew Lynn pointed out recently, HMRC’s official list of “minor tax reliefs” includes the landlord’s energy savings allowance and the landfill exemption for pet cemeteries, the costs of which are so negligible that HMRC doesn’t even bother to calculate a figure.

If we really are going to leave the EU – and both candidates are committed to that – then this is the moment to consider what to do with our new-found freedom to set the taxes we want. The new PM might start with pro-investment tax changes such as allowing immediate and full expensing of capital equipment and lowering the rate of capital gains tax. Phasing out stamp duty (which is a tax on labour mobility) would also stimulate productivity.

What next?

Last Christmas I predicted in these pages that Rory Stewart would become British prime minister during the summer of this year. A number of people found this odd. One Tory luminary took me aside at a drinks party and asked me if I was feeling all right. I told him that I anticipated Rory coming forward into the fray because I have some notion of his sense that his country needs him – I also anticipated that he would make it to the cabinet before Mrs May fell. I thought he might be able to mobilise the idealistic young in the Tory cause.

That’s all very well, the hard-headed money-men reading this will say, but what qualified him to become prime minister at this incredibly dangerous moment in our nation’s history? I think Rory’s personal qualities became clear as the contest played out. At a time when most politicians (I include nearly all of Labour’s front bench in this) sound as if they are spouting pre-digested gobbets from a script, Rory Stewart listens carefully, reflects deeply and then speaks authoritatively. He is authentic – he is what he is – but he is much more than that: he is authentically different. He has the ability to connect with people of all backgrounds – stretching well beyond the penumbra of occasional Tory voters. That is why he will remain a contender for the future.

In most Tory leadership contests the party has chosen the safe pair of hands. That is certainly not Boris Johnson, even whose supporters will admit that he would have to be kept on a very tight leash – as he has been so far in the prime ministerial contest. Mr Johnson would, like Donald Trump, divide opinion further making the wounds inflected by the protracted Brexit debacle more difficult to heal. Boris might be good fun; but he is decidedly high-risk. This was Rory’s Stewart’s ultimate brand: he was the anti-Boris.

Matthew Parris, the veteran Tory commentator, who knows everybody in the Tory high command, writes about Boris in today’s Spectator:

Colleagues know he’s no good, know he’s a cold-eyed scoundrel. They require no persuading of his inappropriateness to lead a nation through difficult times. Reel off the list of his incapacities and they yawn because they agree, and their opinion of the man hasn’t changed in years. What has changed is their opinion of his future usefulness to their own careers…

At a time when sentiment towards Britain overseas is (shall we say) unfavourable, ranging from sheer frustration to barely concealed contempt, we need a leader who could restore Britain’s good standing abroad. Boris Johnson is likely to have the door slammed in his face in Europe even if he is given a warm (if patronising) welcome in Washington. His stock is low abroad and that would bring Britain’s stock lower too. He is widely loathed in Scotland (Ms Sturgeon describes him as a charlatan), thus putting the future of the 13 Tory MPs north of the border in doubt. A French diplomat, when Boris was Foreign Secretary, once asked Foreign Office minister Sir Alan Duncan: What is it like to be Boris’s pooper-scooper?

The overwhelming existential question for the tattered Tory Party is: will the new leader be able to win a general election? If the Tories lose the next election it is not a grinning Mr Farage and his acolytes who will arrive in Downing Street; rather it will be the hatchet-faced Marxists of Corbynite Labour who now want to increase inheritance tax to 100 percent.

The appropriation of the assets of the not-so-rich will begin the very next day. They will impose wealth levies and financial transaction taxes. They will re-nationalise the railways, the water companies, the Royal Mail (LON:RMG) – and why not BT (LON:BT) too? And you will pay for it. They will abolish our high-achieving private schools and, caeteris paribus, all our private health care. Britain will cease to be a leading nation, a pillar of the west, and will emerge as a low-growth rogue state.

The new Tory prime minister will feel the hand of history on his shoulder: he must not fail. This is not a moment for a familiar joker or a chancer – or even a conventional safe pair of hands, for that matter. It should be a man of outstanding quality, leadership and vision – and it remains to be seen if Mr Hunt is that, even if he is much the lesser of two evils. Though he might surprise us yet.