Lucky Hammond should follow Lawson’s lead by cutting taxes
This week has been a good one for Chancellor Philip Hammond, as he prepares for his first Budget in 11 days’ time. On Tuesday came the news that January’s budget surplus was £9.4bn – the highest recorded for 17 years. January is a key month for government finances, when selfassessment income tax bills are paid and when a significant amount of corporation tax payments fall due. It now seems likely that government borrowing in the current financial year will be at least £10bn below the forecast of £68bn made in the Autumn Statement.
On Wednesday, the Office for National Statistics uprated its growth estimate for the final quarter of last year – suggesting the economy has more momentum coming into 2017 than previously thought. Even though the economy is still expected to slow this year and next, this could also create a more positive backdrop for public finances.
Good luck is important in shaping careers and the course of events. “I would rather have a lucky general than a good general,” Napoleon Bonaparte commented on his military successes more than 200 years ago.
So could Hammond turn out to be a lucky Chancellor? He probably would not have thought so when he took office in the middle of a political crisis last summer. But events have generally gone his way since then.
First, the Office for Budget Responsibility reset the baseline for public finances in the Autumn Statement on the basis of weaker growth forecasts and disappointing tax receipts earlier in the financial year. A good maxim for management of financial expectations is to get bad news out early. Then there is then scope to outperform the views of the market if things turn out better than expected.
Second, the Chancellor made a virtue out of necessity in his Autumn Statement. As he was announcing higher public borrowing anyway, he also took the opportunity to boost spending on transport infrastructure, housing and research and development. Increased spending by the new National Productivity Investment Fund was accepted by financial markets as a sensible response to the challenge of supporting the UK economy after the Brexit vote.
Third, the global economic backdrop is favourable for the UK economy. The UK is a highly international economy relying heavily on trade and investment links with the rest of the world. When the world economy does well, the UK economy normally benefits – and this is one of the favourable factors supporting our economic growth at present. The three main engines of the world economy – the US, Asia and Europe – are all performing reasonably well at the moment. Donald Trump is expected to stimulate the US economy over the next two years with tax cuts and deregulation. So even though there are concerns about the protectionist tone of his speeches and comments, the US should still provide a short-term boost to global growth.
The backdrop to Hammond’s first Budget is therefore much better than he might have expected when he took office just over seven months ago. He now needs to work out how to use the benefits at his disposal. There should be a bit more money to play with – so what should he do with it?
There are three ways that the Chancellor can deploy extra resources at his disposal. He can reduce borrowing more quickly, increase spending or reduce taxes.
The Chancellor’s increased borrowing targets were accepted by the financial markets after his Autumn Statement, and it is not clear that he needs to reduce borrowing more quickly. He needs to demonstrate he is well-placed to achieve his targets – but the better news on public finances should enable him to do this easily, without promising to pay back debt earlier than expected.
Public spending has already been increased in the Autumn Statement – with a focus on infrastructure, supporting innovation and boosting productivity. There may be other pressure areas which Hammond chooses to address in his Budget, such as the health service and social care. But he can address these issues by fine-tuning his spending plans and reallocating spending between departments. A successful Chancellor needs to show he has a tight grip on the public expenditure total, and so any variation in the overall spending should be modest.
That leaves taxation, and this is where Hammond should aim to make his mark in his first Budget. The Institute of Fiscal Studies has already pointed out that the share of national income taken in taxation is set to rise above 37pc for the first time in 30 years. We have not seen big headlinegrabbing tax increases since the rise in the VAT rate to 20pc in 2011. But the Government has been extracting additional revenue in more subtle ways – ratcheting up Stamp Duty, withdrawing or restricting allowances and reliefs and not indexing tax thresholds for inflation.
The Chancellor’s recent good luck gives him an opportunity in this Budget which he should grasp – to reduce the burden of tax and start reforming the tax system. But will he be bold enough to do so?
Hammond might do well to look back over the record of his predecessors and reflect on how they used their good luck when it came along. There were some unlucky Chancellors who had to manage the UK economy through turbulent times – like Denis Healey, Geoffrey Howe, Norman Lamont, Alistair Darling and George Osborne. The luckier Chancellors were Nigel Lawson in the Eighties, Ken Clarke in the Nineties and Gordon Brown in the Noughties – all of whom were in charge of our public finances in more favourable economic conditions. Nigel Lawson, however, is the only one of these three Chancellors who is remembered for the positive impact he made in terms of tax reduction and tax reform. His example has not been followed by any of his successors in the past 30 years.
Over the last three decades, the UK tax system has become more complex and confusing, and there is a clear need for reform in many areas. So it will not be difficult for Hammond to make his mark. In his first Budget, he now has the opportunity to signal he is in favour of tax reduction, reform and simplification and take some important first steps in that direction next month.
‘The Chancellor can reduce borrowing more quickly, increase spending or reduce taxes’