Low taxes and a good Brexit will let us budget for success
Among the political classes, once the summer is over, quite apart from the usual infighting – which this year will surely be even more intense than normal – thoughts should turn to the Budget, probably set for November. One of the most important bits of good news over recent months has been the fall in the Government’s borrowing requirement. Does this imply that the squeeze is over and that the Chancellor has money to give away? Or is the pressure still on to raise taxes?
In the financial year 2017-18, the Government’s budget deficit was £39.4bn. Although this sum is still enormous, it is about 14pc lower than borrowing in the previous year.
And in the first three months of 2018-19, the deficit had fallen still further, by about 25pc compared with the equivalent period last year.
It looks likely that the deficit for the year will come in at about £34bn, or 1.6pc of GDP, some 14pc lower than last year and £3bn lower than the Office for Budget Responsibility
‘To make the most of our opportunities, we need to present ourselves to the world as business-friendly’
forecast in March. (We will know more in eight days’ time when we get the borrowing figures for July, which is always a big month for tax receipts.)
Of course, the deficit could be lower. But at its highest in 2009-10, it was about 10pc of GDP. Reducing it to 1.6pc of GDP is a real achievement.
This is especially impressive when contrasted with the pessimism that spewed out from HM Treasury at the time of the Brexit referendum in 2016.
Does the significant decline in borrowing suggest that the economy is stronger than the official GDP figures report? It is always worth entertaining this possibility because the GDP figures are extremely ropey and, by contrast, figures on tax receipts are hard numbers. But, in fact, I don’t think that we can conclude that GDP growth is being understated this year.
The annual growth of tax receipts is broadly consistent with the official GDP figures. But things look good going forward. After a dip in Q1, growth recovered in Q2 and things currently look pretty solid for Q3. This should be enough to secure a favourable out-turn for the deficit for this year.
The main reason why borrowing has been lower this year is a fall in public spending, especially on debt interest. The Government is managing to refinance debt at an average interest rate of about 1.5pc, compared with the about 5pc it was paying on maturing 15-year gilts. This knocks about £2bn off the debt interest bill each year.
As we move into next year, the dominant influence will be Brexit and whatever impact it has on UK economic performance. Yet one of the adverse consequences of our prolonged Brexit shenanigans and the Conservative Party’s internal civil war over Brexit is that there hasn’t been either the time or the appetite for debate about other major issues, including fiscal policy. Consequently, the Government is not giving serious attention to the possibilities and priorities for fiscal policy. It needs to.
Although the current fiscal position is far better than almost anyone could have imagined even a few years ago, this does not mean that the long-term fiscal challenge has been overcome. The ratio of government debt to GDP, which at one point had threatened to soar out of control above 100pc, is now peaking at about 85pc. That is good. But this figure is still much too high. Remember that Gordon Brown’s fiscal rules stipulated that this ratio should be below 40pc. Moreover, we cannot rely upon the Government being able to fund its debt at such low interest rates forever. As and when interest rates return to more normal levels, this will increase the deficit considerably. Longer term, we face an acute fiscal problem because of the ageing population and the increase in the costs of healthcare.
Some analysts have suggested this implies that a significant increase in taxes is inevitable. But, when it comes to economics, inevitable is a word I really don’t like. With apologies to Mark Twain and Benjamin Franklin, I don’t like it even when applied to taxes. (I will concede to them, though, on death.) In truth, we face a choice over the level of government spending (and hence the need for tax receipts) and an intellectual challenge over the role of the tax system in fostering or hindering economic growth.
The establishment view seems to be that taxation does not impede growth. Moreover, because Brexit will reduce growth and hence tax revenues, it strengthens the already strong case for higher tax rates. And a “hard Brexit” even more so. I disagree on all levels.
If we can secure decent rates of economic growth then the fiscal problem will largely melt away. A botched Brexit in which we do not effectively free ourselves from the EU but become a neutered rule-taker will damage confidence in our future and bring us next to no gains from leaving.
By contrast, a proper Brexit will bring the benefits of improved resource allocation and increased competition deriving from a move towards free trade.
But even larger gains will surely come if we adopt a reformed regulatory system. To make the most of our opportunities, we need to present ourselves to the world as a business-friendly economy.
Accordingly, we should be thinking about lower taxes, not higher ones. This will require both a careful and determined effort to contain public expenditure and patience over reducing the debt ratio.
Raising tax rates would be one of the best ways to undermine the chances of Brexit succeeding.
As things stand, however, we face the prospect of the Chancellor being steamrollered into raising taxes by the misguided idea that this is “inevitable”. He should wait until the Brexit outcome is clear.
He may be surprised by what transpires. The improving public finances give him time to wait and see.
Roger Bootle is chairman of Capital Economics roger.bootle@capitaleconomics.com