Sunak is bluffing about paying back our Covid debts

The politics of reducing the gaping hole in the nation’s finances are toxic to the Conservatives

Each spike on the chart tells of some catastrophe. The first one is World War One. The second, World War Two. The next big one is the 2008 financial crisis. The latest: Covid-19. The spikes represent big rises in deficit spending. Afterwards comes the retrenchment. Spending falls back down, but never by quite as much as it rose. Instead, tax revenues rise to plug the gap.

This time around, Rishi Sunak or his officials are supposedly hoping to make a head-start. There will be no tax “horror show”, the chancellor’s notes said as he was snapped leaving No 10, but there will be a little Halloween fright or, as he put it, a “plan to correct our public finances”. You’ve all enjoyed the performance by nice Rishi. Now get ready for scary Rishi!

Am I the only one entirely unmoved by this pantomime? The Government filled last weekend’s newspapers with chilling tales of a massive “tax raid” on corporations, capital gains, drivers and inheritance. That Covid bonanza has to be paid back sometime, tuts the Treasury. Well, yes, but Mr Sunak is just not a credible Scrooge. In truth, the Tories have no real intention of repairing the public finances this side of an election and unless bond markets turn nasty, they will get away with it.

The biggest reason is that Boris Johnson doesn’t believe in raising taxes. Every instinct in him rebels against the idea. Nor does it make any political sense. It would be economic madness to raise them now, before the Covid recession is over, and electoral madness to raise them later, when the next election creeps on to the horizon. As we saw in last year’s election, the Prime Minister also doesn’t believe that “austerity” is politically viable, even if he were the penny-pinching sort. So there is only one course left: keep spending and rely on the Bank of England to finance it.

This doesn’t mean, however, that the deficit is going to stay quite as high as it is today. At some point, the most acute emergency support – furlough and self-employment cash – will be withdrawn, although this may not happen in October as Mr Sunak claims. We won’t stay at the top of the spike for long. But the big, fat debt hangover it leaves behind is here to stay until the economy achieves some sort of new growth miracle or a Labour government arrives to whack up income and inheritance tax.

To understand why, it’s only necessary to look at the politics of all the alternative options. The public is sick of spending restraint and, with the exception of foreign aid, voters will not forgive any major new cuts to departmental spending. There are capital projects the Government could kill, like HS2 or hospital improvements, but such spending forms the core of Mr Johnson’s “levelling up” message and without them he hasn’t got much of a story to tell.

That leaves tax rises. The Tory manifesto effectively ruled out any big increases by promising not to touch income tax, national insurance and

VAT, the Treasury’s three biggest earners. That leaves corporation tax, a levy easily avoided by multinationals which only accounts for about 8 per cent of revenues. There is inheritance, a toxic zone for Tory governments and a tax that is not currently used to raise significant revenues in any OECD country. There are a host of other little taxes, like tariffs, road tax and so on, all far more controversial than they are lucrative. There are property and capital taxes, which sound juicy, but likewise amount to peanuts in fiscal terms.

That brings us back to the manifesto. If Mr Sunak really wanted to tackle the national debt without spending cuts or new wealth taxes, he would have to rip up that manifesto pledge. But even here the Tories would run into problems. VAT is known to be inherently regressive, hitting the poorest hardest, and the Government currently wants to encourage more spending, not less.

Yet raising income tax also poses serious problems. Despite what many would have you believe, the UK already has one of the most progressive tax systems in Europe. It may be true that we tax our top earners somewhat less than our peers. Looking at income plus national insurance rates, they pay on average 51 per cent, versus 55 per cent across nine other Western European countries examined by the Institute for Fiscal Studies. But the really big difference is lower down the income chain. In the UK, the average tax rate for median earners is 28 per cent. Across the other nine countries, the equivalent figure is 44 per cent. When people say that the UK is lightly taxed compared to our peers, they usually gloss over this point. The group we tax least compared to our peers is not the top, but the middle.

Of course, it may none the less still be possible to extract more from the richest. But it seems rather likely that the biggest fiscal fix would come from increasing taxes on the lower-middle classes. Try putting that on an election billboard.

This is why it is essentially impossible for the Tories to fill in the big fiscal black hole they have dug. The majority they won last year relies on a coalition of affluent suburbanites and the patriotic working class. Between them, they cover all the constituencies that would be hit by taxing property, middle incomes and spending.

Meanwhile, so long as the most extreme Covid spending is wound down by the middle of next year, it looks unlikely that markets will turn up the pressure. Quite the opposite, in fact: most economists are fretting that governments will stop spending too soon, not too late. The biggest risk, therefore, is that we run into a big inflation shock in the next two years that sends investors running for the hills. That is a risk that the Tories are clearly willing to take.

After World War Two, Britain’s national debt hit an all-time peak of 250 per cent of GDP. It was not the Conservatives who paid it down, but the combined effect of explosive GDP growth and a frenzy of massive wealth and income tax rises imposed by a Labour government. Mr Sunak might wag his finger and fiddle around at the margins, but while Boris is in charge, the big debt hole is here to stay. For the country’s sake, we’d better hope no one calls his bluff.

The majority they won last year relies on a coalition of affluent suburbanites and patriotic working class