Hammond has a lot of Osborne’s mess to clear up
Public finances were in some trouble even before Brexit. Now it looks as though they may be in worse trouble. But how much worse?
We have just had the revenue and spending figures for September, so we are half way through the current financial year. The deficit is still a little lower than it was in the first six months of the last financial year but
the decline is not as great as expected by the Office for Budget Responsibility. We are closing the gap, but not as fast as hoped, largely because tax receipts have been weaker than expected. They may improve in the second half of the year, when receipts from self-assessment income tax come in, and assuming it does, the independent Institute for Fiscal Studies (IFS) expects a shortfall of some £8bn. If that were right, the deficit, which was £76bn in the last financial year, would come down to about £63bn, instead of the £55bn the OBR projected. So it is still heading in the right direction, but slower than hoped.
Should we worry about this? Well, no and yes. The no bit first.
Somewhat slower correction of the deficit is quite acceptable in a world of low interest rates as long as the general direction of the Government’s policy is clear. We went into the downturn with the worst public finances, bar Japan, or any large developed country. Last year the deficit was still 4 per cent of GDP, again the biggest deficit bar Japan. Anyone who cares about the moral and practical objections to transferring a greater burden of debt onto the next generation can see the need to get the deficit at or close to balance. But in the real world, should a shock occur and the Government need to slow or even reverse cutting the deficit for a year or so, that is surely acceptable. Brexit is a good example of just such a shock.
It is really far too early to see the impact Brexit will have on government revenues but I have not seen a single forecast suggesting that it will improve them. The question is whether this will be a £15bn hit or a £30bn one – that was the likely range of outcomes suggested by the IFS ahead of the referendum. If the former it would delay the deficit-cutting programme by one year; if the latter, two years.
So far the impact on the economy (though not on the pound) has been much less than forecast, so on the face of it that should tip things towards the better end of the scale. The trouble is that quite irrespective of Brexit public finances, revenue felt a bit soft. This may be because of structural changes in the economy and it may be because of changes in habits of the very high-earners.
The structural changes in the economy are not new but are fascinating none the less. Though both the labour force and earnings are growing, they are growing in ways that are unlikely to bring in as high revenues as you might expect. While the shift to self-employment should be revenue neutral – the selfemployed pay their taxes at the same rate as the employed – in practice it may cut revenue. For example, if the self-employed do so through a limited company they may choose to leave more money in the business than take it out in salary. Much of the growth in employment has been among people of retirement age, who may choose to keep income (and hours) below the higher tax threshold and use capital rather than income if they need to pay for luxury items. In the gig economy, younger workers may be choosing to keep income down and take more leisure instead.
And so on.
As for higher-earners, some at least are making lifestyle choices of swapping income for leisure, while others are making changes to their habits to hold down the tax bill. For example, the changes in stamp duty have made a high dent in top end property sales and it seems that many wealthy property owners have decided to stay put. The changes to non-dom status may also now be cutting revenue, although initially they increased it. And as the IFS has noted, more than 27 per cent of income tax revenue last year came from the top one per cent of earners. It observed:
“One implication of an income-tax base that increasingly relies on a smaller group of taxpayers is that the growth of receipts may be more unpredictable and risky.” The underlying risk is obviously increased by Brexit, even if only a small proportion of highly-paid jobs move offshore as a result.
All this makes for a difficult background for the Autumn Statement next month. We should thank George Osborne for setting up the independent OBR as a means of scrutinising public finances, and for cutting nearly two-thirds of the deficit he inherited. But he has passed on a bit of a mess too to his hapless
successor.