Back to the future for Chancellor Hammond
Father of the House gives advice to the Chancellor as he steers a course away from austerity and through Brexit. By Anna Isaac
When Ken Clarke MP prepared to give his first Budget as chancellor, on Nov 30 1993, he was a little apprehensive about the reaction. Clarke had his reasons. He was about to introduce some of the largest tax hikes and spending cuts seen since the aftermath of the Second World War.
“Short-term popularity struck me as irrelevant. I went quite far, because politically I followed the orthodox belief that you do the difficult thing as quickly as you can.”
However, it did not play out as expected. The UK’S longest serving member of parliament, Father of the House of Commons, was in for a shock.
“I tried to enjoy Budget day. I delivered it in as flamboyant a way as I could and I had my large glass of whisky [beforehand] and all of that, and [then] it went very well.
“It was received so well in the House of Commons that I told myself as I sat there ‘perhaps they haven’t listened to what I’ve just been saying’. Because I had imposed some very tough spending totals on most departments,” Clarke says.
They were indeed harsh. Defence had £250m shaved off its budget, and costs were cut in social housing and transport. Clarke had also announced that he was going to raise the state retirement age for both genders to 65. A suite of tax “loopholes” were closed.
New taxes were invented including air passenger duty and insurance premiums. Clarke played a classic chancellor’s trick, what he terms a “surreptitious tax take”, of freezing the personal allowance for income tax.
UK economists are again turning to this Budget for lessons, and for one simple reason. Theresa May, the Prime Minister, has announced the end of austerity, and that means finding an extra £20bn to pay for new NHS spending commitments.
Combined, this “more money, no more cuts” promise leaves Philip Hammond, the Chancellor, in a tight spot. Borrowing presents other political difficulties.
The Institute for Fiscal Studies (IFS), a leading public spending think tank, believes that presents just one alternative: hike taxes.
Such a move would take UK tax receipts to 35pc of national income, the greatest share since the late Forties. It would be the biggest shift since 1993.
The state of the economy now, compared to a quarter of a century earlier, is, unsurprisingly, different.
In 1993, the UK was emerging from recession. Growth hit 0.2pc in the first three months of the year. The two years prior had brought one of the longest, if not the deepest, recessions since the Thirties. Amid the downturn, Black Wednesday, on Sept 16 1992, when the UK Government withdrew the pound from the European Exchange Rate mechanism, cost the Treasury a reported £3.3bn. The political career of Clarke’s predecessor as chancellor, Norman Lamont, never recovered. The government’s spending cupboard was bare.
As Clarke said in his maiden Budget there was an “overriding need” to place public finances on a “sound footing”.
In the past decade, the gap between what comes into the exchequer and what is spent, the deficit, has been narrowing. Thanks to the George Osborne and Rupert Harrison-led austerity programme it is at its lowest level since 2001 at close to 2pc of GDP.
“If you compare it to the US and Japan, where budget deficits are 4-6pc of GDP, the UK, with the 2pc [deficit], has improved a lot. But there’s still some way to go until you’re best in class,” explains Christian Schulz of Citigroup.
While the UK has not just found its way out of recession, but has had several years of growth, the recovery has not been robust. Wage and productivity growth has been sluggish for several years, curtailing economic growth and, crucially, making it harder to improve national debt as a share of GDP as a result.
Whereas public debt was a mere couple of hundred billion in 1993 it is now, following its ballooning from 2007 onwards, standing at close to £1.8 trillion.
“We do have to be mindful of the fact that debt-to-gdp is still very high. It is almost double what it was before the 2009 financial crisis. Whittling away at that debt pile is something that the Chancellor will have to bear in mind,” says Dean Turner of UBS Wealth Management.
Hammond, already caught between national austerity fatigue, grand promises from Theresa May and a party that has a hardcore group of tax-slashing supporters, faces an additional challenge: Brexit. According to Schulz, above all else Hammond must face up to the immediate politics and the “risk that his budget could get voted down because of Brexit and a small majority.”
In many ways, Turner and other City economists think that Brexit will curtail most of the dramatic actions Hammond can take. For Turner, understanding Hammond’s room for manoeuvre is down to a closer look at May’s austerity wording. He believes that it was a promise predicated on a successful Brexit negotiation in the next few months.
“[As a result] The Chancellor will need to keep his powder dry just in case the transition arrangement doesn’t transpire,” Turner says.
Brexit or no Brexit, there is still a black hole in the Government finances unless other departments see their budgets used to find the money for NHS spending, and if Hammond is to balance the books by the mid-2020s. Meeting what the IFS terms the “minimal definition” of ending austerity could be achieved by adding 1pc to VAT, income tax rates and national insurance contributions. The income tax changes would raise around £6bn each year, NICS £8.2bn and VAT around £6.1bn. Combined, they plug the £20bn shortfall. Needless to say this would be politically explosive.
“In 1993 it was a different political world to 2018. Nobody thought budgets were necessarily going to be popular,” says Clarke.
However he does it on Oct 29, Hammond, whom Clarke terms a classic “finance director of a medium firm” has no choice: he simply “has got to raise some revenue”.
Such a slim Tory majority however, makes a less radical combination of a borrowing fudge and small tax rises more likely.
‘I tried to enjoy Budget day. I delivered it in as flamboyant a way as I could and I had my glass of whisky’
Ken Clarke, above, said that when he was chancellor it was a ‘different world’; but Philip Hammond, left, has some difficult choices