Jeremy Hunt’s Budget will be fatal for economic growth

On current political forecasts, Jeremy Hunt will present a Budget on March 15 that will raise corporation tax from 19 per cent to 25 per cent. If he does so, it will damage the economy’s growth prospects. Decisions by businesses on innovation and investment, and by multinationals on where to locate their foreign direct investment, are motivated by expected profit after tax. Hence, productivity growth is affected by government, rather than falling like manna from heaven, which is how it is being treated by the Treasury and the OBR. For these two, profits can be treated like a milch cow, without any negative effects.

It is not just economic theory that shows this is wrong. The data do, too. So it is tragic that the Government seems determined to stick with its growth-destructive fiscal policy, on the grounds that it is necessary to head off inflation and to remain solvent. The economy will run flat, if not into overt recession, in the short term and into weak growth in the longer term.

The grounds given by the Treasury for its tax rises are easily refuted. First, inflation. This is under the control of the Bank of England, which has raised interest rates sharply to bring inflation down to its 2 per cent target. Its success in this is now widely expected. The commodity price spikes that caused the sharp rise in costs are, furthermore, in reverse. As for the contribution of fiscal policy restriction to inflation, this if anything will push it up through its direct effect on wage settlements.

As for solvency, the UK’s market reputation remains strong and hardly altered during the Truss government. The latest UK five-year credit default swap rate (insurance against a country not paying its debts) is under 7 basis points (0.07 per cent per annum), while Italy’s is over 90. During the Truss period, the UK rate peaked at 40, compared with an Italian peak last July of nearly 200.

In any case, the reason that UK long-term interest rates rose during the Truss period was not solvency worries but concern that inflation would increase sharply and trigger higher interest rates. That turned out to be groundless. The situation today is one where solvency is not an issue and inflation is expected to be low. So where is the risk in pursuing a fiscal policy that supports the economy?

The Treasury and Chancellor further maintain that “the fiscal rules” offer no scope for easing. Yet these rules are supposed to ensure solvency, which is not a problem. In effect, the rules have been set artificially tight by choosing a poor criterion: that the debt/GDP ratio should be falling in the 2027/28 fiscal year. This date is arbitrary. One should look at least a decade ahead, to check that the debt/GDP ratio is on a downward trend by then. It turns out that the key requirement for this is that growth should be adequate; at, say, 2 per cent growth, there is no problem because this produces solid growth in net tax revenues, which then outpace likely growth in public service needs.

The Treasury argues that inflation on index-linked bonds and Bank interestrate increases have raised debt interest and that the Bank sell-off of long-term gilts has created a capital loss that costs the Treasury money in refunds. This is smoke and mirrors. These “refunds” within the public sector cost the taxpayer nothing. Index-linked bond values fall in real terms with inflation, offsetting the inflation compensation they pay. Because government debts are mostly long term, interest on them only rises when they mature, which is long into the future. But the Treasury permits the Bank to pay interest on bank reserves held with it, which is quite unnecessary as these reserves are only convertible into cash. The Bank is paying out a huge amount in interest to banks, to the tune of some £40billion a year, lumbering the taxpayer with an immediate extra interest-rate bill.

The puzzle then remains: why is this Conservative government adamant in pursuing policies that, by destroying growth, will also destroy its own prospects of survival? It would be better to perform an emergency brake than to hurtle on towards disaster.

There is no good reason to increase corporation tax. It could plunge the UK into recession