Why Hunt cannot opt for display of fiscal pyrotechnics to win votes
The Chancellor must make investment in long-term growth top priority ahead of his Autumn Statement
With a general election coming in the next year, Downing Street continues to make a virtue out of its supposed fiscal discipline, foregoing – seemingly deliberately – anything that might be deemed fiscally reckless or otherwise unaffordable vote-buying.
That doesn’t mean there won’t be any such crowd pleasers in the Autumn Statement this month.
It’s still remotely possible, for instance, that the long-cherished goal of abolishing, or significantly reducing, inheritance tax might unexpectedly be pulled from the hat.
But the Government still bears the scars of Liz Truss’s short-lived premiership, and if pre-election giveaways are to be ventured at all, it is much more likely to happen in next spring’s Budget, when the Government will be in full campaigning mode, than right now.
Instead, the Chancellor, Jeremy Hunt, is for now focusing on measures to improve long-term growth and investment – or the supply side of the economy, including business taxation. Making so-called “full expensing” effectively permanent has for him become a top priority.
Whether this is entirely wise politically is for others to judge. It is all very well doing the right thing by the economy, but if 20 points down in the polls, survival might be more gainfully pursued via a more obviously eyecatching roll-of-the-dice display of fiscal pyrotechnics.
So if the Chancellor does stick to his guns, he will at least deserve some credit for political bravery. Business leaders have been lobbying hard to make “full expensing” of investment in plant and machinery permanent, a tax break which the Office for Budget Responsibility has estimated would cost £10bn a year.
Hunt has already said that fiscal headroom allowing, he’ll do it, but thus far his own fiscal rules have frustrated him. This may be about to change.
As it happens, the fiscal space deemed necessary may be fast opening up, not least because persistently high inflation has put a rocket under tax revenues.
Rather less plausibly, the Government also hopes to further enhance its room for manoeuvre by cutting waste and improving public sector productivity.
Believe it if you will. Pretence like this is part of the meat and drink of managing the public finances, with the hard work of getting the national debt onto a sustainable footing constantly pushed out into an ever-receding future. Thus the figures are made to add up by routinely assuming that fuel duty will be indexed to RPI inflation, even though there is scarcely a chancellor in the past 13 years who has actually done it. In any case, if the fiscal headroom now exists – and there is good reason to suppose it does – permanent “full expensing” is back on the agenda.
As things stand, Britain has one of the lowest rates of business investment in the OECD. Some of this underspend is understandable. Our manufacturing sector is relatively small compared to others; services tend not to be nearly as capital intensive.
All the same, deficient business investment is a chronic ongoing problem for the UK economy that threatens long-term damage to growth potential. Whacking up corporation tax for larger companies from 19pc to 25pc doesn’t obviously help in this regard. Even at 25pc, the headline rate is still the lowest in the G7, but the international messaging of such a big increase is none the less appalling.
“Full expensing”, which builds on the “super-deductions” tax break Rishi Sunak, the Prime Minister, announced when chancellor, offsets these negatives, at least partially.
Early signs are encouraging. Since super-deductions were introduced, Britain has enjoyed the fastest business investment growth in the G7, albeit from a very low base. Full expensing, which allows companies to save £250k in tax for every £1m invested, gives Britain the joint most competitive capital allowances regime in the OECD. Before its introduction, the UK was a lowly 32nd.
Bigger capital allowances might also help tip the balance of tax advantage in the UK away from the likes of Goldman Sachs and other big financial and professional services firms towards more traditional areas of economic activity. Tax policy should ideally aim for as broad a base as possible, but with low headline rates that are sectorally agnostic and don’t favour one set of economic players over another.
When you see levels of business investment as poor as Britain’s, however, there is a good case for extra incentives, or eventually we won’t have much of an economy left to tax in the first place.
When Hunt originally announced “full expensing” in this year’s spring Budget, he time-limited it to three years. Had he made it permanent, he would, in the judgment of the Office for Budget Responsibility (OBR), have broken his own fiscal rules.
But that was then.
Things have since changed. The National Institute of Economic and Social Research last week estimated that thanks to the effect of high inflation on tax revenues, the fiscal headroom is far higher than OBR forecasts suggested last March.
This may be a tad overoptimistic. That the Chancellor would have as much as £90bn of headroom for tax cuts and spending increases seems a little far-fetched, but if even half this number, there would be ample scope to make “full expensing” permanent and much else besides.
The Government must be ruing the day it allowed its hands to be so tightly bound by the judgments of the OBR. Originally a Tory initiative designed to discredit Labour’s handling of the public finances, the OBR is today enthusiastically embraced by Labour as a stick with which to beat its Conservative Party birth mother.
Labour should be careful with its new-found friends, for the OBR is likely to be as hostile to Labour claims that much higher public investment spending will pay for itself by boosting trend growth as it is of similar assertions made by the Right for the growth enhancing powers of tax cuts.
As for full expensing, research by the CBI and Oxford Economics published last week found that making it permanent could lead to a 21pc increase in the level of business investment by 2030/31 (or an extra £50bn a year), equating to a 2pc increase in GDP.
If only partially correct, the CBI claim lends support to separate analysis by Stuart Adam of the Institute for Fiscal Studies to the effect that the long-run costs of the policy are in any case not nearly as great as the OBR thinks – more like £1bn to £3bn a year in his view.
This is because most of the up-front costs of the tax break will be recouped in future years: firms get to claim more tax relief up front, but less tax relief further down the line than they would have done under the old allowances regime. Short-run scorecard impacts should not govern long-term policy choices, Adam observes. Quite so.
Now all that Hunt has to do is convince the OBR, but I would be very surprised if he fails.
‘If the Chancellor does stick to his guns, he will at least deserve some credit for political bravery’