A Budget That Points The Way But Doesn’t Get Us Very Far

Under the Conservatives public investment as a share of GDP was projected to fall steadily from current levels of around 2.5% to 1.7%. The assumptions that Reeves has given the OBR imply, to the first approximation, public investment staying flat at 2.5% of GDP. That is an improvement, but a relatively modest one, given the lack of public investment over the last fourteen years.

Current public spending

Current spending is everything that isn’t gross public investment. The chart below compares pre and post-Budget assumptions given to the OBR.

Here we have a similar story. The Conservatives had pencilled in further cuts to the public sector compared to current (23/4) levels, while Reeves has assumed the share of public spending in GDP will be, to the first approximation, pretty flat through the next five years at around the current level of 40%. So no additional austerity compared to where we are now, but no attempt to return spending to the levels needed to restore the public services to the state they were in just before austerity began in 2010. In particular, with health services around the world absorbing an ever growing share of GDP, flat in overall terms means most departments will see a falling share of spending in GDP.

If that seems a little disappointing, it is worth remembering two points. The first is the extent of additional austerity implied by the inheritance Reeves received, all to enable unsustainable tax cuts. Avoiding that required the budget undertake substantial tax rises and considerable additional borrowing. As the OBR sets out in the chart below, most but not all of the additional current spending is matched by higher taxes, with some covered by additional borrowing thanks to revised fiscal rules.

The second point to remember is that this is just one budget. My overall impression is that, compared to the potential tax changes I went through in last week’s post, Reeves has in most cases been relatively modest in the increases implemented this time. That leaves scope for further increases in spending matched by higher taxes, if necessary, in later budgets.

Taxation

In my last post I looked at areas of taxation where I thought significant amounts of money could be raised (or, if you prefer talking about resources, where a significant amount of resources could be released to allow for additional public spending), without violating the pre-election pledges not to raise income tax, employees NIC, VAT or corporation tax.

1. Employers National Insurance Contributions

Raising employers NICs can be thought of as partially undoing the reckless (in terms of unsustainable) cuts to employees NICs made by the last government. In fact employers contributions are slightly more progressive than employees, because there is no upper earnings limit on employers contributions. (As I noted in that earlier post, removing the upper earnings limit on employee contributions would raise a significant amount of money in a very progressive way, but was presumably precluded by pre-election pledges.)

This change in employers' NICs accounts for more than half of the additional revenue raised in the budget (£26 billion out of £42 billion by the end of the decade).

2. Other tax increases

As expected, both Capital Gains Tax and the Inheritance Tax regime have been changed to increase revenues, but the scale of the former in particular is modest compared to some of the possible changes I outlined last week. In that sense, this is not so much a ‘soaking the rich’ budget, but a ‘mildly inconveniencing the rich’ budget. As I noted then, there is a strong case for gradualism with taxes that few pay and where behavioural changes are potentially important, so this may not be the last time these taxes are increased.

3. Fuel duty

In last week’s post I noted some tax increases that the Conservatives had pencilled in which Reeves could cancel, but doing so would only make her job harder. Fuel duty was one of those, and here Reeves has not only decided to not increase the duty yet again (on a day after floods generated by climate change killed dozens in Spain), but is in danger of continuing the Conservative practice of planning future Fuel Tax increases but never implementing them. Depressing.

Fiscal rules

Yes, counting government financial assets as well as liabilities makes more sense than just counting liabilities, and this change to the fiscal debt rule allows more public investment which is good. However counting financial assets but ignoring physical assets still makes little economic sense, so the new debt rule run alongside the golden rule still has no purpose other than to suppress public investment.

More unexpected was the gradual move to a three year rolling target for the fiscal rules rather than a five year rolling target. This is simply a mistake. The rationale for a five year ahead target is that forecasts over this time frame exclude cyclical effects. This is clearly not the case for three year ahead forecasts. The Treasury document says that moving to three years ahead will ‘enhance fiscal discipline’, but so would balancing the budget each year! Designing good fiscal rules tries to combine fiscal discipline with good fiscal policy, and good fiscal policy should be counter cyclical not pro-cyclical. This change will do almost nothing to improve fiscal discipline but will make good fiscal policy more difficult. (On fiscal discipline, see also Fuel Duty above!)

The reality is, unfortunately, that the design of fiscal rules is increasingly a political exercise where good analysis is regarded as far less important than short term expediency, the thoughts of Krugman’s ‘Very Serious People’ or political journalists (mediamacro). This is a problem because, as I always say, bad fiscal rules are worse than no rules at all.

Summary

As most of the media will attack this budget for increasing taxes to ‘record highs’, without appearing to give a moment’s thought to why taxes are rising to record levels in most countries, it is natural to be defensive of it. It is, after all, much better to travel in the right direction, albeit slowly, than to keep on going the wrong way.

However, the political danger of moving gradually, in part because one hand is tied behind your back (no tax rises on working people), is that you disappoint those who are naturally impatient to see improvements in public services across the board. A political environment where voters know taxes are rising but where problems in public service provision (including child poverty) continue to fill the headlines is not a comfortable one for any government, because it raises issues of competence in voters’ minds (where is the money going?). Equally risky is continuing to try and flatter the marginal voter (or petrol user!) when you are in danger of losing your political base. I suspect, once the immediate and rather predictable political controversy is over, this budget will be seen as the minimum that could have been done, and that something bolder might have been less risky in the longer term.