Almost as if last year’s disastrous “mini” Budget had not happened, the Conservative party is again excited about tax cuts promised this autumn. Government sources have been busy briefing that the prime minister wants to lower the income tax rate by 2p in the pound; meanwhile, a group of 50 Tory MPs have demanded the abolition of “morally wrong” inheritance tax.
None of the recent activity should be unexpected for Chancellor Jeremy Hunt, who encouraged such speculation in his March Budget. He promised to make the £9bn a year investment allowances in corporate tax permanent “as soon as we can responsibly do so”, while adding in evidence to MPs that “the Conservative approach is that we bring down taxes when we can”.
Lowering taxes “responsibly” and “when we can” was always said with something of a wink to Tory backbenchers. Ministers thought they only needed to wait until the Autumn Statement for the Office for Budget Responsibility to give them cover for tax cuts.
The reason for this confidence is a little arcane. Hunt’s fiscal rules are measured five years into the future. At the time of the March Budget, they implied public debt had to be falling as a share of national income in the 2027-28 financial year, alongside public borrowing dropping below 3 per cent of gross domestic product. This autumn, the comparison year will roll forward to 2028-29, giving the chancellor scope to incorporate another year of unrealistically tight public spending plans into the forecasts, magically improving the outlook for debt and borrowing.
By law, the independent OBR must accept the government’s word that public spending will be held down, regardless of past experience suggesting it is highly unlikely. Even if the fiscal watchdog privately thinks the spending numbers are nuts, it can only raise the odd eyebrow in its write-up. The upshot is that a dodgy forecast can be used as independent justification for pre-election tax cuts.
Conservatives feel they win either way. If tax cuts boost their electoral chances, ministers can deal with the fallout later. If they fail, the consolation is that an incoming Labour government will face an almost immediate public finances nightmare.
That was the theory. In practice, the plan appears to be going a little awry, just as it did for Liz Truss last summer. The economy might be stronger now than expected in March, but that does not normally improve the medium-term public finance outlook. Stronger economic growth now comes in exchange for weakness later.
The bad news for the Treasury is that all expected interest rates are now higher than in March across the five-year forecasting horizon and the UK’s public finances are highly sensitive to borrowing costs. Financial markets now expect the Bank of England’s policy rate to average over 5 per cent in 2023-24 and hover a little around 4 per cent over the next five years — a full percentage point above the OBR’s forecasts in March. Gilt yields are also close to a percentage point higher.
Unlike many advanced economies, the UK has highly transparent accounting of debt interest: these rises in expected borrowing costs will force the OBR to revise up the UK’s deficit by roughly £20bn a year, close to 1 per cent of national income. That is more than the additional headroom ministers hoped to gain by playing games with the fiscal rules. For the time being, then, it eliminates much of the scope for cutting taxes and remaining within the fiscal rules.
Public finance numbers can change and there are several months before the Autumn Statement. But you have to wonder about the discipline and numeracy of a Conservative party that appears to be going into a second summer of tax cut fever when the numbers don’t add up.