Deeper and deeper in debt

We are approaching the end of a year that, in so many respects, has surprised. There is a parallel universe somewhere in which George Osborne has just presented the first Autumn Statement of a post-referendum era, following Britain’s decision to stay in the EU; and another in which Ed Balls is 18 months into his chancellorship following a 2015 Labour victory.

 

But we are in neither of these; and the environment we are in, to draw on a much used word, is challenging. I do not want to go into the details here of Philip Hammond’s Autumn Statement, which has been extensively covered. What I will talk about is the frankly disturbing outlook for the public finances and whether we have learned anything about the new chancellor’s approach to tax.

 

Most of the attention devoted to the new fiscal projections by the Office for Budget Responsibility (OBR) has been about its estimates of the costs to the public finances of Britain’s exit from the EU. Of the £122bn addition to borrowing between now and 2020/21, £59bn is directly attributed to Brexit, about £26bn to deliberate policy actions – mainly extra infrastructure spending, and the rest to policy measures announced in Osborne’s last Budget in March that subsequently had to be reversed, together with other factors.

 

Three things are worrying about the fiscal outlook. One is that public sector debt is now on a rather alarming upward trajectory. A decade ago, it was £500bn. In 2010, it exceeded £1trn for the first time in our history. By the end of this decade, it will be above £1.9trn and knocking on the door of £2trn.

 

A second concern is how much debt is set to rise in relation to the size of the economy. In the OBR’s first ever forecast, as long ago as June 2010, debt was predicted to peak at a touch above 70% of gross domestic product during the last parliament and then begin to decline relative to the size of the economy. It did not, of course, peak during the last parliament. Now it is expected to hit more than 90% of GDP in 2017/18, before embarking on a gradual fall.

 

This is concerning not only because it underlines the extent of the fiscal slippage of recent years, but also because of the absolute numbers. Research a few years ago by the American economists Carmen Reinhart and Kenneth Rogoff showed that government debt levels above 90% of GDP hamper economic growth and thus the economy’s ability to generate revenues. Though the research did not go unchallenged, it was influential among policymakers, including Osborne.

 

The third area of concern is that, while not everybody agreed with it, there was a purpose to the former chancellor’s aim of achieving an overall budget surplus by 2020. This was because the pressures for higher public spending will build as we move into the 2020s, to an extent that they will not build before then. The government’s new aim of achieving a budget surplus at an unspecified date in the 2020s will, the OBR noted, ‘take place against a backdrop of significant fiscal headwinds from an ageing population’. Among those headwinds is what the OBR describes as a much faster increase in the pensioner caseload.

 

So the outlook for the public finances – the annual deficits and debt – is worrying.

 

 

We have learned two things about the new chancellor. One is that he is no fan of tinkering for its own sake; hence his decision to scrap the Autumn Statement and replace it with a single Autumn Budget, something we last saw in 1993 to 1996 when Kenneth Clarke was chancellor.

 

The second, related to this, is that Hammond appears to favour greater tax simplification, something that many of us would applaud. After successive chancellors have left their mark on the tax system by making it ever more complex, a genuine simplifier in 11 Downing Street would be good news. So far, however, there are not too many clues. He has stuck to two of his predecessor’s policies by freezing fuel duty and proceeding with the target of raising the personal income tax allowance to £12,500 and the higher rate threshold to £50,000. Both are unexciting, and both are expensive in revenue terms. He has also said he will stick to the target of getting the corporation tax rate down to 17% by the end of the decade, a pledge that has met with an underwhelming response from business.

 

When might we see some more meaningful tax action, some reform, from Hammond? It would be inconsistent, I would say, for the final March Budget (for now) to be a big one. By then, the government will be embroiled in the task of beginning the formal article 50 process of withdrawal from the EU. Even a bold Budget would be a sideshow.

 

The chancellor would probably want to make his mark in his first Autumn Budget, in a year’s time. There are plenty of ways he could do so, while sticking to a simplifying agenda. Before every Budget or Autumn Statement, I am asked by worried advisers whether there will be an attack on tax relief on pensions. Osborne came close to radical reform in this area in March but was dissuaded by David Cameron, ironically because it was feared that it would make it harder to secure a remain vote in the referendum.

 

If the taxation of pensions is in a mess, it is far from the only area. Across personal and corporate taxation there are complexities and distortions which are ripe for reform. Most reforms, however, create losers as well as winners. And in the challenging times that lie ahead, neither the chancellor, nor more particularly the prime minister, may want to risk creating too many losers.