One swallow doesn’t make for a tax giveaway

The regular monthly official figures for the public finances do not often merit a mention on the BBC’s News at Ten, or feature that prominently in newspapers. The July figures, released late in August, did, however. There were two reasons for this. One was that the public finances were in a rare surplus in July, receipts exceeding expenditure, the first such July surplus since 2002. Given that last year’s Brexit vote was meant to result in a significant deterioration in the public finances, this was indeed newsworthy.

 

The second significant thing about the figures was the interpretation put upon them by some City analysts. This was that they would give Philip Hammond room for manoeuvre in his November Budget. With the economy having slowed sharply in the first half of the year – GDP rose by only 0.2% in the first quarter and 0.3% in the second – and expected to remain subdued in the second half, the argument is that the chancellor might need to provide a fiscal boost at the end of the year to help the country through the Brexit process.

 

Let me apply a little cold water to both of these propositions. There was indeed a budget surplus in July – a debt repayment – of £0.2bn. This was, as the Office for National Statistics pointed out, the first such July surplus for 15 years, and compared with a deficit of £0.3bn in July last year. What the ONS did not point out was that July surpluses have been announced during this period, only for those surpluses to be subsequently revised away. Public sector net borrowing is the difference between two large numbers. A £0.2bn monthly surplus, or for that matter a £0.3bn deficit, is neither here nor these.

 

And, while the surplus announced for July was better than the markets expected, the underlying trend is still for higher borrowing this year compared with last. In the first four months of the current fiscal year the government borrowed £22.8bn, an increase of £1.6bn compared with the corresponding period of 2015/16. Though the borrowing estimate for the whole of 2015/16 has been revised down again, to £45.1bn, the deficit is heading in the wrong direction. Extrapolating the first four months’ figures would suggest the government is on course to borrow around £50bn this year, lower than the Office for Budget Responsibility’s (OBR’s) March Budget estimate of £58bn but still a very hefty number, and one which will make Hammond, a fiscal conservative, pause.

 

The OBR has not yet abandoned its March forecast, pointing out that timing factors may have flattered the latest figures. It has also provided additional reasons for Treasury caution when it comes to any giveaways. In July it published its inaugural Fiscal risks report, intended to highlight medium and long-term risks to the public finances. As it put it: ‘A decade after the outbreak of the financial crisis and recession, net borrowing is well down from its peak. But the budget is still in deficit by 2% to 3% of GDP – as it was on the eve of the crisis – and net debt is more than double its pre-crisis share of GDP and not yet falling. As a result, the public finances are much more sensitive to interest rate and inflation surprises than they were.’

 

Some of these fiscal risks are familiar, most notably the upward pressures on public spending arising from the ageing population and the increased cost of healthcare resulting from both demographic factors and the availability of new and more complex treatments.

 

The innovative aspect of the OBR’s new report, however, was to point to the risks when it comes to tax receipts. Successive chancellors have assumed that the tax take will increase automatically over time, as a result of fiscal drag and other factors. The OBR pointed out, however, that this may no longer be the right assumption.

 

‘The tax system is designed in a way that should increase the tax-to-GDP ratio over time, for example by linking thresholds to inflation so that real earnings growth drags more income into higher tax brackets,’ it said. ‘But in practice that ratio has fluctuated within a fairly narrow range, partly because of pressures on tax bases and effective tax rates that work in the opposite direction. Some taxpayers will always seek to reduce their liability through legal or illegal means. Some heavily taxed activities are in relative decline (fuel consumption, smoking, North Sea oil production). Some activities become harder to tax (changes in the way people work are weighing on receipts). And policy is a source of risk, for example repeated decisions not to implement fuel duty increases.’

 

It was an important intervention. Successive governments have sought to raise the tax burden to fund more spending but in practice the tax take appears to be limited to around 37% of GDP, for some of the reasons set out by the OBR. It follows that a government which intends to spend the equivalent of 40% of GDP will always run a significant budget deficit. The most recent shift has been in the performance of wages and productivity. Before the financial crisis, it was safe to assume a 1% to 2% annual rise in real wages. Now, thanks to the weakness of productivity, it is not safe to assume any increase at all. Weak real wages mean weak tax revenues, for a variety of reasons.

 

The chancellor will take all this on board as he prepares his November Budget. Far from thinking about big giveaways, there is talk that Hammond may revisit the long freeze on fuel duty. Raising it would be brave. Treasury officials are also said to be running their slide rules over pension tax relief again. Talk of a tax bonanza is a long way from the chancellor’s thoughts.