David Gauke is a former Justice Secretary, and was an independent candidate in South-West Hertfordshire at the 2019 general election.
The holiday from fiscal reality is well and truly over. The traditional position of the Conservative Party has been to take a cautious view on Government borrowing and ensure that the public finances are sustainable. This stance has been in part about intergenerational fairness (not leaving future generations with large debts) and in part about the fear of losing the confidence of the bond markets.
After the surge in borrowing that followed the pandemic – with no apparent adverse market reaction as interest rates remained very low – such thinking became unfashionable. “We can borrow cheaply” soon became “we have always been able to borrow cheaply – austerity was wrong” and then “we will always be able to borrow cheaply”. Such thinking even started to influence some Conservatives.
This all came crashing down after 23 September and the so-called “mini-budget”. The markets’ patience snapped.
Rishi Sunak and Jeremy Hunt are left to pick up the pieces and have to deliver in the Autumn Statement on 17 November. An international economic downturn meant that the public finances would have deteriorated since the March Budget in any event, but the Trussonomics experiment has made matters worse. Sunak’s increase in national insurance contributions has been dropped and – even though the UK-specific premium on debt interest has dissipated – the markets are watching closely. The new Chancellor has to err on the side of fiscal caution. It is starting to feel like 2010 again.
Following the global financial crisis, the Coalition government delivered a fiscal consolidation that was 80 per cent spending cuts and 20 per cent tax rises. The Treasury is briefing that this time round it will be 50-50, but even that may overstate what can realistically be found from public spending.
In the decade before 2010, public spending had risen substantially. One could identify expenditure that could be classified as “nice to have” but that, in the more challenging circumstances of our largest ever peacetime deficit, could no longer be justified. Over the last twelve years, public spending has not risen substantially: “nice to haves” have long been removed.
As an illustration of how much harder it would be to cut public spending, let us look at public sector pay. This currently constitutes 20 per cent of all Government expenditure and 33 per cent of all spending on public services.
In 2010, public sector pay was doing rather well compared to private sector pay. If we take into account workers’ characteristics (education, age and experience), public sector pay had moved from being the same as private sector pay in 2008 to being 4 per cent higher by 2010 (private sector pay responded more quickly to the recession). Unemployment was also relatively high. This meant that a public sector pay freeze – bringing with it substantial public expenditure savings – was perfectly deliverable.
The situation now is very different. There is no public sector premium for pay and for many workers their pay has fallen substantially in real terms in recent years. Although it will increase, unemployment is still low and many parts of the public sector face staff shortages because pay levels are insufficient to recruit and retain staff.
The NHS desperately needs more nurses, there are concerns about the loss of staff in the prison service, there have been reports of the police lowering their criteria for new applicants, and the Government has just agreed an above inflation deal with the criminal bar.
Its position is not about a lack of will in taking on trade unions but about the market telling us that public sector pay is not sufficient to recruit and retain the size of workforce we consider necessary to deliver public services. Spending plans that are reliant on pay increases well below the rate of inflation will lack credibility.
This illustrates how difficult it will be to find savings. International development will probably take a hit, and there may be savings to be found in what was an ambitious capital expenditure programme. But it would be surprising if pensions and other benefits did not increase in line with inflation given the cost of living pressures.
(The triple lock might survive this Parliament but there would be some value, in terms of market reassurance, were Hunt to signal that, in the next Parliament. the Government will pursue a more sustainable policy. I would be tempted to link pensions to earnings over the long term. When inflation exceeds earnings, increases could be in line with inflation until earnings have caught up. This maintains the link with earnings over the long term but protects pensioners from real terms cuts when there is a spike in inflation.)
The upshot of all this is that taxes will have to do a lot of the work if the Government hopes to meet its fiscal rules.
If the right has a tendency to believe that all fiscal problems can be addressed by eliminating wasteful expenditure, the left tends to believe that all problems can be solved by taxing the rich more. Neither is true.
The top 0.1 per cent of income tax payers contributes 10 per cent of income tax receipts. To put it another way, 30,000 people collectively pay £22 billion in income tax (which is on average over £700,000 each). Maybe we can get some more out of them but the idea that we can rely on raising tens of billions of pounds more from them without some significant behavioural response – and many of them are very internationally mobile – looks very optimistic.
The truth is that if you want to raise a lot of money, you have to raise it from a lot of people. It also means using the big taxes that contribute two-thirds of Government revenue – income tax, NICs and VAT.
VAT is a relatively good way of raising revenue – economically efficient and more progressive than most people think. It is not, however, as progressive as taxes on income and in the current circumstances that should be an important factor.
The Government, of course, introduced a NICs increase before then reversing it with a return to lower rates yesterday. NICs is politically easier to increase than income tax because of the public’s confusion as to what it is. But it is not as good a tax as income tax because it has a narrower base, thus creating distortions and unfairness. A double U-turn would also look chaotic.
This leaves income tax. Conventional wisdom is that it is politically impossible to raise the rates of income tax, and that is probably right. Thresholds can continue to be frozen and fiscal drag will do its work. But if we need to raise a lot of revenue, do so in a progressive way and not make our tax system any more complicated or distorted, the new Chancellor could do a lot worse than add a couple of pennies to each of the rates of income tax.
All of these choices are grim. It is no wonder that the Treasury is briefing so heavily about the pain that is to come. Even so, it is not obvious that the public or Conservative MPs appreciate the scale of what is to come.