May, Johnson, Truss: each defined their premierships against the Cameron/Osborne emphasis on hair-shirtery, whether that be by upping spending, pushing for “boosterism”, or embarking on huge tax cuts with no concern for spending control. Yet the trifecta of economic bad news we have faced this year – Covid’s legacy, the Ukraine conflict, the Trussonomics farce – means the era of cheap borrowing and easy choices is over. Sunak and Hunt are going to have to make some tough decisions – and the voters aren’t ready for them.
Sunak and Hunt have reassured the markets somewhat – ten year gilt-yields, for example, have fallen back to where they were before the mini-Budget – and u-turns have enabled the Treasury to find £32 billion more in revenue. Yet our September borrowing costs were still the highest on record. The Government thus needs around £50 billion to patch up the public finances.
The OBR looks set to downgrade our expected growth rates for the next few years. Hunt apparently aims to balance tax rises and spending cuts at a ratio of 50:50. Osborne aimed for 20:80 – and, consequently, trimmed most of the low-hanging fruit, such as capital spending.
Osborne also had the political benefit of coming into office after thirteen years of Labour and a financial crisis. As in 1979, voters understood hard choices had to be made. But as our columnist James Frayne has been pointing out, no pitch-rolling has been done by the Government – except, occasionally, by Sunak – in the last year for the hard choices that inevitably were required post-Covid and Ukraine. Moreover, the Truss debacle has made it easier for Labour to bin inevitable decisions on Tory incompetence.
Hunt should take a three-pronged approach: tax rises, spending cuts, and signalling supply-side reforms. We are being confronted by the consequences of failing to be bolder earlier. Tax levels are at seventy-year highs as we did not cut or reform public services sooner. Still, it will politically impossible to reduce NHS spending, as a winter Gotterdammerung looms.
One manifesto committment potentially for chopping is the Government’s triple tax lock – the manifesto pledge not to raise VAT, income tax, or national insurance. The Sunday Times reported that the Treasury had it under consideration. Sunak has previous, since he raised national insurance as Chancellor.
That move was predicted to bring in £13 billion. But reversing that unpopular rise was one of Truss’s few legislative successes. MPs voting to reinstate a hike that they have just scrapped would be farcical even by recent standards. Meanwhile, Hunt has already reversed the pledged cuts to both the top and bottom rates of income tax. Raising VAT would also be inflationary – currently unwise.
Sunak and Hunt are sufficiently realistic to know that, despite the unpopularity of these measures, one or more may be necessary. Nevertheless, we shall work on the assumption that once-bitten, twice-shy. Most of the heavy lifting will be done by “fiscal drag”. With inflation running at around 10 per cent, millions more will find themselves hauled into higher tax brackets.
Sunak previously announced a four-year freeze on personal tax allowances. Extending this to 2027-28, could raise an extra £5 billion. A totemic Tory policy gone: raising the personal allowance was one of Osborne’s greatest successes, and Sunak paid tribute by equalising the national insurance threshold. Freezing inheritance tax thresholds might also raise half a billion or so.
The Prime Minister understands the importance of increasing capital investment. As he out-lined in his Mais lecture – still the best guide to his economic thinking – we already have low levels of business investment compared to OECD competitors. Nonetheless, Hunt could increase taxes on dividends and capital gains – a move predicted to raise several billion.
One proposed measure is to halve or scrap the £2,000 tax free allowance on divided income. This would raise capital costs for companies already struggling with rising interest rates. But it would reduce the 11 per cent tax gap between capital and labour.
The other likely major tax hike is an extension of the windfall tax on energy firms. The case against windfall taxes is obvious: they are arbitrary and damage investor confidence. But Sunak’s justification was the same as Geoffrey Howe’s: global circumstances mean firms making unusual profits, and the Government has bills to pay.
Windfall tax revenues from oil and gas companies would be increased by raising the rate from 25 to 30 per cent (taking the total tax on firms to the international average), maintaining it until 2028, and extending the scheme to electricity generators. The Treasury reportedly estimates this bringing in an extra £14 billion.
Hunt is already reviewing the Energy Price Guarantee past April. With gas prices plummeting, this would cost much less than once feared. Nevertheless, the scheme needs changing. It is more generous than other countries’, and undermines the price signals required to spur reduced consumption. Reworking the scheme allows Sunak to return to his original approach: ‘handouts’ for the most vulnerable, combined with broader efforts to reduce demand.
Spending reductions must go further. The most obvious target are reported plans to keep benefit and pension rises in line with inflation. Doing so and maintaining the pensions triple lock – raising the state pension by the highest of inflation, average earnings, or 2.5 per cent – is predicted to cost £12 billion in 2023-24. Backbench opposition forced Truss to back off benefits, but going after the triple lock is necessary.
The policy is inherently unsustainable, since it requires an ever-larger share of national income as a growing pensioner population faces a shrinking working population. Pensioners are less likely to be in poverty and have significant wealth, with the number of pensioner millionaires increasing from 8 to 27 per cent since 2008.
Sunak suspended the policy in 2021, since the post-Covid recovery would have caused an 8 per cent rise in the state pension. Halving this year’s rise – likely even larger – could save billions, whilst support could still be ensured for the fifth of pensioners facing impoverishment.
The Treasury reportedly aims for pay rises of 2 per cent across the public sector for 2023-2024. With inflation as it is, this is a painful but necessary move that will see real-term cuts to the incomes of many public sector workers. Courting more industrial action is necessary to keep budgets under control. The Government does not want to ape the SNP, and reduce NHS spending to pay off the unions.
Another big commitment to go is Ben Wallace’s campaign to raise defence spending to 3 per cent by 2030. The Ministry of Defence (MoD) excels at wasting taxpayers’ money. The Public Accounts Committee judged that of the department’s 20 largest projects, 13 were running late by a cumulative total of 21 years. No more increases in spending should be allowed until the MoD shapes up.
Nevertheless, an estimated £18 billion is required to raise departmental budgets in line with inflation. Hunt should prune back the rate of departmental spending increases – from 3.75 per cent to 2.75 per cent – to save £13 billion per annum by 2027-28. Sunak only increased it a year or so ago. Reducing capital spending by £5 billion would also save money whilst ensuring levels of investment remain ahead of pre-Covid.
Sunak should not ape Johnson in throwing good money after bad. So HS2 – Osborne’s folly – needs to be reviewed, as its total cost surges past three times the £33 billion already predicted. Cancelling future sections would free up around £50 billion. Some of that could go back towards the £4 billion of improvements to other lines cancelled to pay for it, or to other railway investment in the North.
This can be spun as pro levelling-up – robbing the White Elephant to pay the Red Wall – and it is Sunak’s best chance of showing that, despite tough circumstances, he has not forgotten his party’s 2019 agenda.
Finally, the statement must signify that Sunak and Hunt understand what Truss got right. Simplifying planning regulations in stagnant areas and changing childcare rules: these are sensible reforms we should have implemented a decade ago, and are easier to achieve than wholescale changes to public services.
Our only hope of staying in office is showing our party has some economic credibility, remains committed to the North and Midlands, and will protect the most vulnerable. Raising our growth rate, supporting public services, and keeping the finances in check. It’s Trussonomics Jim, but not as we know it. Whether the voters will understand what Sunak is aiming to do is another question.
Two years to an election. Tax rises and spending cuts on the horizon – alongside inflation, blackouts, strikes, and the rest of the Omnicrisis. Will voters give Sunak the benefit of the doubt? Keep your fingers crossed.