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Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.
The countdown to the Budget on March 15th has begun. With a general election widely expected in the autumn of 2024, Jeremy Hunt has limited time and few fiscal events in which he can make meaningful changes to try and move the political dial.
While people and firms may respond immediately to fiscal announcements, it can often take time for them – or supply-side measures – to feed through into economic activity, and thus into how firms are impacted and people feel. So, just eighteen months out from a potentially game-changing election, the coming Budget is critical. The trouble is that expectations are low, as is the Chancellor’s fiscal room.
Major fiscal changes – either on tax or spending – are unlikely. Instead, I would expect the Budget to focus on addressing inflation (although this is primarily the role of the Bank of England), stability – echoing the message of recent months – and on boosting the supply-side of the economy. This messaging will, unsurprisingly, likely take the form of the Government’s recent five pledges. The first three of which are halving inflation, boosting growth and reducing debt.
The early part of the Budget speech is often about highlighting the country’s relative performance. This should be an opportunity for Hunt to set the record straight. The cost-of-living crisis has been painful, but the country’s relative performance is not that different to major economies elsewhere – particularly in Western Europe.
Sluggish growth predates Brexit, and has been a legacy since the 2008 financial crisis, while more recent challenges from the pandemic and energy crisis are seen across Western economies. Central banks globally have also been behind the curve. Furthermore, austerity under George Osborne weakened those public services that were not ring-fenced.
The Budget speech then proceeds onto the current economic outlook, followed by the fiscal numbers and new expenditure or tax plans. It is this section that is likely to dampen expectations.
Weak growth expectations have already been factored into existing fiscal plans. And while there is scope for some upward revision, this is neither guaranteed nor likely to be significant enough to encourage the Chancellor to ease fiscal policy significantly. At the time of the Autumn Statement, the OBR’s cautious economic assessment was that growth of 4.2 per cent last year would be followed by a contraction of 1.4 per cent this, and modest growth of 1.3 per cent next.
This now seems too pessimistic, although it should be said that the Treasury’s latest assessment of economic forecasts show that the consensus is still downbeat, with the economy expected to contract by 0.8 per cent this year before growing only 0.9 per cent next. It would not be a surprise if the OBR were to project the economy both avoiding recession this year and recovering as inflation falls while the year progresses.
While any upward growth revision would create some increased fiscal space, this will be limited and has be to viewed in the context of an Autumn Statement that provided a small net boost this year, but significant tightening in coming years. When the fiscal numbers are poor there are four areas to focus on: will growth deliver a better outcome, will fresh decisions be needed on tax or on spending or, if needed, will the Government borrow more?
There is always a strong case to use fiscal policy to stabilise the economy. Ahead of this Budget, there has been some focus on whether the Chancellor should reverse his planned hike in Corporation Tax, which is set to hit business competitiveness. Low investment has been a perennial feature of the economy, and hence, as I have argued before, there is a strong case for a simpler and more competitive capital allowance regime. At the very least, there should be a permanent replacement to the super-deduction, which expires this April.
Other areas of focus could – and should – include targeted tax credits for R&D spending for sectors of the economy that will mould the future. These sectors – such as AI, advanced computing and clean technologies among others – provide both large economic opportunities and can improve the UK’s national security. Incentives related to R&D are better than direct subsidies, and necessary to address how spillover effects mean businesses will always invest less in R&D than is desirable.
The Chancellor could also look at full expensing for certain parts of the economy. This is likely to be resisted, however, given the immediate perceived costs to the Exchequer.
In the wake of the mini-Budget last autumn, Hunt focused on stability. One of the failings of last autumn was that the then Chancellor failed to focus on the concerns of the financial markets. There is little likelihood of that now.
The lesson Hunt will likely take from that period is to manage expectations and ensure that the markets are comfortable with what is planned, and that any rabbits out of the hat are seen as affordable and non-inflationary. He has restored stability by removing the uncertainty attached to U.K assets, albeit aided by market expectations of inflation easing globally.
Importantly, the Chancellor should remind people of the scale of the Government’s financial support during recent years. The Government provided about £400 billion in help during the pandemic and around £99 billion for the energy crisis. These are huge sums. In recent Treasury questions recently, ministers outlined that this was equivalent to £1,300 for many households, plus other targeted measures.
Perhaps the help was provided into too many piecemeal ways, but certain aspects of how the plumbing of the state works sometimes means this is unavoidable.
Despite the fiscal help provided during the energy crisis, the concern for many people is about the extent to which inflation is outstripping wage growth. Hence the focus on reducing inflation as acting as a tax cut.
For any economic policy to succeed, the narrative attached to it must make sense, be credible and well received.
The high tax-take remains a policy area to be addressed, although for some Conservatives higher taxes are seen as necessary and inevitable due to the economy’s weak growth and ageing population. There should, too, be an equally important stress on tax simplification and reform. Headline tax rates are important, but they should not be a central aspect of policy alone, but part of a wider agenda.
A year ago this week, Rishi Sunak, as Chancellor, delivered his Mais Lecture in which he focused on three priorities of ‘people, ideas and capital’ in order to encourage a culture of enterprise and address low productivity. In this he is clearly aligned with Hunt. So perhaps the Budget will look for ways to build on the principles Sunak identified then, and in particular boosting access to finance – a theme we have discussed consistently here.
Again, this sadly is not a new issue. It dates back to the Macmillan Gap of the 1930s, and more recently has taken the form of the Growth Capital and Patient Gap. While the UK has incredibly deep pools of capital in the form of insurance and pension funds, only a tiny fraction of it is invested in productive or illiquid assets.
Part of the challenge here is that any reforms, for example changes to the pension charge cap or Solvency II, are often unnecessarily presented as watering down necessary regulations that protect people. We need to move on from all deregulation or regulatory change as being seen as inherently dangerous.
Looking back, perhaps the most similarities are with the chancellorship of Roy Jenkins in the late 1960s. He steadied the fiscal sums in the wake of the 1967 devaluation, only for Labour to lose the 1970 election. Subsequently there were many who felt he could have been more adventurous.