What do our readers want? Asides from peace, goodwill, and an end to the H*ndred, one imagines that tax cuts wouldn’t go amiss. The promise of immediate reductions of post-war high levels of state-sanctioned robbery was one of the crucial reasons why Liz Truss triumphed over Rishi Sunak last summer.
Every economic update therefore comes with Conservative MPs keeping one eye out for whether Jeremy Hunt has enough wiggle-room for a pre-election giveaway. So after months of unremitting gloom, has the economy turned a corner?
Recent days have produced two pieces of news that will be welcomed in Numbers 10 and 11 Downing Street. According to the Office for National Statistics (ONS), inflation rose in July by 6.8 per cent, but wages rose by 7.8 per cent – meaning a real-time pay rise for Britain’s workforce for the first time in many months.
Similarly, the ONS informed us yesterday that public sector net borrowing for the fiscal year so far was £11.3 billion less than had been forecast by the Office for Budget Responsibility (OBR). Public sector net borrowing was £4.3 billion in July, rather than the £6 billion estimated by that undertaker of governments. The figures were attributed to higher-than-expected tax receipts through inflation-linked fiscal drag (and because July is when self-assessed tax returns get included in the figures).
Whilst this might not be happy news to those who have found themselves in a higher tax band, it was certainly welcomed by the Chancellor. And for Tory MPs. John Redwood, our columnist, blamed the OBR for being “ridiculously pessimistic” in its forecasts, and called for immediate tax cuts. Jacob Rees-Mogg – also formerly of this parish – said that there was room for “total abolition of death duties” whilst leaving “billions to spare”.
With the Bank of England’s latest expectation being for inflation to slow to 4.7 per cent by the year’s end, he can hope to hit the Prime Minister’s targets of both halving inflation by next year and having the debt-to-GDP ratio falling in five years’ time. The UK’s debt ratio fell back to 98.5 per cent from 100.8 per cent in June. This is still the highest level since the 1960s, but at least represents a step in the right direction.
Although Hunt may intone that “it’s vital that we don’t alter our course” and “continue to act responsibly with the public finances”, it’s unsurprising if many a Conservative starts to hear the siren call of tax cuts in these positive-sounding figures. Yet any such hopes would be immature – and ignore just how unremittingly bleak our broader economic outlook remains.
One hates to be the bearer of bad news – or sound like a broken record – but the reason why those hoping to see relief for hard-pressed tax-payers this side of the next election are likely to be disappointed remains the same: the surging cost of servicing our debt interest payments. Currently, the UK is expected to face the highest debt interest costs in the developed world this year.
Immediate tax cuts financed by borrowing more simply mean more debt that the Government has to pay back tomorrow. Unless those tax cuts spur an increase in productivity and growth, that means an ever-growing burden on future taxpayers through higher public spending. Jam today means gruel tomorrow. The inability to convince the markets that her fiscal loosening would reach that fabled 2.5 per cent growth target was one of the many things that did for Truss last year.
The Treasury is expected to spend £110 billion on debt interest, according to one forecast. That represents 10.4 of total government expenditure. Between 2017 and 2021, that figure averaged 6.2 per cent. For context, the average among western European and North American countries is set to fall from 4 per cent between 2017 and 2021, to 3.7 per cent this year, due to improving public finances.
That Britain is such an outlier is because around a quarter of our government debt is held in index-linked bonds, which compensation varies in line with inflation. Most countries have fewer than 10 per cent of their bonds held in this way, and we are paying more for the interest in our debt than any other member of the G7. Foreign investors also own more of our debt than in any other G7 country.
On numerous metrics, we are now falling behind our rivals. Amongst G7 members, we trail all but Japan when it comes to the productivity of our small and medium-sized companies . Our productivity has grown by only 0.4 per cent annually since the financial crisis, less than half the rate of the 25 richest OECD countries. We may not yet be a poor country. But we are one that looks increasingly sickly.
The dire consequences of heavy indebtedness and anemic growth are obvious. Taxes are already at a 75-year high. We are teetering on the edge of a recession. Persistently high inflation means interest rates are likely to continue rising. Yet the late Nigel Lawson was right. Spending cuts remain anathema to Tory MPs – especially a year out from an election. And yet a rising number of dependants reliant upon a shrinking tax-base means spending – and thus taxing and borrowing – will continue to inexorably rise.
Hence why gilt yields – which reflect the cost of government borrowing – are now higher than they were under the Seven Week Queen. The chaos around the mini-Budget spooked the markets and sent yields soaring. The logic of Truss’s defenestration and replacement with Sunak was to get them back down and place the Government’s finances on a sustainable path. Has that plan now failed?
Not quite. Whilst Sunak and Hunt succeeded in calming the markets in the short term, investors are increasingly conscious of the dismal future prospects of the UK economy. They can see fiscal consolidation remains unlikely if both parties are committed to such policies as the Triple Lock, a sclerotic health service, and a rackety Whitehall machine that wastes tens of billions in either dodgy procurement, or to pay people to work from home or not do so at all.
If inflation does fall rapidly – and the Monetarist in me has started to think it will – the trouble of servicing our debt will ease. But as long as growth remains stagnant and the demands on the state continue to grow, the same long-term trends will continue. As long as politicians flinch from, say, irritating pensioners or taking the Carthaginian approach to the Town and Country Planning Act, our financial position will continue to deteriorate.
Last week, Daniel Hannan spoke about the need for an economic crisis on the scale of the 1976 IMF bailout being required to shake our politicians out of their comfortable delusions. I have previously written how a recession might be no bad thing, since it would at least both kill off some of our economic deadwood and force the Chancellor to make some immediate tough choices.
Neither outcome would be an especially happy one, especially for the Conservatives’ re-election prospects. But as I have said, if Sunak should put being honest with the nation ahead of putting lipstick on our economic pig, a confected economic crisis might be no bad place to start. If it be now, be now. The sad truth is that until Tory MPs – and members – get serious about the trade-offs required for the long-term sustainability of the public finances, tax cuts will remain a pipe dream.
Of course, bitter economic pills are most easily swallowed by a new government that can blame its issues on its predecessor. In which case, those pining for tax cuts should turn their lonely eyes to Rachel Reeves, not Jeremy Hunt.