Pleasing nobody

In its assessment of Chancellor Rishi Sunak’s Spring Statement (as the March fiscal set piece event is now known), the OBR pointed out that the first quarter of the 21^st century has seen the economy subject to a number of unprecedented shocks of which the war in Ukraine is just the latest. Each shock appears to be worse than the last but with inflation expected to head towards 40-year highs, the economic fallout from the Covid pandemic and the Ukraine war have combined to produce a hit to living standards, the likes of which many people have not seen in their working lifetime. In the course of March 2020, Sunak unveiled a package of measures appropriate to the scale of the problems facing the economy. His efforts in March 2022 were a woefully inadequate response to current problems, managing to be both ineffectual and badly targeted.

The nature of the cost of living squeeze

Last year Sunak announced that he was freezing income tax thresholds at 2021-22 levels until 2025-26. This would be bad enough if inflation was running at or slightly above the 2% target but with CPI inflation set to average more than 7% this year – the fastest pace in almost 40 years – a lot more people are likely to find themselves dragged into the higher income tax bracket if wages follow suit. Last September, Sunak also announced that he planned to raise National Insurance Contributions from April 2022 which I argued at the time was an unnecessary risk when the economy was only just recovering from a severe recession. Most worryingly, domestic energy bills are set to rise by over 50% from next month with the prospect of further big hikes in October. Altogether this combination of events is helping to stoke what many commentators are calling the UK’s biggest cost of living crisis in decades, with low paid workers set to pay the biggest price.

Sunak’s response was risible. He announced a temporary 5p per litre cut in motor fuel duty which (a) sends the wrong signal for a government which likes to talk up its green credentials and (b) does nothing to help the least well off who are more likely to spend money heating their homes than running a car. If the Chancellor was serious about helping this group he could have announced a temporary suspension of VAT on domestic fuel bills and thereby use one of the few additional policy levers derived from Brexit (EU rules require setting VAT on domestic fuel at a minimum of 5%).

To add insult to injury, Sunak announced that from April 2024 he intends to reduce the basic rate of income tax from 20% to 19%, thereby increasing the wedge between the taxation of earned and unearned income. The economic rationale for this is questionable and such is the uncertainty surrounding the economic outlook it may not even be affordable. It was also a blatantly political move, designed to burnish Sunak’s leadership credentials and his party’s standing ahead of an election in 2024, allowing him to continue making the claim that his is the party of low taxation. This is, of course, not true. According to the OBR, the overall tax burden is set to rise from 33% of GDP in 2019-20 to 36.3% by 2026-27 – its highest level since the late 1940s.

The OBR goes on to point out that “net tax cuts announced in this Spring Statement offset around a sixth of the net tax rises introduced by this Chancellor since he took over the role in February 2020, and just over a quarter of the personal tax rises he announced last year.” The FT’s putdown of Sunak’s credentials was funny, damning and accurate: “Sunak is a low-tax Chancellor, in the same way that people who play air guitar in their bedrooms are rock stars. He tried his best. He cut fuel taxes by 5p per litre, which means that, when your house is flooded by climate change, it’ll be cheaper to drive far away from it.”

The bigger economic picture

There is a lot of very good analysis on the state of the economy and what the spring statement implies and I will not repeat it here. The OBR’s mighty tome is the original source for a lot of the analysis (here) and the Resolution Foundation also produces an excellent synthesis (here). However a few issues do bear highlighting. The OBR’s analysis makes the point that “real household disposable incomes per person fall by 2.2 per cent in 2022-23, the largest fall in a single financial year since ONS records began in 1956-57.” It also highlights that in the wake of the decision to leave the EU, the UK “appears to have become a less trade intensive economy, with trade as a share of GDP falling 12 per cent since 2019, two and a half times more than in any other G7 country” (chart below).

Obviously governments cannot be held responsible for exogenous shocks which hit the economy but they do bear responsibility for the manner in which they deal with them. In this regard Sunak’s package of measures falls far short of what is required. Those on benefits face a particularly savage cut in real incomes, with benefits rising by 3.1% as inflation heads above 8%, compared with expected average weekly wage increases of 5.3%. As the IFS has pointed out, the current method for uprating benefits does not work when inflation is high and variable (chart below). A wider point made by the commentator Chris Dillow is that our current system derives its legitimacy from supporting all members of society. Ignoring the poorest undermines that legitimacy. That said, the Tories have hit the poorest voters hardest for more than a decade without any adverse consequences at the ballot box.

When it comes to trade, the government bears full responsibility for the adverse impact. By leaving the EU Single Market, the OBR maintains that the UK will suffer an output loss more than double that of the pandemic. At a time when living standards are under enough strain, the boiled frog problem of Brexit will place a significant additional burden on the economy. This matters because in a little-publicised report, the Government Actuary’s department has calculated that from the 2040s, the National Insurance Fund will be insufficient to maintain projected state pension payouts. Therefore we will either need faster growth, higher tax rates or lower pension payouts to ensure that the fund remains in balance. As an aside, it was notable that one of the measures announced yesterday was an alignment of the starting thresholds for income tax and NICs. How long before the government phases out employee NICs and folds them into income taxes (a subject I covered here)?

Last word

Sunak prides himself on his Thatcherite approach to fiscal management believing in an “ethical” mission to halt the expansion of the state, minimise taxes and restore fiscal self-discipline. I have long criticised politicians who treat state budgets like household finances and Sunak, who is an otherwise intelligent man, appears to have fallen into this trap. Within two years, the current budget balance is projected to return to surplus and overall public borrowing to fall below 2% of GDP. It may well be that the Chancellor will have to use some of these resources to provide extra help to the poorest in society. When even traditional supporters such as the Daily Telegraph balk at the lack of support, you had better believe more needs to be done.