The squeeze is on

The politics …

It is hard to recall a time when a government has been so out of touch with the electorate as that led by Boris Johnson. As the squeeze on incomes posed by inflation rises up the agenda and the government doubles down on Brexit, there is a sense that a lot of things are becoming unglued. In a series of events guaranteed to cause apoplexy amongst party communications managers, Conservative MP Lee Anderson suggested that people needed to learn how to cook and budget "properly", rather than use food banks whilst his colleague Rachel Maclean recommended that people could improve their circumstances by working “more hours or moving to a better-paid job.”

Up until six months ago, despite the warnings signs of incompetence, the Conservatives were still ahead in the polls. The Owen Paterson affair provided the first sign that the electorate was fed up with being taken for fools – a trend which was reinforced by the Partygate scandal. Despite the flow of bad news, however, the Tories are not as far behind in the polls as might be expected. Indeed, Labour’s lead has remained steady at around six percentage points and were this to remain unchanged, it would unlikely be able to form an outright majority following the next election. For the record, Electoral Calculus currently predicts that Labour will win 315 seats – six short of an outright majority (for what it is worth, my own assessment is that Labour might struggle to top 300 seats).

… and the economics

Despite all the political noise surrounding Partygate which has sent the commentariat into overdrive, it is good old-fashioned economics which poses the biggest current threat to the Conservatives’ electoral chances. The cost of living squeeze, triggered by a 40-year high inflation rate in April (CPI at 9% or 11.1% using the RPI measure), is the biggest current problem. In fairness, this is largely the result of exogenous factors beyond the government’s control, particularly with regard to energy prices. However the government does have control over its response, and as the comments from the two MPs above illustrate, this has been sadly lacking.

The main criticism is that it has done little to nothing to protect low income households from the full impact of the squeeze. An uplift of 54% in the energy price cap last month is a regressive move that will hit poorest households the hardest, whilst low income families also have to contend with a food inflation rate running at 6.6%. The March Budget represented a wasted opportunity to provide some support whilst at the end of April, Chancellor Rishi Sunak suggested it would be “silly” to provide support on energy bills before knowing what is likely to happen to prices in the autumn (this from someone who, along with his wife, has just been named as the 222^nd wealthiest person in the country). In fairness, the government has granted a £150 Council Tax rebate this year but according to the OBR much of this will be clawed back over the next five years via a new tax on energy bills, which on a Ricardian equivalence basis does not represent much help at all.

In addition to blaming the public for their inability to cope with the inflation crisis, senior Conservative politicians have tried to pin the blame for the inflation spike on the Bank of England. It was accused by the Chairman of the Treasury Committee of being “asleep at the wheel” whilst the Tory peer Michael Forsyth accused it of “unleashing inflation in our country through failing to meet its proper mandate.” I will deal with the BoE’s position in a future post, but suffice to say that although it has made mistakes, this represents a blatant attempt by the government to deflect blame for its own failures.

Aside from the welcome support provided during the early stages of the pandemic, fiscal policy has generally been too tight over the past decade. George Osborne’s misguided austerity policy meant that the BoE was required to do much of the heavy lifting on policy in the wake of the GFC and the failure to provide sufficient fiscal support in recent months is one reason why the central bank has not been more aggressive in raising interest rates. There is general agreement that fiscal rather than monetary policy is the appropriate tool to provide targeted help to those most in need, and it is incumbent on the government to act rather than apportion blame. It is not as though there is a lack of options.

What can they do?

In the first instance, the government could reintroduce the uplift to Universal Credit payments used during the pandemic with NIESR calling for a rise of £25 per week which it estimates would cost £2.7bn this fiscal year. The Chancellor would doubtless argue that this will simply raise the fiscal deficit. However, it would do so by less than he thinks given that higher-than-expected inflation will boost revenues via fiscal drag following last year’s decision to freeze tax thresholds. An additional measure would be to temporarily reduce VAT on domestic fuel bills to zero and sell it as a Brexit win (EU rules do not permit this to fall below 5%). Removing the levy to fund renewables investment and energy efficiency improvements from household bills, as energy suppliers have called for, would shave another 7.8% from outlays. Adding in the Council Tax rebate, these measures would limit the latest rise in household energy bills to 23% rather than the 54% mandated by the energy price cap.

Labour has called for the imposition of a windfall tax on the profits of energy companies – a measure which the government has so far resisted. There is some merit behind the idea of such a tax. Shareholders who happen to be holding stock at the right time have simply benefited from an exogenous factor beyond their control whilst energy consumers bear the cost. With energy companies making big profits and BP’s profit having doubled in the first quarter of the year, it may be an idea whose time has come (again). Such windfall taxes have been tried before: In 1997, the Labour government imposed an additional levy on the profits of recently privatised industries, arguing that they had been sold off too cheaply. In 1981, Margaret Thatcher’s government taxed the additional profits made by banks as a result of rising loan spreads which were a result of rising short-term rates.

However, there are also many good arguments against the idea. The basis of a good tax system is that it should be fair, certain, convenient and efficient but a windfall tax would violate some of these principles. Most voters would agree that a windfall tax is fair; it is also convenient in that it would be easy to collect. However, it would introduce uncertainty about the future tax regime which would undermine the basis of the system. It would also be fiscally inefficient since it could hamper investment in cleaner energy where energy companies are in the vanguard. Finally, since a windfall tax is designed to tax supernormal profits, how do we determine what is a normal level? There is also the problem that the revenue derived from taxing energy companies would come too late to provide relief for households that are struggling right now. My own conclusion is that whilst there is a discussion to be had about levying higher taxes on energy companies, it might be more efficient to do so via the usual channels by which changes are advised well in advance. In the meantime, some of the other measures outlined above might be more appropriate.

Act now or risk an electoral drubbing

There is no doubt, however, that households are struggling to make ends meet. Consumer sentiment has fallen to its lowest level since the data were first reported in 1974 (chart above) and forecasts from both NIESR and the BoE reckon that the UK will come very close to recession by end-year (even if a technical recession is avoided). Whilst acknowledging that many of these factors are beyond the government’s control, it does control its response. Since the government sold Brexit as an idea that would make people better off whereas the opposite has occurred, there is increasingly a sense that it has a duty to step in (Brexit will undoubtedly be the subject of another post). Failure to deliver on this most basic of Brexit promises is likely to mean the electorate will not be in a forgiving mood the next time the government asks for their vote.