Sunday, November 20, 2016
Hammond has no room for populist giveaways
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Chancellors of the exchequer do not normally elicit much sympathy, usually falling effortlessly into the role of pantomime villain. It is hard, however, not to feel a bit sorry for Philip Hammond, as he prepares for his big day on Wednesday, his autumn statement.

If the new chancellor discovered a “there’s no money left” note from George Osborne in his Treasury office when he took over in the summer he has not yet let on. But he inherited the task of completing the job of restoring the public finances to health, and a continuing austerity programme.

Hammond also inherited, thanks to the Brexit vote – and perhaps his predecessor’s campaign tactics – a deteriorating outlook for the public finances. We do not know exactly what the Office for Budget Responsibility (OBR), the independent fiscal watchdog, will come up with on Wednesday. It is unlikely, however, to be too different to the cumulative £100bn underlying overshoot by 2020-21 (compared with the OBR’s March predictions) estimated by economists at PWC, the professional services firm.

Faced with a worsening of the public finances of this sort, due to the expectation of slower growth in the years ahead as a result of Brexit uncertainty, it would make little sense for the chancellor to weigh in with tax increases or additional spending cuts to try to bring his predecessor’s deficit reduction programme back on track.

This has already been acknowledged by the government, indeed by the new prime minister. No longer will the government aim for a budget surplus by the end of the parliament. The “automatic stabilisers” – tax revenues down and some government spending up as a result of slower growth – will be allowed to operate. That makes perfect sense.

What also makes sense is for the chancellor to focus on the two areas which need extra spending and support: infrastructure and business investment. The abandonment of Osborne’s fiscal rules – all three have been dumped or missed since the May 2015 election - gives him plenty of room for the former.

Fiscal rules, as the Institute for Fiscal Studies has noted, have not been built to last. Of the 12 adopted since 1997, 10 were broken, the others superseded. Chancellors still need them, however. In spite of their record investors and the ratings agencies need to know that governments operate under some fiscal constraints and are not free simply to let rip.

Fortunately for Hammond, there is an off-the-shelf fiscal rule that would work well for him, and permit a substantial increase in infrastructure spending, spread around Britain’s regions. Combined with tapping into private sector funding of infrastructure, and the chancellor should be able to unveil a decent-sized “rebuilding and upgrading Britain” package. It will not come close to rivalling Donald Trump’s $1 trillion (£800bn) mainly private-sector funded and delivered infrastructure plan, though we have yet to see whether that will be deliverable.

How can Hammond spend if the public finances are in a worse state? The answer is to revert to the fiscal target Osborne originally had, which in turn had a powerful echo of Gordon Brown’s original 1997 rules. This is to concentrate on balancing the current budget deficit – the balance of day-to-day spending and receipts – while leaving room to borrow to invest.

A target of balancing the current budget should be achievable by the end of the parliament – PWC suggests a 0.6% of gross domestic product surplus on this measure in 2019-20 - provided that Hammond is able to restrict his giveaways in other areas. Most projections suggest eliminating the current budget deficit remains on course in spite of Brexit. Markets, meanwhile, would not go out of their way punish a government that chooses to spend more on infrastructure. The international tide is turning.

That, with a bit of help for business, should be that. Firms would like to see the back of the apprenticeship levy, want extra help on business rates and would like more incentives to invest during a time of uncertainty. Anything Hammond does is unlikely to prevent business investment being weak over the next couple of years but could mitigate it.

Unfortunately, it seems, that will not be that as far as the autumn statement is concerned. The chancellor is being leaned on by Tory MPs, and more importantly by Downing Street, to announce some populist measures. Wednesday would be a great opportunity for Hammond to pause the policy of raising the personal income tax allowance and the higher rate threshold by more than inflation. But the indications are that he will press on with it.

Fuel duty, successive freezes on which add up to a lot of lost revenue for the Treasury, is also part of the populist agenda. The chancellor should not be trying to shield motorists from the higher petrol and diesel prices, much of which is directly linked to sterling’s post-referendum fall. It seems, however, that he will.

When it comes to populism –and the perceived need to help the prime minister’s "jams", the just about managing families (which has now replaced “hard-working” families) – the list is endless. Does it mean extra money for the National Health Service? It might well do so. Does it mean scrapping or at least modifying Osborne’s planned four-year cash freeze on most working-age benefits, including tax credits? Again, that is very much on the agenda.

As always, there are good arguments to be made for all sorts of things. But this is not a time for fiscal largesse across the board, for the chancellor to play Lady Bountiful. The public finances still need to be repaired.

Nor, looking at the numbers, can it be argued that households are showing great signs of distress, in fact the opposite. Retail sales figures three days ago showed a 1.9% jump in sales volumes last month, for an increase on a year earlier of an extraordinary 7.4%; the fastest rate of spending growth since April 2002. At one time, remember, some feared that consumer confidence would be hit so hard by the Brexit vote than an emergency Vat cut would be on Hammond’s autumn statement agenda.

Now, I am quite prepared to accept that some of the strength of spending reflects foreigners taking advantage of bargain-basement prices. I am also quite prepared to accept that many households are in no position to splash out and that the figures were are seeing now represent something of a last hurrah for consumers, before higher inflation begins to put a serious squeeze on their real incomes.

Even so, the chancellor should be treading carefully. Money is tight and his priorities should be clear. Giveaway measures aimed at households will leave him with a messy and unconvincing hotch-potch statement. He should stick to infrastructure and investment.