Sunday, February 23, 2020
Sunak gets ready to do a reverse Osborne
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

Nothing is predictable these days, which may be the government’s guiding principle, but for this week I am making two assumptions. The first is that, unlike his predecessor, Rishi Sunak will be around for long enough as chancellor to deliver a budget. The second is that the budget will go ahead, as planned, on March 11, as he suggested a few days ago. I hope I am right.

What can we say about a budget from a chancellor whose rise has been rapid, if not quite without trace, and whose views are not yet well known? We are told that he is a fiscal conservative and, interestingly, was allowed at his first cabinet meeting as chancellor to say that he expected departmental ministers to come up with 5% cuts in their programmes.

This does not mean that we will see such cuts in government spending, and most of this is ground to be covered in the summer spending review. But the Treasury, as under Sajid Javid, is keen to make room for the government’s priorities. Quite a lot of work in the presentation of the budget will go into emphasising that the government has not given up in fiscal responsibility.

The responsibility resting on Sunak’s shoulders is considerable. The first budget of what is effectively a new government is very important, in setting the direction for what it hopes will be the next few years. The first budget of a new chancellor who hopes to be around for some time is also very important for him.

History tells us that first budgets matter a lot. Sir Geoffrey Howe, Margaret Thatcher’s first chancellor, used his in 1979 to cut the basic and higher rates of income tax dramatically, funded by a big increase in VAT. Nigel Lawson in 1984 used his first to establish his reputation as a tax reformer, particularly on corporation tax. Gordon Brown’s first budget in 1997 was preceded by his announcement of Bank of England independence, introduced a windfall tax on the utilities and set in train far-reaching reforms, notably the abolition of the dividend tax credit, which hit pensions hard.

The interesting comparison for Sunak is with George Osborne’s “emergency” budget in June 2010. It announced an increase in VAT from 17.5% to 20%, to take effect at the start of 2011. It also announced the start of the austerity programme, what was described at the time as “taking a chainsaw” to public spending, including deep cuts to capital spending, infrastructure, some of them inherited from Labour. So it began, and so it lasted. Javid’s one-year spending review last September, when he announced £13bn of additional spending for 2020-21, was officially labelled as the end of the austerity Osborne had embarked on all those years before. Sometimes, though, these things are harder to shake off than merely announcing them.

Even so, it is fair to regard Sunak as a reverse Osborne. While his predecessor but two had the clear aim of cutting back the public sector and thus leaving it to the private sector to deliver growth, which after a shaky start it did, the new chancellor will be using public spending, and in particular the £100bn of additional infrastructure spending over five years he has inherited from Javid, to drive the economy. The private sector is expected to be weak, so the public sector will fill the gap.

It is a significant moment. The Resolution Foundation, a think tank, noted last week that the new chancellor is set to announce the first government spending boost to the economy since the financial crisis. It expects the baseline growth forecast from the Office for Budget Responsibility (OBR) to be weak, as was the Bank of England recently.

“With just weeks to go until the budget, the new chancellor is going to have to contend with a weaker economic outlook than when the government’s official budget watchdog last reported back in March 2019,” said Jack Leslie, an economist with the Foundation. “The chancellor’s budget investment plans will, by happy coincidence, help offset the UK’s weak economic outlook. Government spending, including up to £100bn of new investment spending, could boost the size of the economy by up to 1% by the end of 2022.”

Indeed, there is already a flavour of this in the latest official figures. The economy flatlined in the final quarter of last year, gross domestic product failing to register any increase compared with July-September. It could, however, have been much worse, if not for a sharp and unexpected jump in government consumption, day-to-day spending. It rose by 2.1% during the quarter, without which there would have been a drop in GDP; not something that would have gone down well as the first big number for the new government.

Can you drive an economy on government spending? £100bn of extra infrastructure spending over five years, if it can be delivered, means adding nearly a percentage point to GDP a year. If nothing else, it should limit the economy’s downside.

The scope for boosting the economy through day-to-day spending is much more limited, unless the fiscal rules really have been torn up, which does not appear to be the case. When those rules essentially require spending increases to be funded by higher taxes, the net fiscal impact is neutral. I won’t speculate on what tax increases the Treasury might be considering, except to note that the feedback to last week’s piece suggests that cuts in pension tax relief or the abolition of the tax-free lump sum would go down like a lead balloon, even if presented as part of a “levelling up” agenda.

There is much more scope, as noted, for substantial additional infrastructure spending. Borrowing to invest is permitted, as long as net public sector investment does not exceed 3% of GDP and debt is falling relative to the size of the economy, neither of which is an onerous constraint.

Even so, it would be an odd and unbalanced economy in which infrastructure spending by government is the only thing that is seriously growing. I don’t think, in normal times, we have ever seen anything like that over a sustained period before.

The new chancellor will be hoping that the improvement in business and consumer confidence seen in business surveys this year will translate into broader-based growth. There was tentative evidence of that in the bounce in official retail sales in January, though it did not prevent a sizable drop in sales when measured over the latest three months. He will also be hoping that public investment fulfils its textbook role of priming the pump for greater investment by the private sector. If nothing else, after the experience of recent years, for a Tory government to be relying for growth on the public sector will take a bit of getting used to.