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Rishi Sunak has near-term challenges but should also look further ahead

Chancellor of the Exchequer Rishi Sunak had hoped the easing of the pandemic would result in a more predictable and stable economy. In reality it meant Supply bottlenecks, rising inflation and a exceptionally strong pressure on real household disposable incomeS. Added to this is the shock of the Ukraine war.

This week’s spring statement has therefore become a significant test for Sunak. How should he meet him? Apparently neither he nor the Office for Budgetary Responsibility know what will happen. But they know the direction of travel. As a net energy importer, the price changes could make Britain poorer by up to 1 per cent. In general, inflation will be higher (possibly well over 8 percent) and output and real incomes lower than previously expected. That is a stagflationary shock.

This is not bad news for Sunak. High inflation brings higher nominal incomes and tax revenues. Meanwhile, cash restrictions on spending, including delays in benefit increases, mean a drastic reduction in real spending. As a result, Budget outcomes will improve dramatically. Borrowing this fiscal year is now expected to be about £23 billion (about 1 per cent of gross domestic product) less than the OBR forecast in October. The £25bn surplus in the current budget forecast for 2024-25 could now be between £45bn and £75bn. Aside from that, as Chris Giles arguesthere is also a compelling case for an unexpected tax on energy producers.

Barring an economic collapse triggered by even bigger shocks like an open energy embargo, the chancellor enjoys fiscal space. In deciding what to do with it, he must distinguish adjustments to lasting changes from transient shocks. It’s still likely that the jumps in energy and food prices and the slowdown in activity will only be temporary. Therefore, temporary padding is the right approach.

Bar chart of annual real growth in median equivalised household disposable income for non-retirees after housing costs (%) showing The pressure on living standards in the UK will be exceptionally strong

The top priority is to protect real government spending. There is no obvious reason for an unplanned return to austerity. A temporary spike in inflation should be offset by increases in departmental cash limits. Increasing the performance is particularly important. According to the Resolution Foundation, the value of most benefits will fall by 4.2 per cent in real terms in 2022-23, for a total cut of £10bn. This is largely an unplanned consequence of delays in adjusting for inflation. But it will cause real trouble. It is not only wrong, it is foolish to plunge tens of millions into misery.

In second place is the cushioning of energy price increases, especially for heating. As the share of spending of the poorest households spent on energy is about three times as much that of the wealthiest households, aid should be concentrated there, most obviously by increasing universal credit. Sunak reportedly hates these perks. Perhaps he thinks the recipients are spendthrifts, Labor voters, or both. That could be why his current plans to cushion energy price hikes are in the form of a £150 cut in council tax for a large number of households and a temporary £200 reduction in electricity bills for all customers. This is grossly aimless. In view of the effects of the Ukraine war, even that will not be enough.

A third priority could be lowering fuel taxes for motorists. This can be a political imperative. But it is difficult to see this as a high-priority use of tax funds.

Finally, some permanent increases in spending must be considered. Aside from the well-known priorities of health and social care, the defense is obvious. UK spending is now bound to increase significantly and sustainably.

Line chart of UK tax revenue (% of GDP) showing that the tax burden is now expected to rise to exceptional levels

Meanwhile, the chancellor is under a lot of pressure from the back seat to refrain from the planned increase in social security contributions. It would have been far better to raise income taxes more broadly. But there are two strong arguments for moving on. First, this tax increase is at least moderately progressive. Second, it recognizes the fact that taxes must constantly increase in response to demographic and social pressures. The Tories hate being a tax-raising party. But that was inevitable at some point. Given that, it might as well be done now.

But while the Chancellor is dealing with the enormous pressure of today, he must also look to the long term. The biggest problem for the UK remains his dismal underlying productivity growth. The answers must include higher investments and more dynamic capital markets. 100% investment tax credits along with higher corporate tax rates should help achieve this along with a switch to collective defined contribution plans.

Crises dominate today’s agenda. But chancellors should never ignore opportunities for longer-term reform.

martin.wolf@ft.com

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https://www.ft.com/content/7486d44c-3b4f-4e9f-9e78-4025f74d4ce4 Rishi Sunak has near-term challenges but should also look further ahead

Adam Bradshaw

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