Philip Hammond will struggle to make the numbers add up if he really wants to end austerity in this budget

Taking more money from people’s pay packets than at any time for the past two generations would feel pretty austere – assuming, that is, that it would be possible to raise more money in taxation

Hamish McRae
Wednesday 17 October 2018 18:36
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Successive governments have created an extraordinarily complex financial system, one that it too complicated for it to run
Successive governments have created an extraordinarily complex financial system, one that it too complicated for it to run

Start with the good news. Incomes have at last started to show decent growth in real terms.

Inflation, as measured by the consumer price index, is down to 2.4 per cent a year from 2.7 per cent in September. That decline has been driven by lower food and non-alcoholic drinks prices and came as a surprise to the markets. True, inflation is still above the Bank of England central target level of 2 per cent, but there is a reasonable prospect of it nudging lower for the rest of this year.

Add in the fact that earlier this week it was revealed that earnings were up 3.1 per cent over the past year – the highest for nearly a decade. So it does look like real incomes are rising again. About time too, you might think, for – on paper, at least – real wages are still lower than they were a decade ago. But a real pay rise is a real pay rise, so let’s welcome that.

Now for the less positive news. Taxes may have to go up in the forthcoming budget, to be announced on 29 October.

The Institute for Fiscal Studies is the gold standard commentator on UK public finances – measured, intelligent, and above all, impartial. It has just produced its "green budget", an analysis it does before each Budget.

The IFS looks at the economic and financial background to the Budget, and how the chancellor might adjust policy to meet taxation and spending priorities. It will not be easy to make the numbers add up. As we report, he will need at least another £11bn a year by 2022 to be able to claim credibly that austerity has indeed ended. The extra public spending needed to support this aim, one set out by the prime minister, will push taxation to the highest level as a percentage of GDP, since the immediate years after the Second World War.

In other words, to end public sector austerity requires private sector austerity. Taking more money from people’s pay packets than at any time for the past two generations would feel pretty austere – assuming, that is, that it would be possible to raise more money in taxation. Every time a government has tried to do so it has failed. For some reason or other, usually slower-than-expected growth, tax revenues have come in lower than expected levels.

What should we make of all this? Or indeed what will Philip Hammond make of it when he delivers his Budget in 10 days’ time? Here are five thoughts.

First a general point – politicians have to work within the boundaries set by their electorates. So the idea that the UK should move to, say, the Scandinavian model of government, with much higher taxation and public spending, may be attractive to some people, but any government would struggle to sell it to the mass of voters.

Next, government isn’t just about money. It is about competence. We have had an example of incompetence just now, with this government having to hand back £1.5bn of money that has been underpaid on benefits. The average underpayment is £5,000. That is shocking but given the complexity of the tax and benefits system, unsurprising.

Successive governments have created an extraordinarily complex system – one that is too complicated for it to run. We have a tax simplification programme but that seems to coexist with even greater complexity.

Third, we in the UK have had to live with a decade of lower-than-expected growth. So, too, has just about every other developed country in the world, but that is small comfort. Leave aside whether this need have happened, whether we are measuring growth sensibly, and what might be done about it. It has happened. Because of that, there are fewer resources available either to us as individuals or as recipients of government services, than we might have expected. By the standards of anything other than the recent past – say the mid-2000s – everyone in the UK is on average wealthier than ever before. We are richer now than in the 1980s, 1990s and so on, and we have services for free, such as Facebook, that would have been hard to imagine 20 years ago. But the cash available for public services is lower than might have been expected.

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Four, wealth inequality has increased as a result of the asset price boom, which in turn is probably the result of the long period of very low interest rates and quantitative easing (the central banks printing money). Income inequality has declined a little, at least in the UK, but the huge rise is property and share prices has created a sense of resentment, and the chancellor has to acknowledge that.

Five, it has taken a long time to get the deficit under control, but the job is more or less done. You don’t have to absolutely balance the books, but governments should aim to borrow only for investment, not for current spending, as set out in Gordon Brown’s golden rule. We have achieved that, and that success should be celebrated. Actually tax revenues have not been bad at all this year. So while the chancellor is in a bit of a box, while revenues remain strong I think he may be able to squeak by, with some increases in spending without any significant increases in taxation.

Finally remember the rule when looking at budgets: focus on the figures and ignore the words wrapped around them.

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