The Tories want to end austerity while keeping spending low. They can’t have it all

These spending plans require either increasing borrowing or raising taxes. But there could be a way out of Rishi Sunak's Budget trilemma

 

Sajid Javid announces 'end of austerity'

At the heart of recent tensions between Number 10 and the Treasury lies a fiscal trilemma. While the Conservative manifesto pledges to visibly improve public services, boost inclusive growth and deliver the green transition, their self-imposed fiscal rules could prevent them from doing so.

Chancellor Rishi Sunak is under pressure from Cummings and Number 10 to find the money needed to deliver their manifesto pledges in the upcoming Budget. Improving infrastructure around the country will require billions of additional spending. The PM’s pledge to “end austerity” necessarily means reversing many of the cuts to public services. Local councils and transport services have seen more than half of their budget cut over the last 10 years — Mr Sunak will have to meaningfully change course.

Can this be done? On the face of it, these spending plans require either increasing borrowing or raising taxes. At the same time, there is pressure to keep spending low and the country’s debt burden under control.

However, Mr Sunak can solve this trilemma by doing a bit of each: enabling much-needed public spending, raising taxes effectively and borrowing sustainably.

First, Mr Sunak should raise spending by 1 per cent, financed by some tax increases. This spending could reverse damaging cuts to councils, transport, and social security. How could he fund this? Many economists agree that making wealth taxes fairer and taxing pollution more can bring in funding without being a drag on growth. Indeed, Number 10 has already floated such measures. This would have the dual benefit of making the tax system fairer and protecting the environment. None of this would require any change in the current fiscal rules.

Second, Mr Sunak should borrow and invest significantly more than is currently planned. Public investment can boost long-term growth and focus the economy in a more climate-friendly direction, while being financially sustainable. Indeed, borrowing about 3 per cent for investment would be in-line with the existing fiscal rule on this. It would also make economic sense when the cost of borrowing is low.

Despite this increased investment, it would still leave the UK with a below-average level of public investment by international standards. In fact, the current fiscal rule limiting public investment to 3 per cent of GDP is entirely arbitrary and has no economic rationale. This is not yet a problem, as it will take some time to find productive projects to invest in, but it is not hard to see that within the next few years, a large number of projects will need financing.

Funding the transition to a net-zero carbon economy by 2050 will require substantial amounts of public investment. After all, by 2050 the UK will need to be running on renewable energy; industry will need to be using mostly carbon-free processes; houses will have to be insulated; and public transport will have to be fast and abundant. Public investment for these vital projects could be about 2 per cent of GDP per year. An arbitrary fiscal rule should not stand in the way of achieving this.

Third, Mr Sunak should be prepared to borrow a bit more to defend the economy against potential economic shocks. Currently, Mr Sunak’s fiscal rules leave very little room to respond to unexpected events, such as the coronavirus. Establishing some more room for borrowing to bolster the economy in case of shocks would be wise.

These measures combined would help Mr Sunak solve his fiscal trilemma and at the same time please Cummings and Number 10, allowing them to deliver on their priorities in the Budget. They would require some adjustment to his current fiscal rules, while at the same time making sure the country’s debt stays sustainable. All of this can be done. Let us hope Mr Sunak sees that.

Carsten Jung is a senior economist at the Institute for Public Policy Research.

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