Did Rachel Reeves set Labour on a path
to ending austerity, and making up for the lack of public investment
over the last fourteen years? In this post I will follow the format
of my pre-budget
post, splitting the discussion into three sections:
public investment, current public spending and taxes. I’ve also
added an extra, rather annoyed section on fiscal rules, and a
summary.
Public investment
The chart below compares the net public
investment plans Reeves inherited from the last government, with her
Budget plans she gave to the OBR.
Under the
Conservatives public investment as a share of GDP was projected to
fall steadily from current levels of around 2.5% to 1.7%. The
assumptions that Reeves has given the OBR imply, to the first
approximation, public investment staying flat at 2.5% of GDP. That is
an improvement, but a relatively modest one, given the lack of public
investment over the last fourteen years.
Current public
spending
Current spending is
everything that isn’t gross public investment. The chart below
compares pre and post-Budget assumptions given to the OBR.
Here we have a
similar story. The Conservatives had pencilled in further cuts to the
public sector compared to current (23/4) levels, while Reeves has
assumed the share of public spending in GDP will be, to the first
approximation, pretty flat through the next five years at around the
current level of 40%. So no additional austerity compared to where we
are now, but no attempt to return spending to the levels needed to
restore the public services to the state they were in just before
austerity began in 2010. In particular, with health services around
the world absorbing an ever growing share of GDP, flat in overall
terms means most departments will see a falling share of spending in
GDP.
If that seems a
little disappointing, it is worth remembering two points. The first
is the extent of additional austerity implied by the inheritance
Reeves received, all to enable unsustainable tax cuts. Avoiding that
required the budget undertake substantial tax rises and considerable
additional borrowing. As the OBR sets out in the chart below, most
but not all of the additional current spending is matched by higher
taxes, with some covered by additional borrowing thanks to revised
fiscal rules.
The second point to
remember is that this is just one budget. My overall impression is
that, compared to the potential tax changes I went through in last
week’s post, Reeves has in most cases been relatively modest in the
increases implemented this time. That leaves scope for further
increases in spending matched by higher taxes, if necessary, in later
budgets.
Taxation
In my last post I
looked at areas of taxation where I thought significant amounts of
money could be raised (or, if you prefer talking about resources,
where a significant amount of resources could be released to allow
for additional public spending), without violating the pre-election
pledges not to raise income tax, employees NIC, VAT or corporation
tax.
-
Employers National Insurance Contributions
Raising employers NICs can be thought of as partially undoing the
reckless (in terms of unsustainable) cuts to employees NICs made by
the last government. In fact employers contributions are slightly
more progressive than employees, because there is no upper earnings
limit on employers contributions. (As I noted in that earlier post,
removing the upper earnings limit on employee contributions would
raise a significant amount of money in a very progressive way, but
was presumably precluded by pre-election pledges.)
This change in employers’ NICs accounts for more than half of the
additional revenue raised in the budget (£26 billion out of £42
billion by the end of the decade).
-
Other tax increases
As expected, both Capital Gains Tax and the Inheritance Tax regime
have been changed to increase revenues, but the scale of the former
in particular is modest compared to some of the possible changes I
outlined last week. In that sense, this is not so much a ‘soaking
the rich’ budget, but a ‘mildly inconveniencing the rich’
budget. As I noted then, there is a strong case for gradualism with
taxes that few pay and where behavioural changes are potentially
important, so this may not be the last time these taxes are
increased.
3. Fuel duty
In last week’s post I noted some tax increases that the
Conservatives had pencilled in which Reeves could cancel, but doing
so would only make her job harder. Fuel duty was one of those, and
here Reeves has not only decided to not increase the duty yet again
(on a day after floods generated by climate change killed dozens in
Spain), but is
in danger of continuing the Conservative practice of
planning future Fuel Tax increases but never implementing them.
Depressing.
Fiscal rules
Yes, counting government financial assets as well as liabilities
makes more sense than just counting liabilities, and this change to
the fiscal debt rule allows more public investment which is good.
However counting financial assets but ignoring physical assets still
makes little economic sense, so the new debt rule run alongside the
golden rule still has no purpose other than to suppress public
investment.
More unexpected was the gradual move to a three year rolling target
for the fiscal rules rather than a five year rolling target. This is
simply a mistake. The rationale for a five year ahead target is that
forecasts over this time frame exclude cyclical effects. This is
clearly not the case for three year ahead forecasts. The Treasury
document says that moving to three years ahead will
‘enhance fiscal discipline’, but so would balancing the budget
each year! Designing good fiscal rules tries to combine fiscal
discipline with good fiscal policy, and good fiscal policy should be
counter cyclical not pro-cyclical. This change will do almost nothing
to improve fiscal discipline but will make good fiscal policy more
difficult. (On fiscal discipline, see also Fuel Duty above!)
The reality is, unfortunately, that the design of fiscal rules is
increasingly a political exercise where good analysis is regarded as
far less important than short term expediency, the thoughts of
Krugman’s ‘Very Serious People’ or political journalists
(mediamacro). This is a problem because, as I always say, bad fiscal
rules are worse than no rules at all.
Summary
As most of the media will attack this budget for increasing taxes to
‘record highs’, without appearing to give a moment’s thought to
why taxes are rising
to record levels in most countries, it is natural to
be defensive of it. It is, after all, much better to travel in the
right direction, albeit slowly, than to keep on going the wrong way.
However, the political danger of moving gradually, in part because
one hand is tied behind your back (no tax rises on working people),
is that you disappoint those who are naturally impatient to see
improvements in public services across the board. A political
environment where voters know taxes are rising but where problems in
public service provision (including
child poverty) continue to fill the headlines is not a
comfortable one for any government, because it raises issues of
competence in voters’ minds (where is the money going?). Equally
risky is continuing to try and flatter the marginal voter (or petrol
user!) when you are in danger of losing your political base. I
suspect, once the immediate and rather predictable political
controversy is over, this budget will be seen as the minimum that
could have been done, and that something bolder might have been less
risky in the longer term.
