Andrew Lilico is an economist and political writer.
Three key issues will dominate this year’s Budget: the “end of austerity”, Brexit, and how the Government intends to raise the funds to pay for its NHS pledge.
Let us start with the last of these. Theresa May promised an extra £20 billion per year for the NHS by 2023. In terms of money-raising schemes, pensions tax relief and the VAT exemption for private schools must both be under threat. Pensions tax relief exists to avoid double taxation. If we want to start taxing things twice, it’s far from obvious that pensions would be the place we would start.
VAT relief on school fees, on the other hand, has a less obvious rationale. Private schools can and do engage in some philanthropic activities, but school fees themselves are manifestly payments for a service rather than charitable donations, and it’s by no means obvious why they should attract charitable reliefs. The key drawback, of course, is that a 20 per cent rise in school fees would drive large numbers of private school kids out of the fee-paying system and into the state system, and there’s every chance the net result would be a cost to the Exchequer rather than a gain. That is not a reason not to abolish the VAT relief —some other system, such as porting of state entitlements, might be a much better way to do things than VAT relief. But we should probably not expect abolition of VAT relief on private school fees to raise any money.
The Conservative manifesto had commitments to raise the income tax personal allowance to £12,500 and the higher rate allowance to £50,000. The income tax personal allowance should, as I’ve set out on these pages before, track the salary a full-time worker would earn on minimum wage. But the higher rate threshold could be frozen once the £50,000 threshold is met. Indeed, there’s an argument for phasing out the higher rate altogether and switching back to a two-rates system, perhaps with a higher basic rate. But I doubt Philip Hammond would be up for that on this occasion.
We will surely see some announcements on the Government’s evolving thinking on the taxation of digital activities — a “Google and Amazon Tax”. Whether it will raise much initially is another matter.
Perhaps we should not expect the Government to seek to raise taxes to fund all of its NHS pledge. After all, apparently “austerity” is at an end. Well, it isn’t really — government debt is over 85 per cent of GDP, up from around 40 per cent before the Great Recession. If we were to hit another serious recession — and they do happen from time to time — and debt went up another 45 per cent of GDP we would be at 130 per cent, the level of Italy today or Greece just as its crisis got going. We need to get debt down so as to restore the buffer to let us borrow through the next recessionary period. That means running surpluses or balanced budgets through much of the 2020s.
But for now it does make sense to pause, with interest rates rising, the world economy stuttering slightly, and Brexit pending. I think it would be reasonable for the Government to allow the deficit to drift out a little, perhaps rising to 2.5 per cent of GDP for the next three years. That would give the Government something of the order of £15 billion extra wriggle room in the short-term.
Another source of savings is, of course, the EU contribution vanishing. Up to the Spring Budget this year, the Government has assumed that the EU contribution would be replaced by “Assumed domestic spending in lieu of EU transfers”, without specifying what any of the funds would be spent on (other than that agricultural support payments will not diminish). That is around £13 billion per year of funds that Hammond will have to start allocating this time.
Another place the Government will find extra money is if we have a no-deal Brexit. Hammond should set out some of our intentions with respect to tariffs in such a scenario. I would recommend that we initially impose tariffs on EU industrial products at the current EU external tariff rate (i.e. tariffs matching those the EU will impose on us) but have a temporary (say two year) zero tariff regime for food, including on non-EU food imports (so as to minimise any residual risks or concerns about food shortages or spikes in food prices). Tariffs on EU industrial goods imports might raise £8-9 billion. Removing tariffs on non-EU food imports would cost perhaps £2-2.5 billion. So the net revenue raising from this policy should be around £6-7 billion for those two years.
Next, in a no-deal scenario we will not be paying perhaps £30-£35 billion to the EU in a “divorce bill”. No-deal Brexit plans should be a key feature of the Budget. Some of that could be a considerable uptick in the £3 billion of no-deal preparation funds that were already in place. But another approach would be to make a virtue of necessity and, if the EU does not want our money in the divorce bill, we should spend it at home. For example, the Government could announce that, in the event of no deal, there will be a one-off £30 billion package of one-year tax cuts. If we announce that if the EU does not take our money we will spend it, that could concentrate minds as well as building public support for the Government’s actions in no deal and providing a one-off boost to business, if done in the right way. I would suggest dividing the £30 billion equally between cuts to VAT, to corporation tax, and to Employers’ NI.
In later years, once we have actually left the EU, we might restructure our tax system more significantly. But the above package of measures should be sufficient in the short-term, to provide a signal of intent and to clear the way to the no-deal Brexit that now seems more likely than not to be where we are heading. The focus should be on being calm, resolute, and seizing the opportunity that fate presents us. Even gloomy Phil should believe that, as he might see matters, lemonade is a good thing to make when life gives you lemons.