David Gauke is a former Justice Secretary, and was an independent candidate in South-West Hertfordshire at the recent general election.
Tax cuts are back in fashion. Having announced tax increases in his March Budget, and having agreed to the Prime Minister announcing further tax increases to fund higher health and social care expenditure in September, the Chancellor is taking every opportunity to let everyone know that he is in favour of lower taxes and plans to cut taxes before the next general election. All of this before any of the announced tax increases takes effect. What is going on?
Before examining what this tells us about what will happen next with fiscal policy, it is worth recalling how we got here.
At the time of the March Budget this year, it was evident that a fiscal tightening of some description was going to be necessary. Nothing needed to be done straight away, but it is politically easier to announce deficit-reducing measures earlier in a Parliament rather than later.
As for whether the tightening should be tax increases or spending cuts, tax increases were always the likely outcome. Years of spending restraint, pledges of high spending at the last general election and a change in the nature of Conservative support all suggested that the political reality was that taxes would go up. And so they did, with a freeze in thresholds for personal taxes and a substantial increase in corporation tax rates.
In September, the Prime Minister wanted to announce that he had solved the social care issue, the Health Secretary wanted more money for the NHS to cope with post-Covid pressures and the Chancellor – as a good fiscal conservative – wanted to ensure that any additional spending is paid for by higher taxes rather than letting borrowing take the strain.
A deal was done. The Prime Minister got his announcement, the Health Secretary got his money and the Chancellor not only got the tax increase necessary to pay for it, but he also got the Prime Minister to announce the increase in National Insurance Contributions.
We then come to the October Budget. The Chancellor had a bit more money to play with because the economy had grown faster in 2021 than had been expected ,and the damage done to the long term health of the economy by Covid had been downgraded. He had a choice between increasing spending, borrowing less and cutting taxes.
Cutting taxes was always the least likely option, because it would have been very strange to announce tax increases one month and then tax cuts the next. The real choice was between either spending the windfall or reducing borrowing, perhaps with an eye on tax cuts later in the Parliament. When it came down to it, more of the windfall went on spending than many expected.
With little tucked away for a rainy day, the possibility of future tax cuts became heavily dependent on the OBR once again downgrading their COVID scarring estimate (they remain relatively pessimistic on that compared to other forecasters).
There are, however, also significant downside risks for the economy. We do not yet know what will happen with the Omicron variant and there may be other variants in future. Triggering Article 16 in January (still possible although less likely than it was) would likely provoke a trade war and damage business confidence.
But even if there is an improved forecast from the OBR in 2022, it will be a forecast made in a period of uncertainty. The prudent course would not be to use any upside sum to either cut taxes or increase spending.
This suggests that the plan earlier this autumn was that 2022 should be a fiscally boring year. There might be some revenue neutral tax reforms but, in terms of the balance between tax and spend, the big decisions were made in 2021. The plan was to implement the announced tax increases, hold the line on additional spending bids and hope for some good news that will permit some tax cuts in 2023.
Politics has, however, intervened.
The response to the increases in NICs announced in September was relatively muted, but the October Budget landed remarkably badly with the Daily Telegraph and Spectator and a fair few Conservative MPs. Belatedly, there is a recognition that this was not a small state government. Shortly afterwards, in a separate development, Boris Johnson blundered over the Owen Paterson case and the Peppa Pig speech, and his personal ratings tumbled.
All of this has left the Prime Minister with a bigger party management issue than a public opinion issue. The Conservatives remain, at worst, level-pegging with Labour, and the Old Bexley & Sidcup by-election result was reassuringly dull. The public has not reacted strongly against the tax rises, but it looks as if the wider Conservative movement has.
To gauge the mood amongst Conservative activists, it is always instructive to look at the ConservativeHome ratings. The Prime Minister is struggling, and the Paterson affair has contributed to that (as the unfortunate Mark Spencer’s rating demonstrates), but the fall in the Chancellor’s rating suggestions a reaction against the tax increases. He is no longer the heir-apparent.
Meanwhile, Liz Truss – associated with lower taxes – continues to ride high and is on (tank) manoeuvres. It was also striking how Lord Frost – previously seen as something of a political creature of the Prime Minister’s – has asserted his independence by declaring his enthusiasm for lower taxes. He sits in second place in the league table.
Let us fast-forward to some point next year when the Budget is about to be delivered. Imagine the circumstances where Conservative MPs and activists are feeling a bit despondent because “this isn’t a proper Conservative government”; voters are feeling the pinch as living standards fall and theTelegraph (Boris Johnson’s “real boss” according to Dominic Cummings) is campaigning for tax cuts; and the Foreign Secretary lets it be known that she thinks lower taxes would unleash this country’s entrepreneurial spirits. How do we think the Prime Minister and the Chancellor will react?
I am going to hazard a guess, and suggest that they will both want tax cuts. Fiscal conservatives will point out that having decided to spend a lot of money (not to mention pursuing a growth-damaging European policy), the country might not be able to afford tax cuts, that there is the small matter of complying with the fiscal rules and that demographic pressures in the 2030s suggest that the long-term trajectory is higher taxes.
I think one could always have been confident that this is the sort of defeatist doom-mongering up with which the Prime Minister would not put. These are certainly not persuasive arguments if they imperil his position in Number 10.
The Chancellor might have been more torn. He is a fiscal conservative, and knows that Chancellors are often judged on how responsibly they act. But he is also naturally sympathetic to lower taxes and conscious of his own place (current and future) in the party, with a Prime Minister willing to be ruthless to get his own way. On the basis of the briefings currently coming out of Number 11, the Chancellor looks like he will be a tax cutter.
Tax cuts as early as 2022 might not be affordable, coherent or wise but there is definitely a scenario in which they happen regardless. If Number 10 and 11 are united in panic, political expediency will trump fiscal responsibility at the next Budget.