Sir John Redwood is MP for Wokingham, and is a former Secretary of State for Wales.
Since March 2021 I have been telling the Treasury that their forecasts are overly gloomy. They underestimate growth and tax revenues, and wrongly balloon expected levels of borrowing. I was not surprised when the Chancellor confessed how wrong the budget forecasts had been during the Spring Statement.
But even I was surprised that the latest figures show that the Treasury borrowed an almost unbelievable £105,000 million less than planned! Keeping tax rates down, cutting Stamp duty, and going for growth produced a much stronger economy than expected. The extra tax revenues were due to more spending and more housing transactions.
So why change a winning formula? Why did the Chancellor underplay the successes and turn instead to gloomier forecasts? Why did he think he had to increase National Insurance , freeze Income tax thresholds, and prepare for a huge increase in company tax rates next year? Once again we were treated to some bizarre figure work from the OBR and Treasury.
Clearly upset by how much better revenues were than expected, they sensationalised debt servicing costs through their presentation. The Treasury appeared as if they hoped the government would be panicked into raising taxes to control debt. They added to the legitimate and affordable cash costs of paying interest on the outstanding debts to savers and other investors the non-cash costs of the indexation of the index-linked debt.
This only becomes a liability on maturity of any given bond and will simply be refinanced by rolling over the real value of the debt when it comes due. They did not put any offsetting figures into the account to show how much the state will benefit from the current high inflation, as it reduces the real costs of refinancing or paying back the majority of the debt that isn’t index linked.
The government needs to understand that the cost-of-living crisis is will be difficult for many. It needs to do more to offset the effects of runaway energy price inflation, rising food costs, and price hikes across goods and services.
We should not be squeezing incomes through a National Insurance hike. We should not insist on VAT on domestic fuel. We should be more generous in offering a cut in petrol and diesel taxation which otherwise will rake in far more revenue than planned.
Given the magnitude of the hit to real incomes now coming, the Treasury should have returned more than 1% of GDP through remitting taxes. This was eminently affordable given the great performance of the public finances over last year. Instead, the Chancellor spent less than 0.5% of GDP doing so, leaving most of his revenue windfall untouched.
The danger now is of the opposite effects. The hit to real incomes will slow growth. Many people will be unable to afford discretionary goods and services after they have paid food and energy bills. The fast recovery of health output credited to the free test programmes and massive roll out of vaccines will slow dramatically. Higher taxes will knock confidence and higher inflation will worry consumers. The economy will slow sharply.
Instead of a revenue bonanza from surprisingly good growth, we will experience a slowdown in extra tax receipts. More people will qualify for top-up benefits and income support. The Treasury will learn that higher taxes can lead to bigger deficits and fewer good options for economic policy.
The official figures tell us that tax as a percentage of national income was at 33 percent in 2019 and will be at 36.2 percent by this Parliament’s end: a substantial rise. It comes from the upwards movement of rates for companies, the personal allowances freeze, and the introduction of the National Insurance/social care tax proposals. It will cut growth and lower take-home pay. It will damage private sector investment, which is already disappointing, despite the temporary super allowance. Businesses look at the coming hike in company tax rates and are alarmed.
I am glad the Chancellor wants to cut taxes, and admires Nigel Lawson. The latter slashed Income Tax rates and extra money consequently rolled in. Sunak should imitate his predecessor. People want to know the government sides with them during an income squeeze.
The public see that external events have created strong upward pressures on oil and gas prices and may understand they cannot be completely shielded from them. They will be less understanding of why, simultaneously, the government shifted from a successful lower rate of tax to a higher one. They will blame the government for taking away money they need to pay their higher bills.
As the Treasury needs more revenue, they must help the private sector grow the economy to deliver the extra cash. They already get a windfall tax on home-produced oil and gas via a doubled corporation tax rate on such activities. They should prioritise extracting more oil and gas domestically with every government assistance to achieve it. That will bring extra revenue as well more well-paid jobs.
Then the Treasury needs to be provide more support of the domestic process industry which is struggling to survive against the background of such elevated energy costs. That could also be a net win on revenues.
The government must dump the gloomy Treasury fiscal rules and substitute just two key aims and controls. One should be to take the 2% inflation target seriously. That means the Treasury helping government do more to eliminate supply bottlenecks at home. The other should be a growth target to galvanise public policy to support expansion of jobs and investment.
We need an update on the Spring Statement urgently. It would be better to head off the worst of the income squeeze before it begins and people are paying higher bills.