From Hammond on to Johnson – where next for fiscal policy?

As Mr Johnson takes over as Leader of the Conservative Hard Brexit Cult, and by virtue thereof as Prime Minister, it is timely to take a quick look at what his economic and fiscal policy options are - at least in the lead up to DD-Day (Do or Die) on 31st October. It’s equally important to take stock of Mr Hammond’s record as he quietly fades away after three years as Chancellor of the Exchequer.

Johnson proposes tax cuts for corporates (reduction in corporate tax rate, already one of the lowest of major economies), and praises President Trump’s example:

“He has been very clever in allowing businesses to offset capital investment in tax, with capital allowances. I think we should think about that sort of thing for start-ups, in addition to cutting corporation tax, which would also be effective.” (Via Tom Newton Dunn, The Sun)

Johnson also promises significant tax cuts for the rich and well-to-do, notably by a big rise in the 40% income tax threshhold to £80,000 and by raising the starting-level of earnings for national insurance contribution (NIC) purposes.

On the higher tax threshold, Paul Johnson of the Institute for Fiscal Studies (IFS) says this

“costs about £9 billion and benefits the 4 million or so income taxpayers with the highest incomes. Most of the gain goes to those in the top 10% of the income distribution would gain an average of nearly £2,500 a year.”

On the NIC issue, he calculates this costs £3 billion for every £1,000 the starting level is raised.

Reducing tax revenues

All these measures will reduce the immediate tax take for government, probably by £20 to 30 billion per year initially, which is 1-1.5% of GDP. The issue is whether they would act as a stimulus or at least as a measure to offset the damage caused by a no-deal Brexit.

As regards corporate taxation, there is no reason at all to believe that this will lead to any significant new investment in real stuff (apart from the tax avoidance industry). It may lead downstream to higher dividends, for the benefit generally of the better-off, once again. But nothing in the shorter term in any event.

And as for income tax/NIC proposals, the rich tend to spend less and save more of any tax give-aways (a lower propensity to consume) so here too, the stimulative effect is likely to be negligible.

Opening the spending taps?

On the spending side, Johnson has promised £5 billion for schools, funding for farmers and fishers, for police, and presumably for the NHS. His likely Chancellor, Sajit Javid, also has spending plans, notably for investment (infrastructure, housing…). Although the FT claimed that Johnson “is planning to open the spending taps”, the amount is not yet clear, but the implications do not look fiscally extraordinary.

Assuming it comes to £20 to £30 billion a year, and that nothing else changed, the budget deficit would increase by £40 to £60 billion a year, making an additional 2 to 3 % of GDP. The current budget is estimated to be in surplus next financial year by 1.4% of GDP, which is roughly Hammond’s much-touted £26 billion “Brexit warchest”. The overall borrowing projected for 2020/21 is just 0.9% of GDP, so adding 2% to this, to bring the overall deficit close to 3%, is by itself hardly likely to shake the gilt market’s foundations.

The argument should in fact be the opposite - that what is required is to reverse austerity in a more fundamental way. Johnson’s proposals for public services will leave many of those services in a desperate condition - not least those provided by local government, which is in an ever more serious financial plight.

We need to spend at minimum £50 billion a year (2.5% of GDP) more on our public services, if we are to stop the rot and start to rebuild the basis of a decent society. Giving tax breaks to the top 10% at this time is a disastrous and divisive policy. (See Ann Pettifor last October Budget Special: To tackle austerity, Britain needs (at least) a £50 billion increase in public spending).

But Johnson has also promised to reduce the public debt. In absolute terms (which he appeared to say), that would mean running an overall budget surplus, which seems unlikely from what he has said. He will no doubt “clarify” that he means reduce as a proportion of GDP. The present government’s fiscal rules include:

• a target to reduce cyclically-adjusted public sector net borrowing to below 2% of GDP by 2020-21

• a target for public sector net debt as a percentage of GDP to be falling in 2020-21

The first target will need to be ditched rapidly; the second will depend on achieving ‘growth’ of at least 3% which, with Brexit looming, and a chaotic Brexit likely, seems fanciful.

In short, we will see the Johnson Conservatives take the Trump / Republican line that “our” deficits are acceptable and no problem, since they are based on tax cuts for the rich. But if “they” ever get in power, the deficit will return as an existential danger - especially if “they” want to increase spending.

Hammond’s failure

The fact that Hammond has so clearly opposed the disastrous no-deal mantra of Johnson and Hunt does him credit, and we may one day look back and say of him, “Nothing in his [political] life / Became him like the leaving it” [Macbeth].

And yet.

The fact that there is really no fiscal obstacle to increasing public spending on public services, and that the need to do so is overwhelming if we are to maintain a society that can be considered civilised, is enough to condemn Philip Hammond’s record as Chancellor. He has quietly overseen the dismantling through austerity of a decent society, taking forward George Osborne’s strategy for diminishing the role of government by the progressive decay and destruction of public services. Public housing, police, health, defence, justice, social care… all have been deliberately degraded on the altar of a promised (eventiual) budget surplus - and all at a time that the bond market is looking for safe assets such as UK gilts.

Under Hammond’s watch, the economy has almost stagnated. This is only partly due to Brexit. The last ten years have seen an average annual increase in GDP per head of population of just over 1%. This is by far the slowest decade since the Second World War. In 2018 the increase in GDP per head was just 0.8%, and in the previous two years, not much more. An average of under 1% in Hammond’s 3 years in charge of the Treasury. This is a record of failure.

Which way will Johnson jump?

In this post I have not dwelt on the likely impact of a “no-deal” Brexit. We know it will be serious, likely to last in sharp form for at least a year while temporary expedients are found and solutions sought. It may create a GDP ‘hit’ of 2 to 3%. No one knows or can easily foretell. The issue here is whether it makes any difference to the discussion and debate over Johnson’s fiscal policy (or indeed our own proposals). I believe that a more accommodative fiscal policy becomes all the more essential, even if our debt to GDP ratio rises. To maintain austerity and a hard Brexit will create and ensure a severe negative multiplier (i.e. the economy’s downturn will feed on itself and deepen, unless government ensures that economic activity is maintained.

And so back to the more general direction of policy…

The Johnson government will be even more right-wing on many issues, but will face huge contradictions between its economic hyper-liberal and deregulatory wing, and the English nationalist, socially conservative wing, whose base is keen on protection. As yet, and true to form, Johnson has promised something for everyone within this uneasy right-wing alliance. Soon, we will see which way he jumps.

My guess is, that first jump will be straight into Mr Trump’s pocket. And the second jump will be at Trump’s command. We’re in for a rough ride.