Anyone looking at the current state of the public finances with a deficit well in excess of £300 billion for the year would assume that it is inevitable that taxes will rise. However, they are looking at the wrong figures.
Nobody is seriously considering raising sufficient taxes to repay, in the short term, the debts accumulated in the course of the pandemic. These are likely to be treated in the same way as the debts incurred in the Second World War and the First World War which were paid off as the economy grew. Trying to pay off even 1/10 of the debt by way of raising taxes would cripple any economic recovery.
The government is likely to play it long and treat the debt as a one-off occurrence. It will put it in the equivalent of a Pandora’s box. The thinking is that it will lessen in importance as the economy grows. This means that it is likely that our children and grandchildren and probably great-grandchildren will still be paying off the debt. To put it into perspective, the First World War debt was only paid off in the 21st century.
The real issue is whether the pandemic leaves the government with continuing increased spending obligations. For a government committed to run a budget which balances current spending with current revenues, there are only two ways to balance the accounts. The first is to raise taxation and the second is for economic growth to deliver more tax revenues without having to raise tax rates.
The outcome of the pandemic is likely to create a permanent need for an increase in health spending. The country is going to need more doctors and nurses as well as other health professionals. It will also need to spend more on social care. On the basis that this pandemic is unlikely to be the last, it will also need to create additional capacity within the NHS to deal with Winter demand.
The enormous disruption to children’s education will also require substantial expenditure in terms of additional teaching and tutoring resources to allow pupils to catch up. It may also mean the long summer holiday break could be curtailed and that will require additional educational resources as well.
As health and education departments fared comparatively well during the years of austerity, there is very limited room for reallocation of resources from other departments. Indeed, the boost to defence spending announced in the Autumn as well as the pledges for more police, customs officers and Border Force officials are just a few of the additional recurring expenses. In this context, the Treasury’s resistance to a permanent increase in universal credit and preferring a one-off lump sum payment, is indicative of the desire to avoid permanent costly increases to expenditure.
Whilst the government is prepared within its rules to borrow money for capital investment, such as new roads and railways as well as other infrastructure projects, it will find it difficult to justify a long-term borrowing commitment to fund current expenditure.
Given the current position, the Chancellor of the Exchequer will need to set out how he plans to bring the public finances back into balance. He will of course be expecting additional tax revenues as the country recovers from lockdown and we all rush out to spend the money that we have saved during this period. However, he will not be able to rely just on economic growth. He will need to increase the tax take. This can be done in three ways. The first is to raise tax rates. The difficulty is that he is constrained from doing so by not only the manifesto commitments but also the damage that high marginal rates of tax generally do to the running of the economy as well as competitiveness.
The second option is to do what most Chancellors would have done since the 1980s, which is to reduce tax reliefs and allowances. In the last Budget, for example, Entrepreneur’s relief was reduced by 9/10 from £10 million to £1 million. There was a chipping away at Principal Private Residence relief. It is likely that this trend will continue and may include further restrictions on pension tax relief for high paid employees.
Finally, there is likely to be even more powers and resources given to HMRC to pursue tax evasion and avoidance. Over the past 20 years we have seen a remorseless increase in HMRC powers. We’ve also seen an increased ability by HMRC to access information regarding taxpayers’ assets and activities overseas; involving the cooperation of foreign tax authorities. We are also likely to see a stepped-up effort in areas of international corporation tax such as transfer pricing.
Primondell is running a series of talks on the Budget which is due on 3 March and the economic and fiscal outlook for the next few years.