LONDON, March 13 (Reuters Breakingviews) - After his predecessor’s reckless fiscal laxity caused a financial meltdown, UK finance minister Jeremy Hunt is likely to take a conservative approach in his first budget on Wednesday. A 30 billion pound war chest will help him to address short-term issues such as public pay. A low-wattage approach, however, will not jolt Britain out of its economic slump. For that, Downing Street will need to scrap arbitrary targets of fiscal probity and craft a plan to boost private investments that can compete with the subsidies promised by the U.S. and Europe.
As a former health minister, Hunt is familiar with the Hippocratic Oath’s principle of “first, do no harm.” That credo didn’t resonate with former finance minister Kwasi Kwarteng. His September plans for 45 billion pounds of unfunded tax cuts led to a bond market crash, an emergency intervention by the Bank of England and the demise of the Conservative government led by Liz Truss.
Having reversed most of those policies in October, Hunt is focused on taking care of the immediate problems, delaying difficult decisions and boring the markets into a muted response. He and Prime Minister Rishi Sunak, his new boss, have more money to spend than when they took over but also a long list of urgent issues. The Institute for Fiscal Studies estimates that borrowing in the current financial year is running 31 billion pounds below the November forecast by the Office for Budget Responsibility (OBR), the UK’s independent fiscal watchdog.
Around a third of that comes from lower spending on energy subsidies to households, driven by an 80% fall in wholesale gas prices since the summer. Another third is due to higher tax receipts – an unexpected boon. The other key factor is lower spending on debt servicing. The drop in government bond yields after the 44 heady days of “Trussonomics” means that interest payments are running around 3.7 billion pounds below forecast this fiscal year.
Much of that windfall will go to tackle short-term matters. Hunt is certain to spend around 3 billion pounds to keep the maximum energy bill for the average UK customer at 2,500 pounds a year, rather than letting it rise to 3,000 pounds. A further 6 billion pounds will freeze fuel duties, avoiding a 23% rise from April.
Paying Britain’s 5.7 million public sector workers is a thornier issue. Government departments have said they can afford a 3.5% annual rise in 2023-2024 fiscal year. That would be below the rate of inflation, which the OBR forecasts at 5.5%, and private sector pay growth, which is running at around 6.8%. If Sunak wants to give nurses and teachers an inflation-matching pay rise, Hunt will have to find 5 billion pounds, according to the Resolution Foundation.
All of that will leave Hunt with little room for maneuver in the long run. That is largely because he wants debt to fall as a percentage of GDP in 2027-2028 fiscal year. He has promised a 54 billion pound austerity package that will kick in 2025, after the next election, to get there. In November, the OBR forecast that Downing Street would meet that goal with just 9.2 billion pounds to spare. That margin could expand if nominal GDP grows faster than expected or borrowing continues to undershoot predictions.
Yet obsessing about an arbitrary target won’t cure Britain’s chronic slow growth. GDP will contract by 0.8% in 2023 and grow by just 0.9% next year, according to 21 forecasters polled by the Treasury. More worryingly, the Bank of England puts the long-term growth rate that is both sustainable and non-inflationary below 1% – nearly half what it was in 2010 to 2020.
A slump in productivity – the amount of output per hour worked – is behind this slowdown. From 2008 to 2020, UK productivity grew at an annual average of 0.5%, a huge drop from the 2.3% averaged between 1974 and 2008, according to the National Institute of Economic and Social Research.
Raising that number requires better education, training and more workers, and Hunt could propose free childcare for 1- and 2-year-olds – a policy that would cost up to 6 billion pounds – to entice some parents back to work. To make Britain more productive, though, bigger investments are also essential. To match the ratio of investment to GDP of other G7 nations, Britain needs an extra 115 billion pound a year of annual investment.
Hunt has already pledged to keep public sector net investment at around 2.5% of GDP for the next five years, in line with G7 peers. Now companies need to do their part. First, though, Hunt has to counter the effects of a rise in corporation tax from 19% to 25% from April, as well as the concomitant end of a “super deduction” that allowed firms to offset 130% of investment against tax.
Reversing the corporation tax hike would be too expensive - up to 16 billion pounds a year - and only increase investment by 1% in the long run, according to the Resolution Foundation. Hunt would get more joy if he allowed companies to offset all investment costs against profits. That would still cost 11 billion pounds a year but would boost investment by 5% in the long run. Stimulating research and development with more generous tax giveaways could be another priority. The existing tax credits have failed to raise UK Research & Development spending beyond 1.74% of GDP, compared to the 2.5% invested by other developed countries. Only half of that comes from the private sector.
The finance minister could pay for these outlays by dipping into a 13 to 14 billion pound “reserve”, a pot of money earmarked for unforeseen spending needs. Or he could dilute his own fiscal rule, on the grounds that boosting growth is more important than hitting a subjective target.
A third option is taxing wealth through property, capital gains, inheritance and transaction taxes. Total wealth in the UK has risen from three times GDP in 1965 to nearly eight times now but wealth taxes have only increased from 2.2% to 3% of GDP, according to the Resolution Foundation. That policy, however, is unsellable to the Conservative Party.
Of course, none of this would have the financial clout to compete with the $369 billion in green subsidies of the U.S. Inflation Reduction Act (IRA) or the 270 billion euros the European Union is considering doling out in response to the IRA. But as Britain faces a future of slow growth and sluggish productivity, its political leaders cannot afford to be fiscally boring.
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CONTEXT NEWS
UK finance minister Jeremy Hunt will set out the government’s tax and spending plans for the next few years on March 15.
