Sunak should raise the lower tax threshold this autumn to put more money in people’s pockets

April 8, 2022

Higher inflation is inevitable. An economic slowdown is expected. Recession is possible. That is the economic outlook and challenge facing the UK. The question is whether policy makers are doing enough?

This troubling economic climate is not unique to us. All western economies are facing an imminent inflation challenge. And, alongside the war and its consequences, this is starting to weigh on confidence and growth prospects for later this year and next.

It was against this backdrop that the Chancellor delivered the Spring Statement two weeks ago. In many respects, it was a missed opportunity. While he cannot be blamed for higher inflation or fuel prices, and although there were some welcome measures, he has to accept some responsibility for the tax take continuing to rise and failing to increase benefits in line with inflation ahead of the cost-of-living crisis.

As expected, the Office for Budget Responsibility (OBR) projected a slowing economy over coming years and higher inflation before it subsides. After 7.5 per cent growth last year, growth is expected to slow to 3.8 per cent this year and 1.8 per cent next. Inflation, meanwhile, is expected by the OBR to rise from 2.6 per cent last year to an average of 7.4 per cent this, and then be four per cent next and 1.5 per cent in 2024.

Such an outlook – with the cost-of-living squeeze hitting people hard, and an economic slowdown ahead – added to the pressure for the Chancellor to do more to help.

Rishi Sunak stepped up to the plate during the pandemic, and perhaps the challenge from that is that it has created the impression that there is a bottomless pit of money into which he can dip. There isn’t.

Yet, as the Spring Statement showed, while debt is still historically high, the public finances on an improving trend because of the strong rebound in the economy over the last year. This presented the Chancellor with ample room to act. Public borrowing was £321.9 billion in 2020-21 and is now expected to be £127.8 billion in the last fiscal year, 2021-22, which is £50.9 billion lower than the OBR forecast only last October.

But even last autumn it was clear that the finances were improving and at that time this cast doubt on the need to announce the increase in the national insurance rate. Moreover, the margin of error on these budget forecasts is high, suggesting the Chancellor should not feel bound by them when it comes to fiscal policy – especially for predictions several years into the future.

There is still much uncertainty about how resilient the economy will prove to be, as previous monetary policy stimulus is replaced by tightening, as the post-pandemic rebound loses momentum and as the cost-of-living squeeze bites. Measures of confidence have already started to deteriorate. The GfK measure of consumer confidence fell to its lowest level in sixteen months of -31 in March. This will likely get worse.

The biggest problem has been monetary policy and in this context the Chancellor should – at some stage – call for a fresh look at the Bank of England’s remit, operations and communication.

For more than a decade, the UK has suffered from a cheap money policy. This has had three damning consequences, each with economic and political implications.

First, it has fed rampant asset price inflation, not just in financial markets, but in property prices. This has fed inequality and inter-generational problems.

Second, the combination of low rates and the Bank’s buying of government debt through large-scale quantitative easing has contributed to financial market instability, with markets not pricing properly for risk.

Third, monetary policy has contributed to inflation. Even though the pandemic and supply shortages may have been a catalyst for rising inflation, the Bank’s complacency last year fed the problem. Moreover, it now means too that if the Bank has to tighten monetary policy, it will do so at a time when the economy is less able to cope.

With monetary policy having been too loose for too long, the uncertain economic climate might suggest the need for the Bank to tread carefully. It also added pressure on the Chancellor to do more.

Now, two weeks after the Statement, the dust has still not settled. In part, this is because there is increasing concern about what lies ahead economically, and whether the Government may be forced to act further.

The Treasury’s mindset is on balancing the budget – which they don’t do well – at the expense of economic growth. The prospect of slower future growth means more of the deficit is viewed as structural, not cyclical, necessitating fiscal caution. Furthermore, the fiscal rules which are aimed at making the fiscal numbers appear credible can end up embedding tax increases into future numbers to pay for spending plans.

Concern about the rise in debt service payments in the coming fiscal year also appeared to weigh on the Spring Statement’s plans. Perhaps this was overdone, with this rise explained by the increased cost of the principle of index-linked debt. This future liability counts as borrowing in the year in which it accrues, hence the spike in the next fiscal year which should not divert attention from the improving trend in the budget finances.

The Chancellor did unveil some significant and welcome targeted measures to cushion the pain. Most notably, increasing the National Insurance threshold, bringing it in line from July with income taxes at £12,570. This helped many people.

The other was the immediate fuel duty cut by five pence per litre until next spring – although this has not been fully passed on. This followed on from help announced before his Statement on council tax, fuel bills and changes to the universal credit taper rate. He also pre-announced a cut in income tax.

The alignment of national insurance and income tax allowances was a big deal. It not only helps simplify the tax system, but may be a stepping stone to abolishing national insurance completely. This is something many Chancellors have talked of, but none have done. This moves that closer.

Despite this, more should have been done and more help is now likely. This leads onto whether the Government is seen to be on the front foot, or are forced into acting. For instance, benefits could have been increased in line with the latest, higher inflation numbers. Also, recently announced changes to student loan repayments were unnecessary, and expensive for students, but bring in the Treasury sizeable revenues.

Looking ahead, there is still scope for the Government to cut taxes such as VAT on fuel, and shift green taxes from fuel bills onto general taxation (else they might be seen as a green poll tax, not linked to peoples’ ability to pay).

I would suggest raising the lower tax threshold this autumn, if not sooner, to put more money back into peoples’ pockets and to start to reduce the overall tax burden. Raising the upper tax threshold may be too expensive, or not politically acceptable.

Overall, the OBR reported that living standards are expected to fall by 2.2 per cent this coming year – the largest fall on record. And, despite the statement’s measures, previously announced policy measures and the more tax-rich composition of economic activity, the tax burden is set to rise to its highest since the late 1940’s, from 33 per cent of GDP in 2019/20 to 36.3 per cent in 2026/27.

Alleviating the cost-of-living crisis, keeping inflation in check and delivering stronger growth is the aim. This should be supported by smarter regulations and sensible taxes that lower the overall tax burden.

This was also published on ConservativeHome

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