Characters Tommy Traddles, Wilkins Micawber and David Copperfield from Charles Dickens's novel David Copperfield. Artwork by Frank Reynolds, 1910. ©Wikimedia Commons
Read more: George Osborne should have been laughed out of the Commons after giving his Budget
After yesterday’s Budget, it is probably fair to say that George Osborne’s role model is Wilkins Micawber. Those familiar with Charles Dickens’s novel David Copperfield will easily see the similarities between the book's eponymous character and the Chancellor: Copperfield is always indebted, hopelessly optimistic and renowned for his belief that "something will turn up."
When we peel away the layers of detail, gesture and obfuscation, what does this budget amount to? We have the prospect of a major tightening of fiscal policy in 2019/20, in the run-up to the next General Election. The Chancellor’s hope is now that money will appear from somewhere, so that he never has to implement this tightening. He will at least be hoping to defer it to the next Parliament.
The Budget headlines may all be about the announcement of the sugar tax, set to raise over half a billion pounds a year, but there was nothing sweet about it. How did it come to this? In November, the Chancellor was brimming with confidence as the Office for Budget Responsibility (OBR) had "given" him an unexpected £27bn windfall, allowing him the leeway to cancel, among other things, the contentious cuts in tax credits that he was planning. The windfall was the product of lower debt interest expense, changes in the way in which VAT and National Insurance receipts were modelled, and higher corporate tax receipts, for example, which offset things like the impact of lower equity prices on tax receipts and the higher cap on welfare spending.
This time, though, the OBR has turned from giver to grinch. A rather more sour assessment of what’s happening to UK productivity, economic growth, and inflation meant that the Chancellor had to reckon with a fiscal outlook which was £56bn worse than previously envisaged. Of this, almost £53bn can be attributed to the impact of lower nominal GDP growth, or money GDP growth, on tax receipts. That is, they are on a permanently lower trajectory than they was expected. The OBR has lowered its estimate of real economic growth for this year from 2.4 per cent to two per cent, and to between 2.1 per cent and 2.2 per cent in each year following. This reflects lower estimates for "trend growth."
This isn’t a phenomenon particular to the UK; the US, Japan, China and Europe are all suffering from the same problem. In many western countries (and regions), this is the product of negative economic trends before the financial crisis, the crisis itself, and the effects of the ensuing recession. In this respect, at least, the "cocktail of economic risks" to which the Chancellor often refers is real. However, it hasn’t changed much since last year.
What has changed for the UK, along with the OBR’s downward revisions of the size of the UK economy and its growth potential, are that a date for the EU referendum has been announced. A vote to leave the EU could have huge economic effects. Naysayers think the Chancellor, the OBR and the Governor of the Bank of England (who recently warned Brexit is a major threat to the UK's economic stability) are scaremongering, but they dismiss concerns at Britain's peril. The financial and economic risks of Brexit, as I argued on Monday, raise the possibility not only of a shock to demand from an inevitable period of uncertainty, but a train wreck as far as the Government’s fiscal strategy is concerned.
The EU referendum was almost certainly the most important consideration for the Chancellor in drafting his Budget. Leaving aside his own pro-EU position and his leadership aspirations, he will surely have wanted to avoid upsetting Conservative MPs. Having already scrapped his planned tax credit cuts, and the leaked reforms to pension arrangements, the Chancellor announced a series of measures aimed at calming his fellow Conservatives. These included higher thresholds for income tax and top rate tax payers, a cut in capital gains tax, modest help for savers and for small businesses, a cut in corporation tax, and a continued freeze on fuel duty, which was rumoured to be lifted in the pre-Budget speculation. Businesses that had previously railed against the new national minimum wage and the fact that they will have to pay the new apprenticeship levy, would also have been in the Chancellor’s "keep-them-sweet" box.
Most of us came away from the Budget thinking that it was primarily designed not to ruffle feathers and to keep the economic ship steady—as the economic outlook is looking significantly harsher. That’s precisely what it was. From a fiscal strategy standpoint, this was a wasted opportunity, since the second Budget in a new Parliament is an opportunity for Chancellors with an agenda to press it, and ride out any unpopularity before turning to the party-bag of goodies in the run-up to the next election. However, the EU referendum has changed the politics of this Budget, obliging the Chancellor to zip it as far as his more adventurous instincts are concerned.
Buried in the OBR report though, we can see that the effect of government decisions on taxation and spending is that the government has given away around £1bn, £7.6bn and £4.8bn in the years 2016/17, 2017/18, and 2018/19, respectively, but will then claw back £13.7bn in 2019/20 and £13.1bn in 2020/21. There is a killer chart (on page 20 here if you want to look) that reveals that the price of this strategy is a close-to-election fiscal tightening of around 1.5 per cent of GDP, which is about as big as the tightening implemented after the election in 2010. Public spending cuts will come into effect, public sector pension contributions are scheduled to rise, corporate tax payments are planned to rise, and there will be £3.5bn of "efficiency savings" (whatever they might be).
The reason the Chancellor has pencilled in these cuts in is to ensure that his last remaining unbroken rule—which guarantees a budget surplus at the end of the Parliament—stays unbroken. The rule on capping welfare has already slipped, as has the rule stipulating steady declines in net government debt as a share of GDP. But are we really going to believe that the government will implement a major fiscal tightening as it prepares for the 2020 election?
So, we are left with a handful of possibilities. The surplus rule may be broken, though this would be heavily spun to try and ensure minimal political fallout. Creative accounting might flatter the pre-election budgetary arithmetic and push the fiscal tightening into the new Parliament. Or some good fortune may turn up: perhaps we will see economic growth, or inflation, or a better environment for asset sales. The Chancellor has gone Micawberish on us.
