The Treasury needs to win the argument for sound money once more

An institution famed for its belief in prudence should have the courage of its convictions, even when politics makes that difficult

May 23, 2022
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Tensions between the occupants of 10 and 11 Downing Street are never far below the surface of British politics. Those tensions currently centre on the extent to which the government should try to offset the impact of rising energy prices on under-pressure family budgets. The Treasury has done something, with a council tax rebate, but other ministers—and perhaps the prime minister himself—seem to think the measures taken so far are not close to sufficient and would like to see much more done.

It is a familiar story, pitting irresistible political forces against an immovable Treasury obstacle. My betting this time is on some repositioning of the obstacle, for two reasons. First, cost of living pressures are even higher than they were at the time of the March budget, with a couple of Bank of England rate rises adding to interest costs. And second, in the short run, inflation improves the look of the government’s finances. Tax revenues rise, and the consequences for public spending of higher wage costs and increased debt interest emerge a little later. So for now the deficit is falling, making it harder for the Treasury to resist pressure to loosen the purse strings.

But why are the Treasury’s instincts always so cautious, as most outsiders would characterise them? Prudence is a virtue, but sometimes excessive prudence can be politically reckless.

The term “the Treasury view” is not heard quite as much as it used to be, but it remains in the water and the walls of 1 Horse Guards Road.

Nick Macpherson, the permanent secretary before current incumbent Tom Scholar, delivered a speech called “The Treasury view: A Testament of Experience” in 2014. He identified a series of propositions which he saw as the bedrock of officials’ views. They included a belief in free trade anchored in multilateral agreements and a view that bilateral deals were usually “a commercial sin.” The Treasury’s failure to sway voters with its Project Fear warnings in the EU referendum showed that this fundamental underpinning was increasingly irrelevant to outsiders. Since 2016 and especially since 2019, the cabinet has been full of sinners.

As far as taxing and spending is concerned, which is at the core of the current debate, Macpherson identified “the provision of sound money” as one of the Treasury’s core aims. That might seem uncontroversial, but in his mind it is linked to a deep scepticism about the government’s ability to raise additional tax revenue to finance additional unplanned expenditure. He noted that “the share of national income accounted for by taxes and national insurance contributions has remained stubbornly stable” for some time, and that in 30 years the tax take had never been higher than 36.4 per cent of GDP in 1985-1986, and never lower than 31.8 per cent in 1993-1994. In 2020, it was 33.3 per cent.

So the argument that additional benefit spending now will be recovered later, through tax increases at a more propitious moment, finds few takers in the Treasury. They see little evidence that taxes overall can be raised on a sustainable basis. If we had a larger, more interventionist state on the continental European model, we would need to find a way of financing it. Yet there is currently a firm political commitment in place not to raise income tax or VAT, by far the biggest earners.

Those who have followed these debates for decades, as I have, might take the view that they have seen it all before, and that whatever the current pressure on cost of living, once again the Treasury will prevail in the end. The chancellor is always the most powerful minister. But that might be a rash assessment.

What has changed is that there is now no underlying consensus on the government benches in favour of Macpherson’s core propositions at the heart of the Treasury view. Red Wallers are instinctively in favour of higher spending on a wide range of exciting public projects. Pork barrels have become “levelling-up” projects, which makes them sound far more appealing. Only Labour’s early advocacy of windfall taxes on oil and gas companies prevents that becoming a new Tory policy. And the Conservatives have presided over the erection of trade barriers with the EU, reflected in a sharp decline in trading relationships. The row over the Northern Ireland protocol could make trade with the rest of Europe even harder.

So the Treasury view, as Macpherson defined it, is under severe pressure and, unfortunately, there is no sign yet of any reformulation of the department’s core beliefs in the new world. This leaves the Treasury dangerously exposed to heretical policy proposals advanced elsewhere in government, especially on public spending. If nothing is done to boost the capacity to raise income, that will inevitably lead to higher public debt, which is already at the highest level since the 1960s. A new Treasury view for the post-Brexit era is much needed.