The election campaign for leader of the Conservative party has been lit up by most candidates promising tax cuts. Obviously, Chancellor Sunak, who is bound by his policies as Chancellor, has been less able to join in but even he has promised tax cuts when possible.

Meanwhile much of the commentariat (including Cebr spokespersons) have pointed out that it could be counterproductive to cut taxes when demand exceeds supply and there are shortages of labour and critical products. Some commentators (surprisingly including former Chancellors Lords Clark and Lamont and George Osborne all of whom should know better) have referred to ‘Dutch auctions’ of tax cuts. They seem confused about auctions – in Dutch auctions the amounts offered get lower and lower. What they appear to mean is that the offers of tax cuts are like ordinary auctions such as the one in which I recently purchased a classic sports car where the offers go up until the bidders get exhausted. These obviously sound less exotic than something imported from Holland but are a more appropriate metaphor. Whether people who use terms they don’t understand are qualified to comment on tax policy is an interesting point.

Although demand currently exceeds supply and the latest GDP data still show rapid growth (we estimate that private sector GDP growth has been at around an annual rate of 6% since the beginning of the year) it is likely that it should start to fall back in a few months’ time. US monetary policy is being tightened and the UK will be forced to follow suit to avoid sterling plunging. Moreover, most other countries are in the same situation and with a coordinated international weakening in demand, it is quite likely that the balance of supply and demand could change sharply. In early 2022 UK inventories have accumulated at a record rate, faster than the pre Brexit period. Even the ending of inventory accumulation mathematically causes a fall in GDP. But if companies decide that their accumulated inventories are excessive, they will liquidate them, supplying goods off the shelf rather than from production. And the swing in GDP could be dramatic (as it was when the same thing happened in mid 1975).

There is another factor affecting the affordability or otherwise of tax cuts. Which is the additional tax revenues that have been raised through unanticipated inflation.

We have updated the analysis we carried out in February to estimate the impacts on income tax from frozen allowances. We have also added in the impact of the other allowances that have been frozen, the impact of higher prices on VAT and subtracted some of the costs from indexed bonds. We have used the OBR’s own ready reckoners to estimate the impacts of all of these. The OBR’s latest economic and fiscal outlook estimates that for each 1% of higher nominal GDP, public borrowing in 2024/25 will be 0.8% lower. Our current forecast is that nominal GDP in 2024/25 will be 5.7 percentage points higher than the OBR assumes. This alone generates £133 billion of net additional revenues. Against that needs to be offset likely higher spending. If we assume that public spending will be the same share of GDP as in the OBR projections, this increases the cost of public spending by £34 billion; higher inflation will raise indexed debt payments by about £7 billion while higher interest rates could raise debt payments by as much as £30 billion. Even allowing for all these, it is pretty clear that the OBR’s forecasting failures mean that substantial additional net revenues are likely to be generated compared with those expected. Which in turn means that net tax (after allowing for expenditure) receipts in 2024/25 will be about £60 billion more than the OBR’s base estimates.

Since these receipts will come from the effects of inflation and fiscal drag meaning that people will be paying more tax than they would have expected, it would not be unreasonable for the additional revenues to be used for tax cuts.

For more information please contact:

Douglas McWilliams, Deputy Chairman Email dmcwilliams@cebr.com Phone 07710 083 652

Cebr is an independent London-based economic consultancy specialising in economic impact assessment, macroeconomic forecasting and thought leadership. For more information on this report, or if you are interested in commissioning research with Cebr, please contact us using our enquiries page.