The Chancellor Rishi Sunak has been given what might have appeared to be the hottest of hot potatoes – he has to start the repairing of public finances after the damage done by the pandemic while handling the hit to household incomes, especially those of the poorest households, caused by the reaction to the Russian invasion of Ukraine.
But not all the cards dealt to the Chancellor have been duds.
He has been helped by the OBR’s forecasts, which have been generally pessimistic since the start of the pandemic. As a result, they now believe that GDP in nominal terms in 2022 will be nearly 2% higher than they thought a year ago despite the strong negative impact of the invasion of Ukraine. Had that not happened their GDP forecast would have been 4% too low. Our fiscal drag model suggests that the 4% extra GDP would have generated £60 billion of additional revenues; even post-invasion the forecast 2% upgrade generates an additional £30 billion (the OBR’s calculations, in this case, turn out to be the same as ours – which is worrying). Some of this would have had to be offset through the higher debt servicing costs both from higher interest rates and from higher payments on inflation-linked bonds but it still leaves the Chancellor with plenty to redistribute. In addition, higher than expected inflation will generate an additional £20 billion of revenues mainly from higher income tax and NICs if wage increases are modest and £40 billion if they are less so compared with £8 billion originally planned from his freezing of income tax allowances and thresholds to 2025/26.
Of this additional £50-70 billion of additional tax revenues which effectively result from bad forecasting, the Chancellor has returned to the taxpayer three sums of money: a temporary 5p reduction in fuel duty until next March worth £2.4 billion; a £6 billion rebate from a rise in the National Insurance threshold and a £6 billion cut in the basic rate of income tax from April 2024. Compared with the extra revenue it is small beer, though presumably, he will plan to distribute more apparent largesse in future years.
The Chancellor has been lucky that the UK’s tech economy, with relatively little benefit from him, has been powering GDP ahead – indeed the buoyancy of tax revenues hints that the tech economy (and hence GDP) is much larger than is officially measured. The OBR’s attempt to explain the buoyancy of receipts in Box 3.1 on page 88 of its Economic and Fiscal Outlook March 2022 concludes ‘other factors must be at play’.
Where he does not seem to have much of a feel for the economy is in understanding what can be done to help growth. He and his Treasury colleagues specialise in attempted bribes to businesses to spend more on investment, on training and on officially described R&D. It is fair to say that in general, all these schemes have had their difficulties – the apprenticeship levy and rebates work in some areas (particularly historic vehicles) but seem to have failed elsewhere. The super deductions to encourage R&D and investment also seem to have failed. Cebr’s own practical experience of trying to participate in these schemes is that by the time the government ring-fences them to avoid what they call fraud, the barriers are such that the net benefits are low. Instead of meddling with schemes, it would be simpler and more effective to let businesses keep more of their own money. But corporation tax is still being raised from 19% to 26%.
As recently as 2015, the UK ranked 11th on the international tax competitiveness scale with a score of 71.5. By last year we had slipped to 22nd with a score of 61.8.
The tax cuts announced today are insufficient to move the UK back up the competitive scale. And will not be enough to rid Mr Sunak of his reputation as a high tax Chancellor.
Douglas McWilliams, Deputy Chairman
Email dmcwilliams@cebr.com Phone 07710 083652