David Willetts is President of the Resolution Foundation.
The process of preparing this Budget has been so messy and inept that we have lost sight of the economic and financial realities behind it.
Here are the basic facts.
The deterioration in the public finances in 2029 since the last Budget is estimated by us at Resolution Foundation to be about £13b. This is not as bad as some of the lurid figures in circulation.
The OBR’s cut to its estimated rate of productivity growth has hit tax revenues. But less attention has been paid to increases in forecast wages which boosts revenues. The two effects broadly balance out. It is the failure to reform welfare which has a cost. But the Chancellor also cut her headroom for meeting her fiscal rules too much in the last Budget and now needs to increase that. That could push the tax increases in the budget up to the £15b-£20b range.
The average British worker is not paying a particularly high average rate of direct tax and employee NI compared with other OECD countries. Indeed, for a full-time employee on mean pay (about £50,000) our average tax wedge on their pay last year was 21 per cent, compared to 24 per cent in the US and 37 per cent in Germany, making our average deductions the lowest in the G7. Even if one adds in employer national insurance (NI) and the effect of this April’s increases, not yet reflected in OECD estimates, our rates of deductions from earnings are still at the lower end of the range of advanced Western countries. It is only at higher earnings that our tax rates overtake the US, Canada or Japan though remaining lower than major European countries and slightly below the OECD average. However, a very odd feature of our system is our big increases in employer NI whilst employee NI and income tax remain low. This unusual mix creates a very strong incentive to be self-employed to avoid employer national insurance.
The real problem is our poor economic performance.
Although there are many factors Brexit is the biggest.
The initial estimates of the effect over the first five years was for about a 4 per cent reduction in GDP compared to what it otherwise would have been. That figure has been widely cited. But there was an easy pro-Brexit assumption that things would then stabilise so the 4 percent hit was the permanent effect. That was bad enough. However, it looks as if the impact of Brexit has continued to grow. The latest estimates are that Brexit reduced GDP by 6 to 8 per cent by 2025, with business investment down 12 to 18 per cent. It is very hard to ignore Brexit when it is continuing to have such a big impact on something we all care about – the performance of our economy.
Public borrowing is too high and too expensive.
The economy has had a series of hits from Brexit to Covid to the war in Ukraine. But with the national debt approaching 100 per cent of GDP it would be hard for any Government to respond to a future crisis with the kind of temporary increases in spending Rishi Sunak delivered during Covid. We are ill-prepared for the next crisis and ought to be bringing down public borrowing and debt to build up resilience for the future. Conservatives prefer tackling the deficit by bringing down public spending rather than putting up taxes. However, no Government has been able to reduce a deficit entirely by public spending measures. George Osborne’s tough public spending measures meant that the high level of borrowing we inherited in 2010 was dealt with by a mix of 80 per cent spending cuts and 20 per cent tax increases.
It is hard to do more than that.
Fiscal Conservatism means a belief in tough effective management of the public finances. That has historically meant some tax rises – as delivered when we entered office from Opposition in 1979 and in 2010.
There is no reason to expect it would be any different for a new Conservative Government. Labour’s catastrophic mistake of ruling out increases in all three of the main taxes should not be repeated.
