The chancellor should make clear in the autumn what his objectives are for borrowing and debt but he should not attempt to announce a full plan for tax, says Gemma Tetlow
Chancellor Rishi Sunak has said that he will set out, in the autumn, three years of firm spending plans for government departments. As the Institute has already argued, there are strong reasons to think that now – amid a pandemic – is not the moment to try to set multi-year spending plans. But, given that this is Sunak’s preferred course of action, the question now is how he should deal with the other side of the ledger.
Normal practice – since 1998 when then chancellor Gordon Brown published the first multi-year “comprehensive spending review” – has been that these spending plans are presented in the context of up-to-date forecasts for economic growth, tax revenues, borrowing and debt. This allows the public to understand exactly where the money is coming from and to judge whether the plans are fiscally sustainable. Those forecasts factor in only tax policies that have been firmly announced.
Ordinarily this imposes welcome discipline on chancellors – making it difficult for them to promise spending giveaways without being crystal clear about where the money to pay for them will come from. But this year is not an ordinary year and, if Sunak wants to lead the UK to a sustainable position for tax and spending, he must chart a different course this autumn. Rather than announcing a raft of new tax policies in the autumn, he should use his autumn fiscal statement to make clear what total revenues will be needed and use this as the basis for building public support for specific policies that can be firmed up later.
Quite what long-term impact Covid-19 will have on the UK economy remains difficult to predict. With the government having put the brakes on further easing of the lockdown – and new localised restrictions being imposed – it is difficult to know how buoyant economic activity will be in a few months’ time, let alone three to five years’ time.
However, the latest projections from the UK’s official fiscal watchdog – the Office for Budget Responsibility (OBR) – paint a worrying picture. All but their most optimistic scenario suggest that the UK economy will suffer lasting damage as a result of the pandemic – meaning it will generate less output and lower tax revenues than would otherwise have been the case. At the same time, the pandemic could well increase pressure for more public spending – whether to provide a more robust social safety net, to fund more resilient public services, or to meet ongoing costs of personal protective equipment and other adaptations needed to run services safely if Covid-19 remains a threat. The results of the spending review this autumn will provide an indication of how the government plans to respond to such pressures.
If the OBR is right that the economy and tax revenues will take a permanent hit from coronavirus – or if the crisis leaves a legacy of higher public spending – then tax rises will be needed to put the UK’s public finances back on a sustainable path. In that scenario, if the chancellor wants the OBR to publish a forecast in the autumn that shows his spending plans being consistent with declining levels of borrowing and debt on a sustainable path, he would need to announce firm tax plans in an autumn budget. There are many ways in which the UK tax system could be improved, which could help to raise additional revenues while addressing inefficiencies and distortions in the tax system. But past experience of tax policymaking in the UK shows how difficult it usually is to make these sorts of reforms. The public are not anti-tax per se, but those who lose out from specific changes tend to be extremely vocal, while those who gain (for example from the better public services that the tax funds) are usually diffuse and silent.
As a previous Institute for Government report showed, successful tax reform requires strong support from the top of government to convey a compelling narrative about the case for reform and build public understanding of the need for change.
The Covid-19 crisis potentially creates a window of opportunity for tax reform, as other crises – particularly wars – have in the past. But the government is unlikely to have had enough time to shift the public debate far enough by the autumn. There is little time to build public understanding of the need for any specific changes to the tax system and this government has little mandate for tax change, having won last year’s election on a promise not to raise the rates of the three main taxes – income tax, National Insurance contributions (NICs) and VAT.
Without laying the necessary groundwork for reform, the chancellor risks having to rely on a subset of less than ideal tax levers, or else attempt controversial reforms without having rolled the pitch (and risk suffering the same fate as Philip Hammond experienced in 2017 when he attempted to increase NICs for the self-employed, in violation of a manifesto commitment). That would squander a rare opportunity to improve the tax system.
Instead, Sunak should opt for a different course of action. He should use any autumn fiscal statement (and the OBR’s new economic and fiscal forecasts that will accompany it) to articulate his objectives for public borrowing and debt and what level of tax revenues are needed to achieve those, given his spending plans – but without spelling out exactly where that revenue will come from. That can then form a basis for building public support for specific tax changes: accepting that someone must pay more is an important first step in moving away from the status quo.
Since he took the job as chancellor, Sunak has said he will lay out new fiscal rules to replace those he inherited from Sajid Javid. In the autumn, he should detail what those rules will be and what – combined with his plans for spending – they mean for the necessary size of the tax take. If the current tax system cannot deliver enough money, the public debate can then shift to the crucial question: where should the rest of the money come from?