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17 June 2018

Theresa May will struggle to find a way to keep her promises on the NHS

Words from the Prime Minister cost nothing. Raising revenue could cost Philip Hammond a great deal. 

By Stephen Bush

Although she – and her aides – attempted to dress it up as a “Brexit election”, the real reason Theresa May called an election in June 2017 was tax.

Her Chancellor, Philip Hammond, had just failed to pass a small but important tax rise for the self-employed, a policy that commanded broad support from experts across the spectrum, was broadly progressive and one with important longterm implications for the health of the public finances. The majority of 12 she had inherited from David Cameron was too small to do anything substantial on tax and spend – and to make matters worse, she had also been bequeathed a series of undeliverable promises around tax rises from George Osborne.

But because of her conduct of her election campaign she ended up in a worse position – no longer bound by Osborne’s policy commitments, yes, but she also had no parliamentary majority.

Now she’s pledged £20bn worth of extra spending for the National Health Service. She claims this is part of the United Kingdom’s Brexit dividend. As George explains in greater detail,  that’s nonsense: there is no Brexit dividend and there won’t be until, at the absolute earliest, 2021. Given that one of the very few genuine bits of leverage the United Kingdom’s is its contributions to the European Union’s budget, I wouldn’t count on there ever being a Brexit dividend worth speaking of. But even should one emerge, it won’t be one that can fund this spending increase. So where will it come from?

£20bn is a lot of money, not just to you and me but to the government as well. So where will Hammond find it? He could borrow it, but that means casting aside their central attack on Labour’s spending plans. In any case, I doubt that he, or his hawkish deputy, the Chief Secretary to the Treasury Liz Truss, would stand for a budget which included £20bn worth of unfinanced spending.

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But the thing about £20bn is that if you want to pay it through tax, you can’t just get that sort of money by taxing the other side’s voters and you have to touch one of the big revenue sources to do it.

You could increase income tax, but a penny increase – from 20 to 21 per cent on basic rate, 40 to 41 per cent on higher rate and to 46 per cent on the top rate – only gets you in the region of £6bn. You’d have to have a significant increase in income tax, in the region of three to four per cent, to get to £20bn. But there is no prospect I can see of an income tax rise of that magnitude being passed by the House of Commons, and there are of course many political downsides to it as well. Wage growth is still very weak and a significant income tax increase will irritate people and harm the government’s popularity. That also goes for national insurance contributions, the other major source of direct taxation.

Conservative MPs have a historic willingness to vote for increases in value added tax. A penny on that nets you around £6bn so again you are talking about percentage increases of four to five per cent if you are using VAT  to bridge the gap. But the changing shape of the Conservative electoral coalition also means that hiking VAT is no longer as electorally painless for the Tories as it once was. It could very easily also fail to pass the House of Commons and would be the subject of fierce opposition from parts of the right-wing press.

Hitting right at the heart of the Conservative electoral coalition is fuel duty, which has been frozen since the Tories first came to office. You can get serious revenue from this route but it would be highly unpopular with Conservative voters and MPs.

Electorally, you could get away with a ten per cent hike in corporation tax which would fund the commitment – but it would struggle to pass the House of Commons, as Labour will of course vote against any Conservative budget and Conservative MPs aren’t going to sign off big increases in income tax, corporation tax, national insurance or fuel duty.

And there’s a really important disclaimer, which is that I’ve assumed for the purposes of this piece that there would be no behavioural changes as a result of these tax rises. Wage growth is weak which makes income tax rises hard. The overall performance of the British economy is not great either and increasing VAT could actually reduce revenue from that source as well as potentially tipping the economy into recession. The fuel duty freeze, likewise, has made weak wage growth slightly less politically and economically destabilising than it otherwise would be. And while hiking corporation tax to 29 per cent would still mean that the United Kingdom had one of the lowest corporation tax rates in the G7 it might also create real financial difficulties for a number of smaller or struggling enterprises.

That is the real dividend not only of Brexit but decisions taken since the financial crisis: an economy that is likely too weak to bear significant tax rises anywhere, a Parliament that is unlikely to pass any tax rises, and an ideological aversion to higher borrowing that makes it difficult to fund spending through that route.  Theresa May can promise more money for the NHS, but Philip Hammond may find it impossible to actually deliver it at his budget in the autumn.