The short-lived Truss era has ended with a whiplash-inducing return to the politics of fiscal restraint. Rishi Sunak and Jeremy Hunt, the Chancellor, have tried to manage expectations before this month’s autumn statement through talk of “eye-wateringly difficult” decisions, black holes and inevitable spending cuts. The echoes of 2010 and George Osborne’s chancellorship are obvious. Now, as then, fiscal responsibility being equated with reduced public spending serves politicians on the right, while trapping progressives in a race they’re unlikely to win. In this context, it’s vital to test both the economics behind Hunt’s policy choices and the political decisions that are too often obscured.
On the economic side, the size of the “fiscal black hole” is cited as determining whether the government can protect incomes and public services, and invest in our economy. Estimates of a £35-50bn hole have abounded in recent weeks. Yet it’s rarely explained what this number is, how it has come to be, or the uncertainties around it. In fact, these figures are a product of the fiscal rules the government has set itself; they refer to how much taxes need to be raised, or spending cut, to ensure the rules are met. Both Labour and the Conservatives have as a condition within their rules that public debt must fall as a share of GDP by a specified year. The government could choose a different metric to demonstrate fiscal sustainability, or a different year in which to achieve it.
Many of the estimates of the shortfall also reflect particularly bleak forecasts for growth and the interest rates on government debt. These figures might prove correct, but by citing only the worst-case scenarios the estimates imply an unwarranted “truth” to the figures.
A report by the Institute for Public Policy Research (IPPR) finds that if growth rates and the cost of borrowing return to their pre-pandemic levels, the government could actually run a primary deficit of £49bn and still reduce the debt-to-GDP ratio (implying an additional £40bn of public spending). Critically, the government can choose policies to avert a low-growth scenario. If you’re trying to reduce debt as a share of GDP, the GDP component is crucial. In fact, this ratio can fall, even as the government borrows more, provided that borrowing is used for pro-growth purposes. After the Second World War the national debt stood at 250 per cent of GDP, but it was steadily eroded through sustained economic growth, falling to 45 per cent by 1973.
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Today, investing in the green transition to create jobs and industry and investing in research and development (on which only Italy spends less among the G7 nations) are crucial to collective prosperity. Conversely, cutting back on investment to “balance the books” will only result in an economic doom loop of the kind we’ve had since 2010.
This isn’t to say that economic policy can be reduced to “everyone’s a winner” – we need a clear and credible plan that identifies who will pay more. In the medium term, if we want excellent public services and a protective welfare state, the government will need to raise tax revenues. Even after recent increases the UK remains a low-tax country by Western standards, far closer to the US than to its European counterparts.
There is an urgent need to support households and businesses through the cost-of-living crisis, both to avoid destitution and business failures, but also to lower the price rises that people feel and expect in future, which can lead to inflationary spirals. But this kind of support, if not funded by taxes, could itself exacerbate inflation. Offsetting some of it with tax rises could create space to help with energy price rises and protect the NHS and education budgets in real terms.
Tax increases should be focused on the financial “winners” from the global surge in energy prices and the Covid-19 pandemic – a time which saw huge windfall gains for the wealthiest households. Options could include equalising taxes on income from work and investment, and increasing the windfall tax on energy producers. Sunak may be right to say that we all need to pay more tax in future, but not before the richest pay their share.
Macroeconomic policy, seen in this light, isn’t simply a technocratic exercise to fill a “black hole”. It’s deeply political. It simply isn’t true that spending cuts are the sensible answer or indeed necessary. Rather, they can be deeply reckless. The government can pursue policies that grow the economy, support incomes and public services, and quell inflationary pressures, funded through a mixture of borrowing and taxes – starting with the very richest.
Regardless of what Sunak and Hunt decide, there are pitfalls aplenty for Labour in its response. Chief among them is accepting the “fiscal black hole” as an immovable reality, or Conservative efforts to impose spending cuts on the next parliament. Austerity is deeply unpopular and would not allow a Labour government to fulfil its ambitions. After a decade of stagnation and inequality the fiscally responsible approach is to build a strong economy, with public investment and tax increases on the wealthy as crucial tools.
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