Prepare for a Tory tax cut
This month will see George Osborne deliver the final budget speech of this parliament. It will be the final budget too of this coalition government. Since this coalition will not survive beyond 7 May, we might see a few formal budget announcements setting the stage for individual party’s election pledges. We should expect to hear much made of the government’s claim to have repaired the public finances, even though it has yet to do so. Any claim to be meeting fiscal targets relies on projections made by the Office for Budget Responsibility, based on assumptions that the coalition will continue after the election and will dramatically slash public spending further in the next parliament. That is why the OBR warned in December that the coalition spending plans amounted to shrinking the share of state spending in the economy to 1930s levels. Yet the OBR was given those spending assumptions by the Treasury, even though no political party actually intends to cut spending to that extent. This is the bizarre and unreal world in which economic debate is taking place at the moment.
However the budget will be important because the OBR will publish revised economic and fiscal forecasts. It will be on these forecasts that manifesto spending plans will be based and judged. The OBR updated forecasts only three months ago but much has changed since, as Chris Giles, the Financial Times economics editor, highlighted last week. The fiscal position may have eased. Partly, this is because borrowing figures are now consistent with December’s revised forecast since self assessment tax receipts have been coming in and have probably been boosted by people shifting income a year ahead into 2013-14 to take advantage of the cut in the top rate of tax, from 50 per cent to 45 per cent.
There are also economic factors to take into account. Gilt yields, or the cost of government borrowing, have fallen further since December, reaching new lows in January. This will reduce the debt interest bill in the OBR’s forecasts. Moreover, the OBR assumed the oil price would be $83, but it has continued to fall, and is now around $60. A lower oil price should boost the income households have to spend by, for example, lowering the cost of driving to work and paying fuel bills. Businesses should be similarly affected. These positive effects should offset lower North Sea oil revenues and could prompt the OBR to raise the forecast GDP growth rate, as well as the estimate of future tax revenues.
The Financial Times suggests these changes could amount to approximately a £5bn per year boost to government finances. This could reset the debate about economic policy. For example, the Conservatives have pledged to cut income tax by changing allowances levels to the tune of £7bn, though without saying how this will be accounted for. Labour’s fiscal targets assume a spending cut of £6.8bn per year after coalition-planned cuts in 2015-16, according to the Institute for Fiscal Studies Labour has signed up to coalition cuts in spending in the first year of government. It is possible, therefore, that revised OBR forecasts could increase the scope for tax cuts, or reduce the need for spending cuts throughout the next parliament. That is not the same thing as saying spending can increase above inflation.
Nevertheless, this does not change the underlying need to raise the productive potential of the United Kingdom’s economy. Otherwise we risk being trapped in a low growth economy, constantly trying to rein in our aspirations to match spending constraints.
There are many uncertainties, and further developments in the economy that could change the outlook in different ways. Labour should not be complacent. There are still many difficult decisions on spending ahead. Meanwhile, as I wrote last month, we should prepare for a Tory tax cut announcement, supposedly distributing the ‘proceeds of growth’. We will need to be clear what we think about it, and why, and what we would do with any improvement in public finances.
This article was first published by Progress on 2 March 2015.