Rishi Sunak has created one of the essential building blocks for a Tory victory in the next general election – an income tax cut. During his speech in the House of Commons last week, the Chancellor was hailed by backbench Conservatives, who believe the promise of a 1p cut in the base rate to 19p before the expected date in 2024 would improve their chances of re-election.
But Sunak, who has always wanted to portray himself as a tax-cutter at heart, was ridiculed when independent figures showed the average household would be paying more tax in two years’ time, even with the 1p cut. That will be ensured by next month’s increase in Social Security contributions and a four-year freeze on personal tax credits, meaning more earned income is taxable.
Never mind, say Sunak supporters, 1p is just the opening bid. Once the recovery from the pandemic is in full swing and the spiral of inflation triggered by the Ukraine war has subsided, a crackdown on public spending will allow for a 2p or even 3p cut over a couple of years.
In an increasingly insecure world, it’s understandable when beleaguered families are tempted to vote against tax increases. When the government says there is little it can do to protect them and the companies they work for, and uses all its might to denounce those who propose exploiting low interest rates to gain additional support through more borrowing finance, the demand for lower taxes is expected to increase.
Just a few months ago, Sunak would have been forgiven for believing he was leading the Conservatives into this election. The party’s tolerance of Boris Johnson’s dogged lies was shrinking and it seemed likely that he would be sacked before the end of the year.
Boris may still get the boot but the Chancellor can’t count on it and for now has to sell his idea of Jam Tomorrow to a skeptical crew in No 10 who are now keen to spend big. He also has to sell it to a skeptical public who can’t think of voting for his party in two years while they turn down the central heating today.
Sunak was supported last week by the Office for Budget Responsibility, the forecasting unit set up by one of his predecessors, George Osborne, to take politics out of estimating the impact of government policies on public finances and the broader economy.
The OBR has been criticized in the past for underestimating the impact of cuts in public services, public sector wages and benefits on the economy and on business confidence. Between 2010 and 2016 it consistently overestimated business investment growth, then was forced to revise its calculations and admit that UK business investment – and productivity growth – had shrunk by six in the 2008 crash.
In their latest ruling, released last week with the chancellor’s spring statement, OBR officials swallowed the happy pills again, arguing that labor productivity – measured as output per hour – is expected to rise by an average of 1.3%.
That may not sound high, but compared to the average growth rate of 0.7% in the decade after 2010, it is extremely optimistic. And when business investment has remained at or near zero for so long, it’s hard to see where the funding for such productivity growth is supposed to come from.
This year could be different. The OBR expects a big tax break for business investments to trigger a 10 percent pickup this year. But, like so many of his government’s initiatives, it is an isolated case and its impact will soon wear off.
The OBR also expects consumers to overcome uncertainty about the end of the pandemic and the Ukraine war and start spending their savings. Up to £150billion could remain of the estimated £250billion built up during the pandemic.
Samuel Tombs of consultancy Pantheon Macroeconomics says: “The recent sharp drop in consumer confidence makes it difficult to justify such a large downward revision in the savings rate.”
Absent the projected increase in business investment and productivity, and consumer spending squandered, Sunak’s economic recovery will lag sharply.
Tombs says the OBR will be forced to reconsider its guidance and expects downgrades to be on the menu. That will spell disaster for a chancellor who has chosen to take criticism for his austerity today as a fair price for praise ahead of the next election.
His tax cuts would be prohibitive or would only be revived with the borrowed money. The venture would be a flop, and his party would likely pay a heavy price.