The chancellor tried to present a cheerful picture of Britain's finances in his budget speech this week, says John Stepek. But the national debt hasn't gone away and we have a hunch about who'll have to pay for it.
Chancellor Philip Hammond found himself in the unusual, and welcome, position of having more money than he expected when he gave his Budget speech this week. The Office for Budget Responsibility (the independent public finance watchdog) reviewed its economic forecasts and found they were systematically too pessimistic. The upshot as we examine below was that the chancellor found he had more breathing room than expected.
Of course, the government is still spending more every year than it raises in taxes (the deficit is currently 1.2% of GDP). This in turn means that the overall debt pile (the national debt) is still growing, not shrinking. Given that mending the public finances has been deemed so important in recent years, did Hammond decide to pay down the deficit with the "spare" cash? No. Instead, he paid for extra NHS funding (which Prime Minister Theresa May had already committed him to) plus another £2.7bn on pushing the Conservative party's flagship welfare reform, universal credit, over the finishing line.
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It's like discovering you haven't quite reached the limits of your overdraft this month, and deciding to spend more than you'd budgeted for, just to max it out. The politics, if not the economics, is entirely understandable. Hammond wants to stop rebels in his party from scuppering a Brexit deal. He also has one eye on the general election that will (sooner or later) follow any such deal being done. So he has to promise both voters and his fellow MPs that there are better times ahead as long as the voters vote Conservative, and the MPs back May's Brexit plans.
The Overton window has moved a long way
But what's also interesting is what the Budget tells us about how much politics has changed since the financial crisis. The Overton window is a political theory that originated with the late think-tank executive Joseph Overton. It refers to the relatively narrow range of ideas and policies that represent the received wisdom at any given point. Ideas in the middle of the range are popular those outside the window are deemed radical, or even unacceptable, by both the public and the establishment.
The key point is that the window can shift. Ideas once viewed as outlandish can become mainstream, and arguments once seen as settled can be reopened. And a political party doesn't have to achieve power to move the Overton window its mere presence on the playing field can pull the set of acceptable ideas to the left or to the right (or, as Overton preferred to frame it, towards bigger or smaller government).
The Budget shed light on just how far the Overton window in the UK has shifted since the financial crisis erupted into public view in 2008. The decade of Labour governments under Tony Blair, then Gordon Brown, could hardly have been viewed as a period of "small government". The welfare state ballooned and a policy of liberal interventionism led us into several military conflicts, most notably the disaster that was the Iraq war. But on markets and economics, the general view (in theory) was that the government would stay out of things as long as the City was paying its way. "Big picture" economic policy should be left to the Bank of England, and the march of globalisation and digitalisation should be allowed to take place unhindered, as the downsides would be outweighed certainly on a global basis by the upsides.
That attitude has changed dramatically. In 1998, Labour MP (now peer) Peter Mandelson said:"We are intensely relaxed about people getting filthy rich, as long as they pay their taxes." Even with that caveat about taxes, it's very hard to imagine that any moderately headline-conscious politician on either side of the House of Commons would use the words "filthy rich" in any sort of positive context these days.
The pick 'n' mix of measures that Hammond tossed out during his (oh so long) speech amply demonstrated this theme. As well as the extra spending on the health service and welfare reform, the minimum wage was hiked; the income-tax thresholds for both lower- and 40%-rate payers were raised a year earlier than planned (though a stealthy hike in the threshold at which National Insurance contributions fall from 12% to 2% offset much of the gain for the latter); and first-time buyers were given a modest extra stamp-duty break (see page 22 for more on these measures). But at the same time, landlords' tax breaks were tightened yet again, along with anyone whose personal income-tax arrangements are remotely open to question (private contractors and freelancers continue to be primary targets for the government).
The government is here to help
On the corporate side, there were cuts to business rates for small businesses and tax breaks for "intellectual-property-rich" acquisitions by smaller firms. But PFI schemes now viewed as an egregious waste of money and a taxpayer rip-off have been scorned and abandoned. Multinational tech companies, meanwhile, face a digital-services tax, jokingly referred to as the "Clegg tax" following former deputy prime minister Nick Clegg's decision to take a job as a lobbyist for social-media giant Facebook. The Clegg tax isn't expected to raise much (£400m enough to pay for three days' interest on the national debt at current rates), but that's not the point it's a placeholder for a presumably tougher regime to be introduced once international reforms are agreed.
In short, if you're a man or woman in the street, and feel you've been given a rough deal by the system (and certainly, that's the way voters have been acting), then the government wants you to know that it's on your side, and that it's going to do something about it. And if you belong to the rentier class, or the elites, or the rich well, you've been warned. You need to pay your fair share and the definition of "fair" has been upgraded substantially.
For a statistical illustration of this shift, you need only look at the fact that the UK tax take as a share of GDP at around 37% is set to hit its highest level since the mid-1980s. The rise from the early 1990s low of around 32% happened largely under Labour, but the increase since the financial crisis has continued steadily under Conservative or Conservative-dominated parliaments. The Overton window has now shifted to the point where there are no longer any "small government" (even in theory) parties with any prospect of power. The Conservatives have defaulted to paternalism; Labour to centralisation.
Our national debt nearly doubled under austerity
This matters for all of us, both as investors and taxpayers. Why? Because despite the chancellor's vaguely cheery demeanour, the public finances are still a mess. We've grown rather too comfortable with high levels of national debt and we can always comfort ourselves with the idea that we are neither Greece nor Italy. But as Jeremy Warner points out in The Daily Telegraph, "public debt is still nearly 50 percentage points higher as a proportion of GDP than it was prior to the financial crisis". In 2010 two years on from the banking blow-up the UK's national debt was just under £1trn. Back then, George Osborne embarked on his austerity programme, with many a blood-curdling warning about "the cuts" issued by economists and newspaper columnists across the land.
Yet eight years on, while debt as a proportion of GDP has fallen a little to 85% of GDP the UK owes close to £1.8trn. So as Warner notes, while Hammond might say that the hard work is over, in reality "he has made very few inroads into the enormity of the overall debt burden". And it doesn't look like he'll make further progress any time soon. Yet, says Warner, regardless of what happens with Brexit, there will be another recession at some point, while our ageing population means that "the big bulge in baby-boomer healthcare and social costs will soon be with us". The painful truth is that the "really tough decisions over what the UK can afford, and what taxes it is prepared to pay for it all, have yet to be made".
But we already have a clear view of the direction of travel. Whatever kind of Brexit we get, and whoever ends up in power, expect the tax burden to go up. And while the chancellor had to go easy on major changes in this budget, due to the government's weak position in the House of Commons, don't be surprised to see measures that hit investors' pockets much harder in future. Pension tax relief, for example, gained yet another reprieve, but if you haven't used your allowances yet, get a move on just in case Hammond doesn't like our eventual Brexit deal and hits us with his threatened "emergency" Budget in spring.
Where the cash came from
Merely a month or so before the budget, it looked as though chancellor Philip Hammond would have to raise taxes in order to meet Theresa May's pledge to further increase spending on the NHS. However, an upgrade to the public finances from the Office for Budget Responsibility (OBR) saved him from having to do so. As Chris Giles points out in the Financial Times, following higher-than-expected tax receipts and lower-than-expected government spending, the OBR re-examined its figures and concluded its forecasting techniques have led it to be overly pessimistic on a systemic basis. As a result, the deficit (the government's annual overspend), was set to be around £13bn lower this year than previously anticipated, and £68bn lower in total up to 2023-2024. Had Hammond decided to bank this prospective saving, noted OBR chairman Robert Chote, the deficit could have been eliminated by 2023-2024. As it stands, he's spent the lot so we look set to run a deficit for the foreseeable future.
John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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