The pendulum swings towards higher taxes

When, back in 2010, the coalition government set itself the target of repairing the public finances by 2015, ministers and officials I spoke to were agreed that one austerity parliament was about as much as the public would be prepared to put up with. After that, austerity fatigue would set in. That was why George Osborne had the ambition of eliminating the so-called current budget deficit (the deficit excluding public investment) by 2015.

He did not make it. Osborne’s response was to set himself a tougher target – achieving an overall budget surplus – by 2020, implying another five years of austerity. Those 2010 voices were, however, right. One parliament in which public spending was under the cosh was one thing; two parliaments were too much.

Austerity fatigue helps explain why Jeremy Corbyn and Labour did much better in the 8 June election than expected, and why Theresa May failed to secure the majority she was hoping for. It is reflected in the latest British Social Attitudes survey, which showed that people were prepared to pay higher taxes for better public services.

Most of all, it is reflected in the response of the May minority government since the election. Ministers, including Boris Johnson, Michael Gove, Jeremy Hunt and Justine Greening, and backbench MPs are pressing for the 1% public sector pay cap, which they think damaged the Tories electorally, to be lifted. The government found £1bn for Northern Ireland in order to secure the parliamentary support of the Democratic Unionist Party. Policies which were intended to help bring down the budget deficit, including scrapping the triple lock on pensions and reform of social care, were missing from the Queen’s speech.

This is a reversal of the usual pattern. Normally, governments keep the bad news until after an election, on the grounds that memories will have faded before voters next go to the polls. This time, however, such is the weakness of the government’s position, that tough policies are either being reviewed or put on ice after the election. There is even talk of university tuition fees being re-examined.

Something has to give. What will it be? Philip Hammond, as chancellor, now has a fight on his hands. Either he sticks with a deficit reduction programme that he did not design, or he accepts bigger budget deficits as the price of the government’s weakness, having already accepted roughly £100bn of additional borrowing over the next few years, mainly as a result of Brexit. Or he puts up some taxes.

The chancellor has had some good news on the public finances. Official figures showed a downward revision to £46.6bn in public sector net borrowing for 2016/17. This is well below expectations, though the Office for Budget Responsibility is for now sticking to its forecast of a rise in borrowing to £58bn this year, 2017/18. The chancellor, meanwhile, is determined not to be seen as a soft touch.

The Financial Times, in an editorial on 1 July, put it simply: ‘If austerity has reached a political limit and the debt level does not provide room for increased borrowing, there remains but one option. Taxes must be raised.’ This is where Hammond’s instincts also lie. The March Budget, overshadowed by article 50 and the subsequent election, has faded in the memory. However, people will remember that, until he was forced into a U-turn by Tory backbenchers, Hammond wanted to increase national insurance on the self-employed. He will want to ensure that any largesse on public sector pay or elsewhere is at least partly paid for.

The question, if that is the prescription, is what taxes could be raised, particularly by a government with a precarious parliamentary position. One option is to proceed by stealth, most notably by not persisting with previously planned tax cuts. Though these were pledged by the Tories in the election, May’s failure to secure a majority has, it could be said, done the same for her manifesto as Brexit did for David Cameron’s two years ago.

So, instead of cutting corporation tax to 17%, as planned, the government could simply stick to the existing 19% rate. Business would not like it but firms would find it preferable to the Jeremy Corbyn alternative, which is to push the rate back up to 26%. Similarly, the expensive pledge to raise the income tax personal allowance to £12,500 and the higher rate threshold to £50,000 (from £11,500 and £45,000), originally due to be achieved by 2020, could be the subject of a go-slow. It is probably right that these allowances and thresholds are indexed. Raising them by more, which is the equivalent of a significant tax cut, looks like a commitment the government could do without.

I would go further. Thanks to George Osborne’s aversion to increasing fuel duty, despite a pledge to do so when the oil price fell sufficiently, the government is short of roughly £7bn of annual tax revenue, compared with a situation in which the duty had been indexed. The longer the duty freeze goes on, the harder it will be for a chancellor to break it. Forecourt prices fluctuate all the time. Most motorists would not notice the occasional penny or two on duty.

Would these relatively small changes be enough? That depends on how much slippage there is in the government’s spending plans, and how committed it is to pressing on with the repair of the public finances. The trouble with minority government is that it is harder to get unpopular measures through the House of Commons. Just as Tory backbenchers have rebelled against cuts in benefits and tax credits, so forcing a change in direction – even when the government had a majority – so they would rebel against unpleasant tax rises. The pendulum has swung and the management of the public finances has become a lot harder.