The trillion-pound question

Spring Budget 2020 and the tension between higher spending, low taxes and fiscal credibility

24 February 2020

Adam Corlett

Jack Leslie

Daniel Tomlinson

This report focuses on the big choices that the Chancellor will have to make this year over the balance between day-to-day (current) spending, taxation and additional borrowing. 2020 will contain three ‘fiscal events’, with the Budget on 11 March starting a parliament-defining process that will run across the Spending Review and Autumn Budget to follow later in the year.

We find that the Chancellor has more headroom than expected against the proposed current balance fiscal rule, but caution against eating into this (via extra borrowing) to fund additional current spending commitments. Instead, we offer tax raising proposals that could help the government finance their demands for additional spending.

It’s clear, both from Spending Round 2019 and the Conservative Party manifesto, that austerity is over and the size of the state is set to rise. The question for 2020 is whether the Conservatives, having given up being a small-state party, are also content to say goodbye to being a low-tax party.

Key findings

The Bank of England recently revised down GDP growth for 2020 by 0.7 percentage points, in line with an average downward revision across independent forecasters of 0.5 percentage points. The OBR will likely follow suit when its forecasts are published alongside the Budget, with a downgrade to the size of the economy at the end of 2022 of around 0.5 per cent appearing likely.
We estimate that the OBR may forecast a small improvement to the public finances of around £8 billion in 2022-23. This is largely the product of lower interest rates and lower inflation reducing the cost of government debt, and the fact that weaker-than-expected GDP growth is being combined with a slightly stronger-than-expected labour market. This implies that the Chancellor may now have headroom of around £10 billion against the proposed current balance fiscal rule.
Rishi Sunak may have said in 2015 that in normal times “public spending should not exceed 37 per cent of GDP”. But he has just become Chancellor in a government set to preside over a state that is over 40 per cent of GDP (based on 2019 Spending Round and manifesto commitments) and is on track to remain at least this large until 2023-24, which is the first year in history that annual state spending will pass the £1 trillion mark.
Reversing half of the reduction in per-person, non-health departmental spending since 2010 would entail £24 billion of additional spending by the end of the parliament. The Prime Minister’s pledge to fix the crisis in social care once and for all will not be easy to fulfil. And preventing child poverty from rising any further would entail £5 billion injected into welfare spending to head off the effect of previous cuts, some of which are still in the process of being rolled out.
Delaying the point at which the current balance rule applies even by two years (to 2024-25) would buy the Chancellor only slightly more fiscal space – around £5 billion, but headroom of either £10 billion (against the proposed 2022-23 rule) or £15 billion (against a 2024-25 rule) would be significantly smaller than the average forecast revision three years out (£29 billion) or five years out (£53 billion).
The Conservative manifesto cancelled the planned corporation tax cut from 19 per cent to 17 per cent which, even net of a range of smaller business tax cuts, provides around £5 billion of additional revenue by 2022-23. Welcome, too, was the lack of a firm manifesto commitment to raise the National Insurance Contribution (NIC) threshold to £12,500. Were that target to remain a priority for the Prime Minister, a sensible approach would be to increase the NICs threshold while freezing the income tax personal allowance at £12,500 to help align the two. Achieving the £12,500 ambition by the end of the parliament would carry a net cost of only £400 million if both the personal allowance and higher-rate threshold were frozen, but with the side effect of continuing the trend of bringing more taxpayers into the higher rate of tax.
Fuel duty has been repeatedly frozen at successive budgets and is now 29 per cent lower than pre-2010 plans, costing the Treasury £11 billion per year. Continuing to freeze fuel duty would leave an additional £4 billion hole in the government finances by 2023-24 and also sit poorly with the government’s climate agenda. A cautious approach of increasing fuel duty in line with CPI inflation, rather than the default RPI, would reduce this annual cost to £1 billion.
Beyond avoiding tax cuts, there are a range of sensible small changes the government could make in the short term to increase revenue and create a fairer tax system. These include: scrapping the poorly designed Entrepreneurs’ Relief to raise up to £3 billion a year for other priorities; freezing the generous tax thresholds for VAT and inheritance tax, raising around £150 million and £400 million, respectively, in 2023-24; and delivering on a promise to “prioritise the environment” in this Budget, including by reforming Vehicle Excise Duty to increase up-front taxes on the most polluting new cars.
The Spring Budget should also lay the ground for longer-term tax reforms. Pension tax relief has a net cost of £35 billion a year and could be better targeted, for example via a flat rate of tax relief (raising up to £9 billion if set at 20 per cent) or a reduction in the maximum tax-free lump sum (raising £2 billion if set to leave three quarters of lump sums unaffected).
The new government also has the opportunity to reform or replace inheritance tax to raise revenue and reduce loopholes for the wealthiest. This should include looking again at £800 million of business and agricultural property reliefs, and at the generous treatment of inherited pension pots.
Regional disparities in council taxes are hard to justify, and do not align with the government’s ‘levelling up’ agenda, with a £130,000 Band C two-bed semi in Blackpool paying more in council tax (£1,624) than a £67.5 million nine-bed house in Mayfair (£1,508). Material reforms, not least updating property valuations from 1991, would be welcome. Even replicating relatively minor Scottish changes (increased rates for higher bands) in England would raise over £1 billion a year.

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