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Two budgets this year add up to one big problem for Hammond

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What does this year have in common with 1979, 1993, 2010 and 2015? It is a year of two budgets. And now we know that this year’s second budget will take place on November 22. And that’s nice to know. The timing of budgets is rather more orderly and predictable than was the case under some previous regimes.

Not much else looks orderly and predictable, however. Seven years in, austerity is biting hard and, as recent announcements on public sector pay have demonstrated, it looks increasingly hard to maintain. Yet the public finances are still in deficit and the government’s debt, at more than 80 per cent of national income, is more than double what it was only a decade ago. And while the chancellor’s own fiscal rules provide him with some leeway, if he takes them at all seriously he won’t be giving away much in spending unless he can claw it back in taxes.

Those are the constraints he faces even before factoring in economic uncertainty. We have forecasts for growth, incomes, tax receipts and just about everything else. But while the forecasts used by the Treasury, from the independent Office for Budget Responsibility, are a long way from stellar, they don’t include a major immediate negative impact from Brexit. With luck there won’t be one. But there is no getting away from the uncertainty around both the shape of Brexit and its consequences. That uncertainty would lead any half-cautious chancellor to keep some flexibility up his sleeve, not to use it all now. The signs are that Philip Hammond is at least half cautious.

So what on earth is our poor chancellor to do? Funding increased pay, reducing tuition fees, giving more money to the health service, easing the cuts to benefits or indeed agreeing to any other demands for more spending, by cutting spending elsewhere, look ferociously hard. There’s no point robbing Peter to pay Paul when Peter has no money either. The prison service, the health service, social care, local government — all of them coped pretty well with the first few years of austerity but are now visibly struggling. The idea of cutting the welfare budget further is also surely for the birds. True, the opposition showed little interest at the election in the planned sharp cuts to working age benefits. But I presume that at some point more of our parliamentarians will notice what is happening — perhaps as universal credit is rolled out to many more voters from next month — and start to make a serious fuss about it. As for getting any more from the pensions budget, even the oh-so-modest cuts to pensioner benefits mooted in the Conservative manifesto have been dropped from consideration in deference to the new parliamentary arithmetic.

There are, in principle at least, plenty of options for tax increases. But that same parliamentary arithmetic will surely stymie most of them. There must be no chance of increases in the real cash cows: the main rates of income tax, VAT or national insurance. If a perfectly sensible, indeed increasingly necessary, step towards aligning the taxation of the self-employed with that of employees couldn’t get through parliament after the March budget then it would be astonishing if any such change got through this time round.

Perhaps the easiest course for Mr Hammond, if he does want a bit more tax revenue, would be not to implement the corporation tax cuts that are due over the next couple of years. That could raise him about £5 billion against the current baseline. While it may not please some of his colleagues on the Conservative benches it would presumably attract support from a Labour Party in favour of much higher corporate taxes. Mr Hammond also needs to stop bleeding money through the continued failure to maintain real levels of fuel duties. Concern over the health effects of diesel may give him cover to raise duties on that at least, if not on petrol. No doubt Treasury officials are working on all sorts of other tax wheezes aimed at bringing in revenues in ways which we won’t notice. In this case good politics will, to our cost, surely trump good economics.

His other option is to throw a bit of that innate caution to the wind and use up some of the fiscal headroom he has left himself. On the most recent forecasts borrowing should be down at about 1 per cent of national income by 2020 against a target of 2 per cent. That’s getting on for a £20 billion buffer. Given the uncertainties around the future that’s a much smaller buffer than it sounds, but the temptation to use at least some of it must be considerable. The case for doing so, beyond relieving the pressures on public spending, is that government can still borrow at record low levels and an economy still in the doldrums could do with a bit of stimulation. The case against is that the OBR doesn’t think there is any spare capacity to unleash through looser fiscal policy. It may also hasten a rise in interest rates while the political and economic uncertainties ahead put a premium on keeping fiscal ammunition in the locker.

For all our sakes I wish Mr Hammond and his team the very best in navigating their way through this horrible combination of continuing fiscal and economic weakness, future economic uncertainty and unusually sharp political constraints on action. He may be regretting having a second budget this year. But at least there will only be one next year. Unless we have another election of course.

This article was first published in The Times and is reproduced here in full with permission. Paul Johnson is director of the Institute for Fiscal Studies. Follow him on twitter @PJTheEconomist.

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IFS Green Budget 2017, in association with ICAEW and with funding from the Nuffield Foundation. The report looks at the issues and challenges facing Chancellor Philip Hammond as he prepares for his Budget in March.
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