Don’t worry about the debt – Rishi Sunak can still afford to reverse his tax increases
Moreover, the pace at which the debt ratio should be reduced is not set in stone. As it stands, the OBR forecasts that the current budget deficit (i.e. excluding investment spending) will be reduced to zero and the debt ratio will peak in 2023-24. But these two milestones could reasonably be achieved later.
Two key principles should guide the Treasury’s thinking on this subject.
First, the direction of travel must be clear and financial markets must remain convinced that, even if the debt ratio is high, it will inexorably decline within a reasonable period of time.
Second, the deficit reduction effort must not weaken the underlying growth rate of the economy. If so, it may even be counterproductive.
According to these two principles, the cancellation of the planned increases in social contributions and corporation tax would be perfectly reasonable. When the full effects are felt in a few years, this would increase the annual budget deficit by around £30bn (1pc of GDP).
In principle, this could be compensated by a reduction in planned public expenditure.
Slashing spending a little doesn’t have to equate to a bout of “austerity”.
There was no good reason for departmental spending to increase at the rates envisaged by the Chancellor in last October’s budget, bringing the ratio of public spending to GDP to 42%, around 2% above the 2015 average -2019.
It was a political choice and, in my opinion, the wrong one. Given today’s high inflation, there will be pressure for more spending. We must resist it and seek savings.
But even if the government does not have the courage to reduce the planned growth in departmental spending, that will not prevent the cancellation of the tax increases.
It would be perfectly reasonable to leave debt (and therefore the debt ratio) higher than currently envisaged.
Next year, if the tax hikes were undone, borrowing would likely reach around £120bn, or just under 5% of GDP, well down from this year, let alone £322bn. sterling last year (15% of GDP).
There is a good chance that the cancellation of these planned tax increases will end up being self-financing, in particular because it would result in an increase in business investment. In the meantime, we have the ability to allow the numbers of borrowers to bear the pressure.
Roger Bootle is president of Capital Economics. You can contact him at [email protected]