The Budget could be an awkward moment for fiscal conservatives

There is no getting around the fact that these are awkward times for fiscal conservatives, such as myself. It has never been harder to make the case for lower taxes. We have the largest national debt for half a century as we come out of the worst recession for three hundred years, with zero political appetite for public spending cuts. It is essential – for both the Conservative party’s political prospects and the country’s economic prospects – that the UK retain our reputation for sound finance. This is why the Treasury Select Committee have been gathering evidence on the options for tax after coronavirus, with our recommendations to be published tomorrow. One thing is clear: there are no easy options for the Chancellor in his budget this Wednesday.

As I have said in Parliament, we need a laser-like focus on growth to reduce debt as a proportion of GDP as rapidly as possible, as took place after the Second World War. But even optimists have to admit that we are not going to repeat the blistering performance of the 1950s, so while growth will help, it is not a silver bullet. Among our witnesses there was unanimous agreement that the government would have to go for some fiscal consolidation. There was also agreement that now is not the time to do it, as it would choke recovery – and, until sustained growth returns, we won’t know the scale of the structural budget deficit that needs to be filled. But the Chancellor does need to start the process and lay down some markers for the coming years. As a country, we have to learn to live within our means again.

The Conservative solution after the financial crisis was ‘austerity’ cuts to public spending. Both economically and politically, that made more sense at the time. After the Labour government, there was a structural budget deficit that wouldn’t disappear with growth and the public preferred spending cuts to tax rises. But a decade later and polling by former No.10 pollster James Johnson now shows that the reverse holds true: the public would prefer tax rises to overall spending cuts. That doesn’t mean that there aren’t some cuts they don’t like – cutting the overseas aid budget was not popular among the metropolitan elite, but it was across the wider public, and I suspect the freeze in MPs’ pay is also very popular.

So if we are to raise taxes, which should it be? There are two basic criteria for tax rises: we need to minimise the political squawking it provokes and minimise the impact on growth. Some of our witnesses made the case for income tax rises as a quick way to raise significant money with limited economic damage. But that would not only be politically painful, it would be a clear breach of the Conservative manifesto commitment to not raise the rates of income tax, national insurance or VAT.

Those three taxes are the biggest revenue earners for the government, which means the manifesto commitment rules out increases in taxes that raise two thirds of government revenue. That doesn’t mean they can’t be tweaked – we have a pretty narrow VAT base for example, but extending VAT to food is a regressive political non-starter. One relatively painless move is to freeze the income tax thresholds, with freezing the higher one being more progressive than freezing the lower.

The impact of raising taxes on growth depends on what tax it is. For example, few would argue that the very high taxes on tobacco harm growth. In contrast, our witnesses generally agreed that high levels of stamp duty on house buying and wealth taxes were particularly economically damaging.

One of the biggest revenue raisers the government is free to increase is corporation tax. This would be a reversal of the strategy pursued by George Osborne, but how badly would it impact growth? I was rather surprised that even our most business-friendly witnesses admitted that moderate increases in corporation tax would cause little harm. The main reason being that our current rate is so far below the other major economies and the international average that we could raise it significantly and still have one of the lowest rates in the world. President Biden increasing US corporation tax by 7 per cent makes a UK increase politically and economically easier. There is also growing scepticism about how beneficial having a hyper-competitive corporation tax rate is for a country. Our witnesses generally doubted that corporation tax played a big role in investment decisions. Despite having the lowest corporation tax in the G7 from 1997 to 2017, we had the lowest non-government investment as a share of GDP, while in 2019 the IMF concluded that Trump’s business tax cuts only played a small role in investment growth. One advantage of a rise in corporation tax as we come out of recession is that it is not paid by companies that are making a loss – only profitable companies pay. More important for growth is increasing tax relief for investment and research and development, which in the UK is rather limited. Increasing corporation tax to fund relief for investment could promote growth overall.

What about a windfall tax? Some companies did very well out of the pandemic and could certainly afford to pay more. Windfall taxes are not new in the UK, with both Margaret Thatcher and Tony Blair introducing them. But the bar for them should be very high indeed, and generally a response to an abuse of market power. If they are retrospective, they can be very unfair. Just because a company has increased profits doesn’t mean they are ‘excess’ profits – it could just have been particularly busy serving people’s needs. But some businesses, like supermarkets, have made unearned gains from not paying business rates. Others, like online market places, have seen a boom in business while paying limited tax.

The Chancellor faces no easy options on Wednesday. The two imperatives are a budget for growth and a budget that starts restoring our national reputation for sound finance. Doing both at once is a difficult balancing act.