Budget Response: How Hammond treated and tricked his way to temporary political survivor

At a time of national crisis, amid deep economic uncertainty, a grey chancellor with a public reputation for dullness stood up at the dispatch box. Sitting next to him was his boss, the Prime Minister, who was facing sustained leadership questions amid their perceived emotional inability to relate with voters. The beleaguered prime minister was publicly supportive of the chancellor although was privately believed to want to replace the uninspiring occupant of number 11 with a close ally.

If this sounds like a description of Philip Hammond yesterday, that is deliberate. However, it also effectively describes the mini-budget ten years ago today when Alastair Darling rose to deliver a budget amid the collapse of the banks, an emerging recession and widespread market panic. The two men can be easily compared. Both renowned for their technocratic nature and perceived blandness, they both survived as Chancellor partly due to their Prime Minister’s inability to replace them with a favourite (Ed Balls in Gordon Brown’s case, Amber Rudd in Theresa May’s).

However, their response to their respective challenges could not have been more different. I was a few months out of University and newly in the government economist service when Alastair Darling delivered his pre-budget report approximately ten years ago, just months after the collapse of Lehman Brothers. As an Economist in HMRC, I worked at a junior level on the analysis surrounding what developed into a major fiscal stimulus.

Despite similarities in the scale of the economic uncertainty and the public perceptions of the Chancellor, there could not have been more of a difference in their response. Brown and Darling grasped the wheel firmly, taking a strong and much criticised decision to temporarily cut VAT with immediate effect. They also embarked on temporary investment incentives in the form of greater capital allowances, which increased the payback time for business investment.

These were large, temporary and strategically targeted tax cuts, but they weren’t tax cuts undertaken by a motivation to win votes. The VAT cut was wildly mocked as having an ineffectual impact on prices, a failure to recognises that its principal impact was on business cash-flow. Temporarily increasing capital allowances was a geeky policy, not supported by the left due to it’s business focus or the right which wanted a corporate income tax rate cut.

Cutting personal income taxes or increasing public spending on pensions or healthcare would have been politically more popular, although less targeted as well as harder to reverse. Brown and Darling were politicians able to take gutsy decisions with a clear strategy with the national interest at heart.

In 2008, the strategic imperative was obvious. There was a financial crisis, the depth of which was unknown, and the government declared the pre-budget report a ‘fiscal event’ to take the necessary mitigating action. You could disagree with them (and people did) but no one doubted purpose and strategy.

Contrast this with Monday’s budget. Brexit, the great source of uncertainty looming over our economy, was barely mentioned, leaving no sense of a chancellor or a government aggressively preparing to either mitigate its problems or take advantage of its opportunities.

The only consistent raison d’etre of the conservative government since 2010 has been deficit reduction. This was abandoned rhetorically and practically, with the OBR confirming that Hammond’s budget will increase the deficit, in contrast to Conservative objectives for the last decade. This will bring short-term respite (but not popularity) but at the huge expense of failing to emit a sense of purpose which all governments need.

Beyond the lack of any serious sense of purpose, Hammond appeared intent on insulting us. It’s never a good sign when you have to resort to the god-awful cliché ‘hard working families’ before you’ve even reached the second paragraph. That Philip Hammond and his special advisors couldn’t be bothered to use any more original language suggests they’ve basically given up.

Hammond conducted the budgetary equivalent of Corbyn’s much-mocked crowdsourcing of Prime Minister’s Questions, seeking to placate different interest groups and funding needs seemingly at whim. Random dollops of money were spread about on various philanthropic causes, including a strange one-off mid-budget allocation of £10,000 per primary school and £50,000 per secondary school. He even appeared to allocate £10 million for the sole purpose of making a joke about John McDonnell.

His set piece announcement of an extra £420 million for potholes was the perfect metaphor for the budget. Rather than structural reform, he proposed sticking plasters on existing problems. He was probably only persuaded at the last moment not to re-announce John Major’s famous traffic cone hotline, so people could report the existence of such potholes. There seems to be something about failing conservative governments which make them obsess over baffling and specific transport issues.

The one significant expenditure commitment was a dramatic splurge in healthcare, contrary to the previous conservative manifesto and even in excess of what Corbyn and McDonnell had promised. A dramatic 4% increase in health expenditure would have been opposed by a stronger Chancellor and Prime Minister, and still requires someone in the political spectrum to be bold enough to ease their head over the parapet and ask the hard political and economic questions.

As a % of public spending, healthcare was 23% in 2000, but will increase to 38% by 2023/24. Although there is undoubtedly significant need for more healthcare spending, a reforming government would have been far bolder with the use of taxes on unhealthy food and drinks as well as exploring Charles Clarke’s old proposal for user charging. Another splurge on health further depletes resources for sectors such as education, which is left with what appear to be sympathy handouts rather than long-term investment.

He would randomly drop in mentions about the number of new jobs created, successively failing to tell us how many had been occupied by his predecessor, George Osborne.

Such a dire budget required a response by a dynamic progressive leader. Unfortunately, the only way Corbyn could be described as rising to the occasion is that his performance matched Hammond’s. He delivered obviously pre-prepared lines about tax cuts for the rich, to much bemusement. Hammond is many things, but he’s not stupid enough to leave a gaping political open goal like that for Corbyn to hit. Corbyn was tiring to listen to, with no real strategic thinking for UK future other than that public expenditure needed to increase in seemingly every area.

Sadly, despite years of austerity, the availability of funds for a public expenditure binge does not exist. The tax burden in the UK is not low, being similar if not higher than though most of the New Labour period in government. According to the IFS ‘Raising tax revenue by 1% of national income would put the tax burden in the UK at around the highest level seen in the post-war era. Such an increase, which would take tax receipts to around 35% of national income, would still leave the UK’s tax burden ranked near the middle of OECD countries.’

So, a general tax rise isn’t the answer as Momentum and others would have us believe. That doesn’t mean there is potential for exciting and dramatic tax reforms. These tax reforms could be used by a progressive opposition to create an exciting distinction between the incumbent government and a dynamic alternative.

Corporation Taxes: Mythical Treat funded by dastardly trick

Corporate income taxes have been cut successively by recent governments from both parties. Under Labour, the headline rate decreased from 31% in 1997 to 28% in 2010. This was a good move. In theory, the corporate income tax has a big impact on company decisions on where to locate and invest, and its sensitivity as a tax can justify moves to lower it to stimulate investment and company relocations. Corporate tax was at the top of an OECD ranking of the most damaging types of tax[1].

However, this logic has been pushed to extremes. From 2010 to 2015, the slow reductions under Labour accelerated dramatically despite a much harsher fiscal environment. The corporate income tax rate declined from 28% to 20%, and is now planned to reduce from 20% to 17%, at an estimated loss of £6.8 billion per year according to the IFS[2].

When the UK has by a large margin the lowest corporate income tax rate in the G7, the rationale behind such a move is unclear. Proponents argue that it is to maintain and enhance attractiveness of investing or locating in the UK. This is a worthy goal, although it’s not explained how corporate income tax compares as a concern for investors in the UK relative to productivity and infrastructure.

Those very same weaknesses in productivity and infrastructure, are strongly related to business investment. Sadly, one of the least reported and most worrying figures from yesterday’s budget was the collapse in business investment, a structural problem for the UK economy which precedes Brexit.

Given the UK’s headline corporate income tax rate has been cut dramatically and is far lower than most comparable economies, it appears odd to suggest that further cuts would seriously influence this. Given the likely lack of impact on business investment, this is tax revenue wastefully lost and must be made up by taxes elsewhere, spending reductions or higher borrowing.

Continuing cutting the corporate income tax rate is a policy with diminishing returns. Once it is quite substantially lower than most of our competing or neighbouring economies, it is a pure snake oil salesmanship to suggest that further lowering of the headline rate is an effective economic stimulus.

The tragedy behind this is that corporation tax is important in determining investment, although the headline rate is only one aspect of corporation tax, and one which laypeople (and perhaps more worryingly political reporters too), pay excessive attention to.

The treatment of investment is also crucial, and on this front the UK is not a good performer. The low headline rate of corporate income tax in the UK dramatically exaggerates the generosity of the UK. According to the IFS: ‘Compared with other countries, the UK has a much less competitive tax base, largely due to a particularly ungenerous set of capital allowances.’[3]

The capital allowance rules are vitally important. Their purpose is to allow businesses to deduct the costs of economic depreciation from corporate income tax. Indirectly, their generosity plays a major role in determining the payback period for investments in assets. Currently, UK law allows companies to deduct 20% of outstanding assets value per year.

A 2015 analysis from CBI claimed[4]: the UK still has the lowest present value of capital allowances in the G20. CBI analysis suggests that if the UK were to raise its capital allowance regime in line with the G7 average, then the investment share of GDP could be raised from 14.7% to 18%.

For this reason, they are a very big concern with industry, particularly the heavier investing industries such as manufacturing. At a time of concern amongst such industries (particularly the car industry) about the UK’s future trading environment, a major tax issue for such industries has been overlooked.

The CBI has also commented Our capital allowances regime…..excludes important types of investment such as buildings and certain intangible investment costs associated with the take up of technology.

The treatment of business investment is a major concern for many UK industries, including those at the scientific cutting-edge. According to the Medicines Manufacturing Industrial Partnership, ‘In recent years the UK has suffered from an uncompetitive tax regime for capital expenditure, which particularly affects capital intensive sectors such as medicine manufacture. The UK offers tax deductions for capital expenditure through capital allowances with rates that compare poorly to other tax regimes and to accounting rates of depreciation’.[5]

If Hammond had merely ignored this issue, he would have been blamed. However, he has made the current situation worse. He announced with some fanfare a treat for businesses in a temporary increase in the ‘annual investment allowance’ (AIA) from £200,000 to £1 million. This is the investment per company which can be offset against profits immediately before the standard 20% kicks in. To large companies investing tens or hundreds of millions per year, this means no more than an increase in the income tax personal allowance does to a multi-millionaire.

The accountancy firm RSM UK was quick to dismiss the measure ‘The high initial capital allowances limit will affect few companies’. Most investment is obviously by large companies with the means as well as the need for large-scale investment far exceeding the £1 million threshold. Their decisions to invest will be unaffected entirely. The vast majority of small firms are already covered by AIA, making it extremely unclear what the purpose of the increase in the AIA was.

A meaningless gesture would be frustrating enough. However, worst of all, this measure was financed by decreasing the capital allowances available for investing in long-life assets (assets which are expected to last more than 25 years-solar panels). Under this cruel trick, companies can only deduct 6% of the value of long-life assets as a cost rather than 8% as is the case currently.

This has a big impact on investments in long-life assets, such as ships or solar panels. Whilst previously, it took 28 years to get tax relief on 90% of cost, it will now take 39 years, making such investments less profitable for companies. Reducing such long-term investment is exactly the worst way to tackle the UK’s low productivity.

It has shown the city-based nature of UK economic policy that this isn’t greeted with howls of outrage. UK cross-party policy has for years been set to incentivise short-term profits over investments, naturally leading to companies cutting costs and increasing prices rather than investing with a longer-term view. A cynic would relate the conservative party’s financial dependence on the city here.

A radical new progressive alternative to this budget would be to focus corporate income tax policy on promoting and supporting investment rather than profit. Cancelling the proposed additional cut in corporate income tax from 20% to 17% (or even increasing it to a rate still lower than the rest of the G7) could be combined with a more generous relief of investment expenditure.

The impact would be mildly higher tax collection from low-investing companies (but still low by international standards) but lower tax rates on companies which invest in productivity-enhancing infrastructure and equipment.

Such a policy would support the much discussed and much needed rebalancing of the economy towards investment and industry, disproportionately helping areas outside London.

The potential for tax to rebalance an economy is also seen, and also missed by Chancellor Hammond, with environmental taxes. These have huge potential as both a source of revenues as well as an effective mechanism to divert economic activity towards cleaner alternatives if it effectively combined with broader tax cuts.

We saw a new tax on manufacturer and import of plastic packaging, in cases where less than 30% of the product is from recycled plastic. This is a good start. However, it does not take place until April 2022, and Hammond missed the chance to introduce an accelerator into the tax so that either the tax rate or the % of recycled plastic required would increase at pre-announced intervals.

The Chancellor announced he had considered a tax on disposable plastic cups but argued that he wasn’t convinced that such a tax would lead to a decisive shift. This was an odd argument, since even in the unlikely event it made no difference to disposable cup use, it is good tax policy to be taxing and generating money from damaging externalities whilst using such revenues to reduce other taxes.

More serious however was the continued fuel duty freeze, which has persisted for 8 years, and is estimated to cost around £9bn a year, a large and little discussed tax cut[6]. A courageous chancellor would remove the freeze. A clever chancellor would have explicitly linked an overdue increase in fuel duty with expenditure on potholes, as well as more spending on public transport in rural areas.

Likewise, duty was also frozen for short-haul flights, implying a real term cut in tax and flight costs and failing to generate revenues which could be invested in environmental alternatives. A similar fuel duty escalator successfully applied for vehicles should be introduced here.

One final trick: Personal Income Taxes

The Chancellor maintained the recent conservative and political obsession with the personal allowance. From the personal allowance of £6,475 the conservatives inherited in 2010, there has been a nauseating focus on increasing this in every single conservative budget. Soon it will £12,500. The relish with which he announced this, and the heroic cheers which accompanied him clearly demonstrated that this treat from his red box and the rabbit out of the hat.

The trick became apparent in budget small print the next day, when it was revealed that National Insurance Contributions (NICs) would be increasing. NIC’s is a tax on employment, something the conservatives recognised in the 2010 election campaign when they correctly labelled Brown and Darling’s proposed NIC increases as a ‘tax on jobs’. At a time of concern over justifiable concern over real take home pay, Hammond has followed previous chancellors in moving NICs in the wrong direction.

It also leads to odd distributional consequences which the biggest beneficiaries of the tax reform being workers past retirement age (since they don’t pay NICs), whilst the losers are their younger colleagues.

In a final attempt at misguided populism, he exhibited his man of people credentials as the protector of the humble pub, by freezing duties on beer, cider and spirits. If he wanted to protect pubs, he would have taken the politically gutsy move to install minimum pricing on alcohol, thus undermining the supermarkets undermining of the pubs.

This budget will go down in the memory as a politically motivated and economically illiterate budget which defied the government’s central purpose whilst failing to provide the government or the country with another one. It is apparent that the budget was not was really controlled by the Treasury and its Chancellor, but Hammond is guilty as an enabler and missed the chance to go down as an unpopular but principled Chancellor, putting the national interest first rather than short-term political survivor.

Steve Macey is a former HMRC Economist who has consulted for the governments of Nigeria, Liberia, Sierra Leone, Saudi Arabia, Kyrgyzstan and Laos on tax reform

[1] Å. Johansson, C. Heady, J. Arnold, B. Brys and L. Vartia, Tax and Economic Growth, OECD ECO/WKP(2008) https://www.oecd.org/tax/tax-policy/41000592.pdf

[2] https://www.gov.uk/government/publications/corporation-tax-to-17-in-2020/corporation-tax-to-17-in-2020

[3] https://www.ifs.org.uk/publications/9207

[4] http://www.cbi.org.uk/news/race-to-the-top-tax-to-support-sustainable-growth/race-to-the-top-developing-a-corporation-tax-regime-to-support-sustainable-growth/

[5] https://www.bioindustry.org/uploads/assets/uploaded/62a38587-eaba-497a-bb157b299c2cbd74.pdf

[6] IFS

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Consultant in tax reform and extractive industries in frontier and emerging markets. Thoughts are my own.

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