We need more serious conversations about both tax and spending

The UK’s economic problems clearly run deep, and tax cuts alone will not fix them, argues Julian Jessop

The run-up to the March Budget has seen the usual flurry of rumours about how much room the Chancellor has for tax cuts and how he might use it. This time, however, there is also a growing consensus that the current fiscal framework is not fit for purpose. 

Even the chair of the Office for Budget Responsibility (OBR), Richard Hughes, has acknowledged that the OBR’s projections are a “work of fiction”. He was referring to the lack of detail on the government’s plans for departmental spending, which is assumed to fall steadily as a share of national income despite rising demands. We need to talk about that too.

There was at least some good news for the Chancellor this week. Borrowing in the financial year-to-January was £9.2bn less than the OBR’s projections, with large downward revisions to previous data more than offsetting a small overshoot in January itself. 

But this only helps a little. The ‘fiscal headroom’ is the amount by which the government could cut taxes – or raise spending – and still meet its targets for borrowing and debt in five years’ time. This depends on what the OBR is predicting for the end of its forecast horizon, not on the recent past.

My best guess is that the OBR will judge that this ‘fiscal headroom’ has increased to around £20bn, due mainly to the fall in the cost of government borrowing.

The temptation may be to use almost all of this £20bn for another round of pre-election tax cuts. But the law of diminishing returns often applies in politics, as well as economics. Opinion polls suggest that the public are now more worried about the quality of public services.

There would be economic risks too. The main reason why the UK slid into recession at the end of last year was the drag from higher inflation and interest rates, which is already fading. It is therefore crucial that the Chancellor avoids doing anything that might reignite inflation, encouraging the Bank of England to keep rates higher for longer.

Which taxes to cut also depends on what exactly the economic benefits are supposed to be – a question which is not asked often enough. 

If the aim is to boost demand in the economy, the support should focus on poorer households who would be more likely to spend any tax savings. These households would benefit the most from lifting the freeze on personal allowances, which could also be justified as giving back some of the Treasury’s unexpected windfall from higher inflation.

However, there is already some additional stimulus in place from the recent cuts in National Insurance contributions. Poorer households will also see the biggest gains from the large increases in pensions, benefits and the national minimum wage in April.

If the emphasis is more on improving the ‘supply side’ of the economy – the incentives to work, create jobs or invest – tax cuts should also target the high marginal rates faced by many other households, and the rising burden on businesses. This might be less likely to worry the hawks at the Bank of England.

Either way, the UK’s economic problems clearly run deep, and tax cuts alone will not fix them. There is an urgent need for the government to pursue pro-growth policies across the board. 

This should include regulatory reforms, measures that improve rather than hamper the flexibility of labour and product markets, and more action to tackle the productivity crisis in the public sector. Unfortunately, this agenda is far less popular.

Julian Jessop is a fellow at the Institute of Economic Affairs