Two weeks after becoming chancellor, and with a Budget scheduled for March 11, Rishi Sunak has been presented with a difficult set of choices by Treasury officials concerned about the UK’s weak economy.
They have told him there simply is no way of simultaneously increasing public spending as fast as prime minister Boris Johnson would like, keeping taxes down and adhering to new Treasury fiscal rules that only allow borrowing for capital investment.
Boxed-in by this conundrum, Mr Sunak looks set to respond by putting off his most difficult decisions until later in the year — because he has what officials call a trilogy of fiscal events in 2020.
The Budget on March 11 will be limited to fulfilling certain flagship promises in the Conservative election manifesto, but will be followed in the autumn by the outcome of a review setting levels of public spending for at least three years. Finally, there will be a second Budget in the autumn to ensure all the numbers add up by the end of 2020.
Some in the City of London think this trilogy of fiscal events gives the chancellor room to be creative with the timing of his policy initiatives.
Lisa Alexandersson, economist at JPMorgan, said she was confident that Tory manifesto pledges on extra health spending and cuts in national insurance payments “will be honoured [on March 11] even if downgrades to [economic] growth are so large” that either the Treasury’s fiscal rules will be broken or it will have to raise taxes at some point thereafter.
The fundamental problem for the Treasury is that, regardless of the timing, the poor economic backdrop gives ministers little room for big Conservative policy initiatives on “levelling-up” under performing regions, improving workers’ skills or financing social care while maintaining the Tory manifesto commitment to balance the current budget within three years — under which tax receipts are supposed to match day-to-day spending.
The coronavirus outbreak only complicates matters further.
On Wednesday, the Institute for Fiscal Studies, the think-tank, estimated that even without any new spending commitments, the government was on course to run a deficit on the current budget, based on the latest Bank of England economic forecasts and the spending plans set out in the Tory manifesto.
Isabel Stockton, economist at the IFS, said “if the chancellor wishes to spend more on public services or to cut tax, this cannot be funded by additional borrowing while also maintaining this [current budget balance] target”.
After adjusting for money due to be paid back to the BoE under the term funding scheme, which provided cheap financing to banks, she added that underlying public debt was also set to rise as a share of national income.
One option for Mr Sunak would be to ditch the fiscal rule to balance the current budget that was drawn up by his predecessor, Sajid Javid.
Government officials appear to be preparing the ground for such a move, saying only that the government will stick to “a fiscal framework”.
But on Wednesday Mr Javid warned against ditching his fiscal rule that bars borrowing for current spending, saying “it would not be right to pass the bill for our day-to-day consumption to our children and grandchildren”.
David Gauke, another former Treasury minister, said it would be “very strange” for a Conservative government to allow debt to rise in normal times and cautioned that “markets are forgiving until they’re not”.
But there is pressure from Number 10 to relax the Treasury’s fiscal rules and economists do not have cast iron theories for optimal levels of government debt, especially when the state can borrow for 10 years at an interest rate of just 0.5 per cent.
Erik Britton, managing director of Fathom Consulting, said he put little weight on fiscal rules because governments always broke them when they deemed it necessary.
“We could safely abandon the [current budget rule] without any damage to fiscal credibility,” he added, saying there was a pressing need for a large budgetary stimulus.
Another option for Mr Sunak is to abide by the fiscal rule for a balanced current budget on March 11, and pencil in spending plans for the next three years, which he might then have to augment in the review published in the autumn.
Cabinet ministers have been told to find 5 per cent savings in their departments as a baseline for the review, which could give the government more scope to change spending priorities.
These exercises have, however, traditionally resulted in ministers offering up ideas for cuts that are so politically unpalatable that they cannot easily be banked by the Treasury.
The other option for Mr Sunak is to raise taxes, but in each area the government has floated ideas — raising fuel duty, a new levy on expensive homes and restricting pension tax relief — it has run into vehement opposition from those who would lose out as well as Conservative MPs.
Barring economic forecasts on March 11 that are much more optimistic than expected from the Office for Budget Responsibility, the fiscal watchdog, Mr Sunak would appear likely to avoid contentious decisions in the first of his trilogy of fiscal events this year.
But Torsten Bell, a former Treasury official who is now director of the Resolution Foundation, a think-tank, said that extra time would not make the choices any easier.
“The idea that it all gets magically easier by the autumn goes against the law of history,” he added.