On 3rd March the chancellor will unveil his budget. In my role as Chair of the House of Commons Treasury Select Committee I have worked with leading economists to focus on what it might and should contain. The dilemma the chancellor faces is the need to reassure the markets that he is serious about getting on top of our ballooning deficit while ensuring that any measures to tackle it are not announced too early and end up blunting our recovery. I don't envy him.
Regarding the deficit, the gap between tax revenues and public expenditure has exploded in the past 12 months. Tax revenues have plummeted due to business closures, tax deferrals and VAT cuts plus some people have been earning less and so owe less tax. Government spending has increased significantly because grants for businesses and programmes like the furlough scheme, while absolutely vital, have also been hugely costly. A lot more money has also been needed for the NHS and other vital services to cope with the impact of the pandemic. At the moment this growing deficit is manageable because interest rates are very low. But this won’t be the case for ever and when they do rise we will face an annual bill of roughly £10 billion for each percentage point increase – about a quarter of what we spend each year on defence.
Broadly the solution to tackling the deficit and so reducing the risks to the public finances around interest rate rises will be to increase taxes and/or to cut spending whilst pushing hard for economic growth. Given the Government’s push on investment (including more money for healthcare, education, policing and defence), it is likely that tax increases will need to play a key role. One option would be to increase Corporation Tax. It is one of the larger revenue raisers and UK rates have been reduced from 28% for bigger companies in 2010 to 19% today. This is a tax increase that would bring in significant revenue while probably doing little to affect our business competitiveness. A rise to 23% would still be competitive internationally while raising more than £10 billion a year. Corporation Tax is only levied against profitable businesses so those that are struggling with losses will not be hit.
I suspect, though, that the Chancellor will play it cautiously for now – key will be to avoid dampening growth – tax rises will have to wait for the time being. For now he will continue to focus on support schemes to help businesses and as many workers as possible (both employed and self-employed). This is going to be vital in order to try to preserve as many jobs as possible whilst we all wait for the recovery which will follow the opening up from lockdown. All of this critically dependent on the roll out and effectiveness of the vaccination program. This is looking good at the moment.