Why We Should Take the Politics out of Fiscal Policy

On Wednesday the Chancellor announced his Autumn Statement to Parliament. For my non-UK subscribers this is where the government updates the country on the state of the public finances, gives us some spin on the health of the economy, and sets out tax and spend measures. It’s a big deal in UK politics as we usually get two ‘fiscal events’ each year and the media and wonk world love to obsess over what will be in it. As someone who has provided informal advice on two of them before, it was nice to be an outsider again.

So, how did it go? There were certainly some positives in there, but overall it was a bit underwhelming.

On the positives, it was great that the Chancellor has made full expensing permanent. This is something I had hoped would happen but the heavy lifting had been done by Sam Dumitriu, the Centre for Policy Studies, and other groups who have been making the case for it for a number of years. This is a really great thing and will incentivise firms to invest in new equipment in order to increase productivity and drive economic growth.

As for the technology sector and startups, lots of very good stuff as well. Increased funding for AI and quantum computing, improving the attractiveness of listings, investment reform, and R&D tax credit changes (Dom Hallas of the Startup Coalition has the lowdown on this).

It was also positive to see ways to increase FDI taken seriously. The government has agreed to adopt the measures of the Harrington Review which you can read here.

I was also relieved to see that the government didn’t lower or scrap inheritance tax. I’ve written here before about why it is in dire need of reform. However, as I wrote for CapX this week, at a time when the burden of taxation falls disproportionately on working people, a cut to inheritance tax would involve shifting the burden even further away from wealth and onto the shoulders of productive people.

It was also encouraging to see cuts and reforms to national insurance contributions. Unfortunately, the Chancellor missed an opportunity to end the injustice that is fiscal drag by unfreezing income tax and national insurance thresholds. I wrote for City AM on Thursday on why this matters.

I was also relieved to see that the government did the right thing by uprating Universal Credit in line with September’s inflation level rather than the lower October figure. I suspected they would do this in the end but only briefed that they wouldn’t for political reasons. Unfortunately, they will be bringing in reforms to the benefit system which I have written about before and will be cruel, counterproductive, and reveal that the government doesn’t actually understand the UK labour market.

On Tuesday I wrote an article for the Evening Standard where I explained what the Chancellor’s 5 tax priorities should be. These were: make full expensing permanent; end fiscal drag; abolish stamp duty; stop tinkering with VAT; and unfreeze fuel duty. I suppose one out of five isn’t too bad.

I didn’t expect the Chancellor to unfreeze fuel duty because the government never does this. I also expected even more tinkering with VAT. We did see some of this as period pants are now VAT exempt but at least the Chancellor resisted pressure from backbenchers and lobby groups to abolish VAT on sunscreen and dog food.

What is more, the government has funded the tax cuts it did make by real term cuts to public spending and investment. There is no way that this will hold up by this time next year as departments see their funding slashed but I imagine Jeremy Hunt and his team are assuming that will be somebody else's problem by then…

The fact that Chancellors of all parties routinely make important fiscal decisions not based on sound economics but what is politically popular in the short term is deeply concerning. It is rumoured that the reason the Chancellor brought forward his national insurance cut to January is because the government is gearing up for a Spring General Election. 

As such, if Jeremy Hunt is still Chancellor by then, I would not be surprised to see a number of very popular but completely unfunded tax cuts and giveaways. The government would hope that it would give them a boost and so win the election and then they can deal with the fallout later. There will also be a number of traps laid for the next government which they know it would be unpopular for them to reverse.

This is no way to run a major economy. The government should not be playing politics with the public finances and the impact that has on the livelihoods and wellbeing of its people and the prosperity of the nation.

My initial solution to this was to propose that we have a ban on fiscal events in the run up to a General Election. This would reduce the likelihood of these gimmicks from governments but would obviously be difficult to enforce as we have reverted back to not having fixed-term Parliaments (the correct move). 

Instead, we should look at ways of making fiscal events less of an event by taking the power away from politicians. We rightly no longer have the government overseeing monetary policy in the UK for this very reason. It was just too tempting for governments struggling in the polls to lower interest rates in the run up to a General Election in order to give the economy a quick boost and take pressure off mortgage holders. Instead we have given control of monetary policy to a committee of technocrats.

We should do something similar with fiscal policy. This would look similar to the system proposed by Aveek Bhattacharya of the Social Market Foundation. It would establish a Fiscal Policy Committee (FPC) which would consist of economic experts who would determine what the overall government budget should be and provide a target range for the deficit. 

This would effectively mean that the FPC would direct the government on how much money it should borrow. The remit of the FPC should be two-fold: fiscal sustainability and economic growth. The FPC would recommend how much borrowing is sustainable each year and how much borrowing is needed to manage demand in the economy with a target for economic growth of at least two per cent each year. 

Such a reform would take the politics out of much of fiscal policy, would allow for better coordination with the Bank of England’s Monetary Policy Committee on managing the demand side of the economy, and set an actual target for economic growth.

However, we should go even further. The government should adopt Stian Westlake’s proposal of abolishing the Treasury. Its functions should be split so that there is a separate department which deals with managing spending (this is where the FPC would be based) and a Department for Economic Growth would be established which would also subsume the functions of the current Department for Business and Trade.

This Department for Economic Growth would be overseen by a Secretary of State supported by ministers who would make the ultimate decisions. However, there would also be an Economic Growth Committee (EGC) of experts whose role it would be to propose tax and spend policies which would grow the economy by at least two per cent. The government would be at liberty to ignore the recommendations of the EGC but they would have to explain why they have chosen to do so.

Under this system the MPC, FPC, EGC, and an independent Board of Trade would work together to develop and implement policies which drive sustainable economic growth. This will take much of the politics out of economic policy and allow the government to make the difficult decisions necessary to boost productivity, improve living standards, and grow the economy.

As ever, thanks for reading. If you enjoyed it, feel free to buy me a pint: https://www.buymeacoffee.com/opportunitylost

Have a great weekend!