IFS Green Budget sets the scene
The IFS Green Budget gives an independent view of the UK economy, and Donald Drysdale finds that it provides a useful perspective on various economic and fiscal options.
The Green Budget
In October the Institute for Fiscal Studies (IFS), in association with Citi, published its Green Budget 2019 analysing the issues and challenges that were then facing Chancellor Sajid Javid as he prepared for his first Budget.
Since then, much has changed. A general election is scheduled for 12 December. The Budget which had been planned for 6 November was called off. It now seems likely that an incoming government (of whatever hue) won’t deliver a Budget until January at the earliest.
You might be tempted to set the IFS Green Budget aside, thinking it has been overtaken by subsequent events. That would be a mistake, because it contains crucial material which the competing political parties should now be addressing in their general election campaigns.
Before I proceed, please note that ICAS takes no party-political sides. In commenting on policy options, I mean to do so impartially – without fear or favour.
The Green Budget studies the causes of the current global downturn, and discusses the role of fiscal and monetary policy in addressing it. It examines how different elements of the UK economy have performed in the past year, highlighting the resilience of consumer spending and the poor performance of business investment.
Brexit is very high on the current list of uncertainties. The IFS sets out forecasts for the UK economy under four distinct Brexit scenarios: continued uncertainty; a no-deal scenario; a negotiated Brexit deal; or a second referendum on a Brexit deal negotiated by a Labour-led coalition, culminating in a vote to remain.
The document blames Brexit, and the political difficulties it has raised, for creating a serious barrier to the ordinary progress of government under Theresa May’s leadership. It speculates how successful an incoming administration might be in shifting the focus onto economic growth and a range of domestic policy priorities.
There’s a chapter that looks at the announcements in this year’s spending round and emphasises the importance of keeping things in perspective – particularly in the context of the real-terms cuts that have been imposed by the austerity programme since 2010.
Another chapter produces an updated baseline forecast for the public finances, and looks ahead to analyse a variety of scenarios for the medium term. It considers the case for having fiscal targets, comparing those likely to be adopted by Conservative and Labour governments respectively.
The Green Budget ends with two chapters focusing on particular tax issues. One of these examines how satisfactorily tax policy treats motoring as we find it today, and how it might be made ready for the future.
The other (Chapter 8) looks at options for cutting direct personal taxes and supporting low earners, with particular reference to the Prime Minister’s proposed tax policies.
Income tax reforms
Prime Minister Boris Johnson has said that he’d like to cut income tax radically for high-income individuals by raising the UK higher-rate threshold from £50,000 to £80,000, while also raising the point at which people start paying national insurance contributions to help low earners.
The IFS argues that these would be costly reforms, both of which would predominantly help those in higher-income households. It examines other ways of cutting taxes for high-income individuals, whilst also simplifying the system, and suggests a more targeted way to boost the incomes of low-earning families by raising work allowances in universal credit.
It proposes removing the tapered withdrawal of the personal allowance on incomes above £100,000, which creates a £25,000-wide 60% marginal income tax band and affects ever more people each year. Instead, raising the UK higher rate from 40% to 45% above the proposed new threshold of £80,000 would raise broadly the same amount of tax in a simpler way.
While simplification is a worthy objective which could gain wide support, it is unclear to me whether a hike in the higher rate would be politically palatable – especially among the better off. It might simply be perceived as a massive cut of £70,000 in the additional rate threshold.
National insurance reforms
The IFS agrees that raising the point at which employees and the self-employed start to pay NICs, at a cost of £3 billion a year for every £1,000 it goes up, would benefit all who currently pay NICs – that’s all workers above the bottom 12% of the weekly earnings distribution, or any employee aged 25+ working at least 20 hours per week at the national living wage.
If the aim was to help the lowest earners, increasing work allowances under universal credit would be much more effective. The IFS calculates that spending the £3 billion on increasing work allowances could raise the incomes of the poorest fifth of households by 1.5%, compared with less than 0.1% under an equally-costly NICs cut.
The Green Budget suggests that, if the employee and employer NICs thresholds were both raised by the same amount, the total cost would be £5 billion a year for every £1,000 they go up. While I’m sure employers would welcome this, companies might find it largely cancelled out by Johnson’s latest announcement that corporation tax will no longer be cut from 19% to 17%.
Chapter 8 of the IFS Green Budget points out that NICs and benefit policies are set by Westminster for the whole of the UK, but income tax on the earned income of Scottish taxpayers (other than the personal allowance) is devolved to Scotland. This difference in treatment between income tax and NICs causes significant confusion.
Under the Barnett formula, changes to income tax in the rest of the UK affect the Scottish block grant from Westminster. The IFS can’t predict how Holyrood would respond to changes in the block grant, so its analysis of the distributional impacts of reforms involving changes to income tax excludes Scotland.
As an alternative, Scotland’s Budget Report 2019 from the Fraser of Allander Institute offers specific analysis of the Budget uncertainties facing Scotland, and I shall come back to these in my next article.
Election fever has now taken hold. As I write this, some of the political parties have not yet published their election manifestos, but there seems to be a general determination across the board to loosen the constraints of austerity and increase public spending.
A substantial increase in public borrowing seems inevitable, and current low interest rates might make this a tempting option. However, government debt is at a historical high and, even with a smooth Brexit, is expected to rise even higher through 2019/20 and 2020/21.
Keeping debt falling as a share of national income whilst avoiding further austerity would require a strong growth performance and an orderly Brexit.
Even if a Brexit deal is secured, the IFS finds a strong case for the incoming government to resist any calls for a substantial package of permanent tax cuts or further increases in day-to-day spending, unless these are to be covered by tax rises of a similar size.
Article supplied by Taxing Words Ltd