Leadership contenders repudiate Johnson’s fiscal legacy at their peril

UK Policy Prosperity

Leadership contenders repudiate Johnson’s fiscal legacy at their peril

Commentary
Posted on: 12th July 2022
Ian Mulheirn
Executive Director for UK Policy and Chief Economist

“Tax rates are very very high. Do we want to continue on that path or reset?” asked Business Secretary Kwasi Kwarteng in an interview on Monday, framing the Conservative leadership race. That the race has already coalesced around candidates’ efforts to outbid one another on tax cuts, suggests a fundamental repudiation of Boris Johnson’s legacy that would have profound electoral consequences.

It’s true that taxes are historically high. As a proportion of GDP they’ve jumped from 36.7% in 2019, to 40% from next year, the highest tax burden since the 1940s. But that’s not because the exchequer is raking in more money than was planned before Johnson came to power. Rather it’s because the economy is now expected to be significantly smaller by the middle of the decade than was anticipated in 2019.

Two events, early in Johnson’s premiership, blew a large hole in growth prospects and therefore long-term tax revenues. First the self-inflicted damage of Brexit, Johnson’s hard variant of which is expected permanently to shrink the economy by around 4% compared to what it would otherwise have been. The exchequer can expect to be short around £30bn per year by the middle of the decade as a result.

Then came the unavoidable shock of Covid-19. The health costs have been severe, and the economic cost significant too, with the OBR expecting the economy to be around 2% smaller than it would have been from here onwards. That amounts to lost tax of around £23bn per year by 2026.

The Johnson-Sunak fiscal era can be seen as an effort to dig us out of this £53bn fiscal hole. The case for Brexit was built on a pledge to increase spending on public services. So it should come as no surprise to Conservative Brexit supporters that a Vote Leave government would, at the very least, have to maintain planned levels of spending. In the context of public services under heavy strain after the pandemic, a decade of austerity and an aging population, it was questionable whether even that would be electorally viable for the Conservatives. The absence of a credible reform agenda only underscores the point. But they at least sought to balance acceptable public services with fiscal rectitude.

Putting to one side Sunak’s many temporary crisis giveaways, the underlying fiscal stance evolved in three steps. First came the corporation tax hike and a four-year freeze on income tax thresholds, announced in March 2021. Together with some later measures these were expected to raise around £33bn by the middle of the decade. The Health and Social Care Levy, announced in September 2021, is set to raise around £19bn by 2026. The current burst of inflation has since swelled revenue predictions from the income tax freeze, netting the Treasury a further £10bn by 2026. That allowed Sunak a £14bn tax-cutting fig leaf in the budget earlier this year, hiking the NICs threshold, freezing fuel duty and pencilling in a 1p cut in the basic rate of income tax from 2024.

Digging holes and filling them in again: the Johnson-Sunak fiscal record

Johnson fiscal impact v4 still

Overall it’s a wash. Some £48bn of net tax rises to offset a £53bn fiscal hole created entirely by stunted economic growth. Mr Kwarteng would have been closer to the truth if he’d said that the tax burden is high because growth has been very very low.

That fiscal legacy is now being rejected by all candidates, from the libertarian wing to the moderate right. Jeremy Hunt, Sajid Javid and Liz Truss have offered tax cut pledges of between £35bn and £50bn per year.

If they’re to follow through on these radical tax cuts, what gives? They have two politically thorny options. Do they follow Donald Trump’s example and allow the budget deficit to balloon, shredding the Conservative party’s credentials as cautious managers of the nation’s finances? Or do they look to cut tens of billions from spending, two years out from an election at a moment when spending demands from education to defence are rising sharply?

Whichever path the next leader chooses, it’s not just Johnson’s fiscal legacy that they’ll be repudiating, but his electoral coalition too.

A more relaxed approach to fiscal discipline is liable to alienate traditional Conservative voters and hand an advantage to the Liberal Democrats in a swathe of seats across the south. Meanwhile it’s hard to see how a prospectus of even more dilapidated public services will propel the Conservatives to victory in the red wall or the cities.  

Things have come full circle. The economic promise of Brexit was always a mirage as is now becoming clear. Brexit won the Conservatives an 80-seat majority before reality bit. But now, exacerbated by Covid, its impact on tax revenues has detonated that electoral strategy. The upheaval of the 2019 general election looks increasingly like an aberration more than a realignment of British politics. And the party risks emerging from its leadership contest with neither a ‘red wall’ nor the reputation for fiscal competence that has been the bedrock of its electoral success for decades. Them’s the breaks.

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