Our Response to the Chancellor’s 2020 Budget

The Corona crisis looks likely to break the rules.

The government’s much-hyped investment splurge is in line with what was foreshadowed in the Conservative election manifesto, which proposed headroom allowing investment of up to three per cent of GDP. But the short-term shock of Coronavirus illustrates the brittleness of that framework.

The hit to the deficit over the next months will be large as tax income falls, benefit payments rise, and the government rolls out emergency support to the self-employed, small businesses and critical public services. However, with the OBR’s forecasts having been locked in February and significant uncertainty over the impact of the health crisis, exactly how large deficit hit will be is unclear.

Indeed the OBR itself notes that while current plans give the government a 60 per cent chance of meeting their balanced budget rule in 2022-23, the chances are likely to be lower than this once the effect of the crisis is factored in. It seems inevitable then, that come the autumn, things won’t look so positive.

All of this raises questions about the value of the current rules, so it is welcome that the Chancellor plans to review the fiscal framework over the coming months. That review will no doubt provide some cover for the Chancellor changing the rules come the autumn. But if the new approach is to be any better than the failed approaches of recent years, it needs to recognise that any attempt to set stringent debt or deficit limits in the short term is doomed to failure in the face of unexpected developments.  

As TBI proposed last month, a much better rule would explicitly allow more flexibility at times of crisis but put the public finances under tighter controls at other times.

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As promised in the Conservatives’ election manifesto, the Chancellor confirmed that the threshold at which workers start paying NICs will increase to £9,500 a year in April. Most workers will pay £85 less in NICs than they would have done if the threshold had been increased in line with inflation in the usual way.

The impacts of this policy will be similar to those of the increases in the income tax personal allowance that we have seen over the last decade. Repeated increases in the personal allowance have reduced direct tax liabilities for those on middle to high incomes, even as cuts to benefits have reduced the incomes of the poorest and other tax changes have increased taxes for the very richest. This has created a bizarre tax schedule at the very top and led to marginal tax rates across the board (see figure below).

Over the next decade, policy should focus on targeting support on the most needy and rationalising the tax system to achieve redistribution in the most economically efficient way. In particular, it is time to look again at the UK’s outdated system of property taxation and shift away from taxing work towards taxing land. There was, however, little sign of such a strategy from the Chancellor today.

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Figure 2

Income tax and national insurance schedule 2008-2020

The Chancellor announced that the National Living Wage will increase to two-thirds of average wages by 2024 and will also apply to those aged 21-24. This is equivalent to a minimum wage of about £9.75 an hour in today’s terms, and follows Arindrajit Dube’s review of the international evidence on minimum wages.

The minimum wage has been an undoubted success story over the last 20 years, but it is not a panacea for a number of reasons:

• First, a growing number of low wage earners work part time, either by choice or because they are unable to find additional work, limiting the gains to higher hourly wages.

• Secondly, many of those earning the minimum wage are not in low-income households, generally because their partner is a higher earner. There are as many minimum wage earners in the highest-income 60 per cent of households as the poorest 40 per cent.

• Thirdly, those minimum wage earners who are in low-income households – the group of most concern to policy makers – actually gain the least from increases in the minimum wage. This is because they are often entitled to means-tested benefits and see these benefits reduced if a higher minimum wage increases their earnings. Minimum wage earners in the poorest 30 per cent of households lose 50 per cent of any increase in their earnings to a combination of higher taxes and lower means tested benefits on average, whereas those with above-average household incomes on average get to keep 70 per cent.

A higher minimum wage is not an adequate substitute for the big reductions in cash support for low-income working families that we have seen since 2010. The government should look to maximise the gains from the introduction of Universal Credit by introducing it as originally planned, with higher earnings disregards and a lower withdrawal rate so that low-income working families receive higher benefit payments and get to keep more of any increase in their earnings.

Unfreezing LHA still leaves an unaffordable £1,100 gap between the benefit and average rental prices for 2 bed properties on the 30th percentile.

The Budget confirms that Local Housing Allowance (LHA), frozen since 2016, will increase only in line with inflation (CPI) next month. Maximum rates were cut substantially in 2011, to the 30th percentile of properties by rental value. But then the link to actual housing costs was broken, with entitlements raised more slowly than housing costs in subsequent years, and not at all since 2016.

At the start of the cuts, the coalition government’s rationale was that reductions in the generosity of support would not be borne by low-income households alone, rather they were expected to be passed on in lower rents going to landlords. But recent research show that rental prices changed very little as a result of the reforms, so subsidy reductions have in fact overwhelmingly been borne by tenants rather than landlords.

How heavy has that burden been for claimants and how much difference will the increased generosity make next month? Our analysis shows that the gap between the support available and actual housing costs is vast, with the LHA allowance for an average two-bedroom property about £1,096 per year below the current 30th percentile from next month – only about £50 less than the current gap. This is a substantial amount of money for claimants. We estimate that the average two-bedroom claimant family had an income (excluding housing benefit) of £17,000 this year, therefore the LHA shortfall represents around a 6.5 per cent of their remaining income.

Figure 3

Gap between housing costs and housing benefit for a two-bedroom house at the 30th percentile

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Public support is growing for the government’s target of net zero carbon emissions by 2050. Yet the Chancellor has shirked one of the most effective policy levers for achieving this by failing to end the freeze on fuel duty that will now enter its tenth year.

With the UK playing host to the COP 26 climate talks at the end of the year where it aims to showcase its net-zero strategy to the rest of the world, ducking the chance to tackle the single biggest source of carbon emissions (23%) leaves the government with some explaining to do.

Fuel duty has been frozen at 57.95p per litre of petrol and diesel since 2011. The freeze means that the real value of fuel duties (relative to CPI inflation) has fallen by 17% since 2010-11^[_]. At today’s fuel prices this means that today there are the equivalent of 700,000 more cars on our roads each year than there would otherwise have been.

The freeze has also come at some cost to the Treasury. The OBR estimates that the freeze will have raised net debt by £84bn by 2022-23 (3% of GDP)^[_].  Fuel duty is still by far the most important source of revenue from motoring taxes, forecast to raise £28.4bn in 2019-20, with an additional £5.7bn from the 20% VAT levied on the duties.

If the government is to get serious about putting the UK back on track with its net zero ambitions it needs to re-establish the indexation of fuel duty. Doing so for the duration of this parliament could cause fuel prices to be about 16% higher by 2024 than they would otherwise be, resulting in a reduction equivalent to around half a million cars off the road all else equal. If it continues the freeze, we estimate that vehicle emissions will be around 1.4 megatonnes of CO2 per year higher as a result by 2024.

Figure 4

Car equivalent reduction from reinstating the fuel duty indexation

You do not have to look far for the political reasons for failing to end the freeze. Taxing petrol is politically difficult. In France it led to violent riots by ‘gilets jaunes’ throughout 2019. The European Social Survey underlines the political fault-lines over the cost of driving, with support for taxing fuel significantly higher among the well-off than among lower income groups. This is unsurprising when we consider that, as a proportion of disposable income, fuel duty is on average three times higher among people in the lowest-income decile compared to the top 10%.

Nevertheless, there are ways of compensating the losers from higher fuel duties and neutralising the opposition. One such option would be for the government to commit to issuing a flat-rate per car rebate of the additional revenue raised through indexation, which would amount to around £150 per year for each car by 2024. A rebate would disproportionately benefit poorer drivers, raise the incentive to shift to electric vehicles, meanwhile the duty rise would continue to encourage all drivers to reduce their mileage.

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