Comment Blog 23 January, 2017

How “competitive” can Theresa May be?

Last week saw two game-changing moments for UK fiscal policy.

The first was a new long-term forecast by the OBR, covered by Will Mosseri-Marlio here. The long term position of the public finances has markedly worsened since the last forecast, largely due to new estimates on the rising costs of the NHS. Net debt is now projected to reach over 200 per cent of GDP by the 2060s, compared to 85 per cent in the 2015 report.

The second was a new Government ambition for taxation. Theresa May spoke of “competitive tax rates” and the Chancellor used similar language. Theresa May said that if the UK had to walk away from a Brexit deal, the country “would have the freedom to set the competitive tax rates and embrace the policies that would attract the world’s best companies and biggest investors to Britain”. She even said that, “if we were excluded from accessing the single market – we would be free to change the basis of Britain’s economic model”. Various commentators, such as Wolfgang Munchau in this morning’s FT, interpreted this as a “low tax strategy”, even a “tax haven”. Theresa May unsurprisingly refused to endorse this language in her interview with Andrew Marr yesterday, but didn’t refute the basic idea.

Her problem, however, is that she could never implement that policy, given the forecasts in the OBR report. (Some may say that she was also talking about a specific scenario, not her policy in general. I think however it is very significant when both a Prime Minister and Chancellor say that a policy direction would have great economic benefits. At the least, it would be very odd for her to support uncompetitive tax rates in the future.)

The OBR asks how the UK can return to the level of net debt normal before the economic crisis, i.e. 40 per cent of GDP, in 50 years’ time.  The answer is a huge dose of fiscal tightening. If swallowed in one go, the package of tax rises – delivered in 2021-22 – would need to be worth £84 billion in today’s money.  A more gradual treatment plan would see £30 billion of fiscal tightening in each decade until the 2060s.  This all compares to the current annual levels of £711 billion in taxation and £779 billion in spending. Meeting this challenge set by the OBR requires a step change in the UK’s approach to tax and spend.

Such a change could still be “competitive” if other countries were increasing their own tax burdens even faster, because of their own public finance problems. This does not appear to be the case. The last review from the OECD, in 2014, showed that the UK has to make the second biggest fiscal adjustment among developed nations to reduce government debt (in this case, to 60 per cent of GDP by 2030). Only Japan has a bigger adjustment to make. Germany has barely any adjustment to make at all (see figure 4.3, p.240).

For Reform, the OBR report gives much greater impetus to everything that we are trying to do i.e. understand how to improve the Welfare State while keeping it affordable. For the Government, however, it raises deeper questions about exactly how its fiscal ambitions could ever be achieved.