Politeia: Fiscal change after Brexit?

This government has been consumed by the Brexit process. This is not surprising as governments typically can only manage one big project at a time. However, with Brexit now only six months away, it is time that the government thought about fiscal policy, which has been drifting in an ‘austerity fog’ since the 2015 election. The Treasury has trodden water, refusing to give way on its basic austerity-set plans for spending, while maintaining the overall tax rate approximately unchanged. The result has been a rather rapid move towards surplus: in 2015/16 the PSBR was 3.8% of GDP and in 2018/19 this will have fallen to about 1.4%.

During this time the share of government revenue in GDP has remained steady at 35%. By implication government spending has fallen from nearly 39% to around 36.4% of GDP. This reduction has come virtually entirely out of current spending, as capital spending has continued at about 3% of GDP. The Treasury will have congratulated itself on managing to control spending in this way, in spite of the endless pressures from most departments to raise it.

It has now embarked on gloomy warnings of the effects of Brexit on the economy and so tax revenue. However, these are contradicted by its own world trade model when correct assumptions about EU-UK trade barriers and likely Free Trade Agreements with other countries are fed in. The Treasury gloom fulfils two purposes: to dampen departmental spending demands and to push the government towards the ‘softest’ of Brexits, as close as possible to the status quo.

While all this may suit the Treasury, it is bad for the economy to perpetuate this negative mindset towards change in tax and spending. Furthermore, it is politically dangerous for the survival of a free market economy, now threatened by Jeremy Corbyn’s extreme socialist plans. Between now and the next election the Conservative government needs to put forward plans that inspire new faith in that economy.

A good starting point for this process would be a set of forecasts post-Brexit that build in the proper assumptions just mentioned. Opening up the UK to free trade not just with the EU should bring substantial gains, as free trade has in the past. Our calculations suggest around 4% of GDP. There is also the gain from regaining control of regulation, especially in finance, but also across the whole economy; true there may be curbs on change from the EU Brexit agreement for a time but in the long run the UK will now be able choose whatever path it likes in this respect. Finally there are the gains from ending the financial transfer to the EU and closely limiting unskilled immigration with its high fiscal costs. Overall the boost to GDP could reach 7% or more, with better regulation particularly important in the longer term and adding much more to this, as we face a world of much faster technical change.

My Cardiff research team calculated at the time of last year’s Budget that with the trends now developing in the public finances plus the revenue gains from this Brexit boost to the economy, the government was in a position to reach a safe ratio of debt to GDP by the mid-2020s and still have scope for tax-cuts and spending increases of the order of £25 billion a year from 2020 and a further £40 billion a year from 2025. This total comes to around 2% of GDP. If applied intelligently to boost the competitiveness of the economy, it could raise the growth rate from 2025 to 2030 by a further 0.2% per annum.

It is an extraordinary thing that economists like us feel the need to encourage politicians to spend more money and cut taxes. Usually it is our role to discourage profligacy in the name of ‘economy’. However, the mantra of austerity has truly taken hold in the UK, so long (now a decade) has it been necessary to subscribe to this policy to bring debt down to sustainable levels. With popular tolerance fraying and the threat of an opposition determined on large scale socialism allied with a massive spending programme, this really is the time for Conservative politicians to show some strategic intelligence and boldness in fiscal plans.

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