We cannot take the suspense. Philip Hammond labours like Caractacus Potts in the Treasury shed. Creak, bang, curse, he tinkers away into the night, preparing to unveil his latest Budget contraption on November 23rd.
There is a sense of foreboding too. Will it fly beautifully, like Chitty, Chitty Bang? Or send him careering dangerously around Westminster, like the malfunctioning rocket pack?
Judging by the speculation in the press, it would be well to stand clear. First, (hammering noise) an income tax cut for young people was mooted and then dropped. Now it is being suggested that a temporary cut in stamp duty for first time buyers is a possibility.
I am no fan of stamp duty – the worst tax on the statute book, amidst stiff competition – but we should be suspicious of such a fiscal Toot Sweet. Prices for first time buyers would simply rise to take account of the cut. They have already been artificially lifted by the subsidised loans in the Help to Buy scheme.
The benefits would similarly accrue to the vendors, largely housebuilders, whose profit margins, share prices and executive remuneration are already at record levels. A recent study by Morgan Stanley found that Help to Buy had contributed to a 15% premium in new house prices, matching almost pound for pound the cheap 20% equity loan provided by the government. (Wait till the initial 5-year period runs out and the interest rate goes through the roof, but that is another story).
As the stamp cut would be temporary, it would be unlikely to stimulate investment in further construction of new homes.
The losers would be existing homeowners hoping to move house, perhaps to start a family, as they would be outbid on properties by first time buyers.
This stamp duty idea exemplifies a paucity of economic thinking by the current Government. If you are interested in the reform of property taxation, far better to remove the distorting effects of stamp duty altogether by cutting it to a flat 1% for both buyers and sellers. Any loss in revenue would be offset by rising revenues from new construction, VAT and higher volumes in the housing market (which remain below pre-crisis levels). A reforming chancellor might also examine the council tax bands, to ensure that those in large expensive houses pay their fair share.
Property taxation is a classic example of how, somewhere along the way, the Conservative party has lost both its market nous and its understanding of economics. The consequence is that the Government has no economic strategy to speak of and short term fix has been piled upon political gimmick.
Let us start with market nous. Unnoticed in Westminster, economic growth is accelerating. Yes, you read that right. The National Institute of Economic and Social Research – which has as good a track record as any – has said growth recovered to 0.5% in the three months to October. However, in all likelihood, inflation will remain a problem due to the rapid rise in the oil price to around $65 a barrel.
What this means is the tax revenue forecasts are probably too pessimistic and the chancellor does not immediately have to worry too much about the deficit. The deficit would be even less of a problem if the chancellor took a more long-term approach to taxation, and set taxes at levels which maximised incentives, economic growth, productivity and revenue.
If that is the good news, there is plenty of bad news. A combination of the change in the political context, exemplified by the rise of Jeremy Corbyn, the exhaustion of austerity as a political narrative, and decades of underinvestment mean that the demand for increased public spending is fierce. According to IMF data, gross fixed capital formation in the UK, at 17.2% of GDP has been substantially below the G7 average of 20.2% for 25 years.
This is mostly due to cuts in public investment, which at 2% of GDP remains below the level before the financial crisis. Indeed, one of the big contributors to deficit reduction under the Conservatives has been large cuts in capital expenditure by the Government, as opposed to cuts in current spending. Evidence of this is everywhere: traffic jams, full commuter trains, insufficient A&E facilities, a shortage of social housing, etc.
The anchor of economic policy is the so-called fiscal rule, that the Government should reduce its cyclically adjusted net borrowing to 2% of GDP. As Ed Balls explained when he was shadow chancellor, that fails to distinguish between current spending and capital investment. Controlling current spending on day-to-day items is sensible. But if the Government borrowed for capital investment, on which it made a return, who cares if it adds to the deficit at a time when its cost of borrowing is the lowest since the Victorian era?
A better option than simply raising public investment would be to revive public/private partnerships in a new form to invest in infrastructure. These could borrow via a new, properly regulated, project bond market, partly underwritten by the Government. Not only would these be kept off the public balance sheet, they would have an independent life of their own and so not be micro-managed by Whitehall. Victorians built railways, canals, hospitals and the like by tapping their own deep and liquid capital markets, and we should do the same.
Another idea which ought to be given serious consideration is using the State’s remaining stake in RBS and other assets to seed a sovereign wealth fund, which could co-invest alongside the private sector in infrastructure and innovation.
This is the sort of strategic thinking which one hopes for in the Budget and indeed from the Conservative party more widely, but with a few honourable exceptions, there is little sign of it. If we are to make a success of Brexit, we are going to need more than tinkering in the Treasury shed.