Paul Johnson 7 Feb 2017 11:41am

Philip Hammond's austerity challenge

Philip Hammond, in his first Autumn Statement, delighted many of us by promising to abolish Autumn Statements. He intends to revert to the practice of Ken Clarke, chancellor from 1993 to 1997, of having just one Budget a year, in the Autumn. Right now though this looks like a promise of jam tomorrow. This year we will explicitly have two full budgets, one in March, the second sometime in the Autumn

This year’s first Budget is due on 8 March, a week or two earlier than we have got used to. Put that together with the fact that there is another to come this year and that Article 50 is due to be triggered by the end of March, then there is a good chance that this will be a relatively low key affair. New fiscal rules and a somewhat different fiscal direction were set out in the Autumn Statement just a couple of months ago.

The most significant issue, the uncertainty over the medium-term effects of the UK leaving the EU, remains. A cautious chancellor – and it looks like Hammond will be cautious – might well decide to save any further big decisions until the second Budget of the year.

That is not to say he faces anything other than some big challenges. Seven years after George Osborne set out his initial plans for “austerity” we are still running a budget deficit expected to be around £70bn this year – more than 3% of national income. The Office for Budget Responsibility’s (OBR’s) latest forecast is that it will still stand at 2% of national income in 2018/19 and 1% in 2019/20, comprehensively missing Osborne’s target of getting to surplus by then.

Hammond has set himself a new, rather looser set of fiscal targets consistent with still running a deficit into the early 2020s.

He will still, however, have to deliver some substantial spending cuts even to meet his current less rigorous targets. In fact, day-to-day spending on public services is due to fall considerably more sharply over the next three years than it has over the last three. Even where, as in health, spending is not being cut, years of very tight spending settlements appear to be leaving the NHS struggling to cope.

In terms of rates of spending growth, this will be easily the toughest decade for the NHS since it first took shape in the 1950s. In the face of intense lobbying we wait to see whether Hammond will decide to make any more money available for the NHS or for other services facing big real-term cuts. If he does it seems likely that he will either raise taxes or cut spending elsewhere to pay for it. He has room within his fiscal rules to do more; but he seems unlikely at this stage either to reduce his future room for manoeuvre in the face of considerable uncertainty, or to start acquiring a reputation for fiscal laxity.

On the other side of the balance sheet one of Hammond’s headaches arises from the continued weakness in tax receipts. Given current levels of economic growth, they continue to disappoint. One potential reason for this, identified by the OBR and by Hammond himself in November, is the increasing tendency of workers to declare themselves not as employees but as self-employed or as companies.

The problem from the taxman’s point of view is that the self-employed pay less tax than employees, and one-person companies less tax than the self-employed, for the same amount of income generated. And both self-employment and incorporation are growing more quickly than standard employment.

The chancellor promised to review this differential tax treatment in his November statement, and we devote considerable space to analysing the issues and the options in the Green Budget. This is certainly an area ripe for reform.

It is not a good idea to attempt to tax very similar forms of income very differently as we currently do. But this is also where taxation of earnings, profits and capital come together.

Really sorting this out is likely to require radical change, not least to the scope of National Insurance contributions, which remain the biggest reason for employees being taxed more heavily than others.

Paul Johnson is director of the IFS. The IFS Green Budget, produced in association with ICAEW and with funding from the Nuffield Foundation, is available on ifs.org.uk