The chancellor, Rishi Sunak, will have to order steep tax rises or another brutal round of spending cuts to plug a £40bn gap in the public finances caused by emergency spending during the Covid-19 crisis, the former Tory Treasury minister David Gauke says today.
The warning of painful income tax and VAT rises from a respected figure with seven years of ministerial experience at the Treasury comes amid growing anxiety in sections of the Conservative party about the ballooning deficit and spiralling debt burden.
Tory concerns about how to pay the bills have mounted after Sunak spent a further £30bn last Wednesday on measures aimed at firing up consumer spending and saving millions of jobs. Gauke, writing for the Observer online, says the country is heading towards an annual deficit of £350bn and that for the first time since the early 1960s the size of government debt will exceed the size of the UK economy.
Last night other senior Conservatives said publicly and privately that prime minister Boris Johnson and his chancellor would have to be honest with the country about the pain ahead, and spell out how to bring borrowing under control this autumn to calm the markets.
The Tories now face acute political and economic dilemmas. With the Johnson government committed both to “levelling up the country” and avoiding increasing taxes where possible, something will have to give, Gauke says, if a sterling crisis is to be avoided. “Once we are through the economic shock ... the government will have to fill this gap with tax increases or spending cuts,” he says.
“Unlike the situation in 2010, it is hard to see that there are substantial savings to be made in government spending. The one obvious exception is the pension triple lock – if wages are stagnant (or even falling) and inflation is negligible, it would be an act of intergenerational unfairness to increase the state pension by 2.5%.
“But it is clear that tax increases will have to do most of the heavy lifting ... a £40bn tax rise would be the equivalent of an increase of 7p on the basic rate of income tax or an increase of 6% on VAT.“The political challenge in raising tax by the necessary amount will be immense. Any plan will need to be seen as being fair – those with the broadest shoulders will have to bear the greatest burden – but must not undermine our attractiveness as a location for investment and wealth-creating individuals.
“It is also not yet clear that the Conservative Party as a whole is reconciled to the reality that sound public finances will require higher taxes.”
Former Tory leader Iain Duncan Smith said that while the government could probably live with higher levels of debt than in the past, due to low costs of servicing it, there would “almost certainly” have to be “windfall” tax increases on businesses, such as food retail, which had done well in the Covid crisis. However small and medium sized businesses that would be “critical to the recovery” had to be protected as would consumers as painful choices were made.
“We should always be worried about the levels of borrowing,” he said. “The next statement in the autumn will have to show how we intend to restore the balance.”
In his statement last Wednesday, Sunak announced a short-term VAT cut for hospitality and tourism and an August “eat out to help out” discount scheme. He also cut stamp duty for nine months, raising the threshold in England and Northern Ireland to £500,000, as well as creating subsidised jobs for young people.
The former Tory peer and business journalist Patience Wheatcroft, a former editor of the Sunday Telegraph, said the extent of borrowing was “terrifying” and with Brexit approaching the economic dangers were immense.
“It is hard to see how tax increases can be avoided,” she said. “‘Make the rich pay for Covid’ is not a slogan with obvious appeal to a traditional Conservative government but it might appeal to Dominic Cummings.”
Will Tanner, the former No 10 deputy policy head and director of the thinktank Onward, said Sunak had been right to try to give the economy a “much-needed shot of confidence…at a point of maximum vulnerability”. He added: “But it was just as notable what he left unsaid. Today’s unprecedented borrowing is merely tax or spending cuts deferred. By the autumn the Treasury will need a robust plan for how we are going to pay for all this.”
Any threat of tax rises will, however, put the Tory government on a collision course with its traditional supporters in the business community. Business leaders insist ministers must maintain support through to next year, with funds set aside to increase investment in new industries to boost growth.
Adam Marshall, director general of the British Chambers of Commerce, said: “Now is not the time for us to be cutting back spending or increasing taxes, which would have the effect of pulling the rug from under the economy.”The International Monetary Fund (IMF) and Organisation for Economic Cooperation & Development (OECD) have said in recent weeks that governments should be relaxed about higher borrowing.
Both organisations, which supported the coalition government’s austerity plans in 2010, believe lower borrowing costs are likely to persist for several years and governments should use the cheap funding to promote a green agenda with investments in a range of carbon-reducing schemes.
Jagjit Chadha, head of the National Institute for Economic & Social Research, said the role of the Bank of England in lending to the government and keeping down interest rates had proved crucial and would keep borrowing costs low for many years.
“To the extent that the spending by the government will be temporary and designed to deal with the pandemic, we can think about it as like fighting a war and paying for it over the longer term,” he said.
“The average term of government debt is already 15 years and I see no problem in issuing 30-year bonds to finance spending for what is an extraordinary event.”
Carys Roberts, head of economics at the left-leaning thinktank the IPPR, said Sunak’s mini budget had “failed to grasp the scale of the problem, and especially the potential for mass unemployment”. She added: “The idea that we are out of the woods is for the birds.”
But she backed proposals for a tax on excess profits made by firms that had performed well in the pandemic.
