Rishi Sunak can't answer the UK's big tax question

UK Chancellor of the Exchequer Rishi Sunak didn't need to explain why his government is spending and borrowing so much when he issued his budget statement Wednesday. That much was obvious: The independent Office for Budget Responsibility forecast the country's economy will shrink by 11.3 per cent this year, the largest fall in output in 300 years. Even by 2025, the country's economy will be 3 per cent smaller than it was when Sunak delivered his March budget. Britain's "economic emergency has only just begun," he warned.

But like the many other times when the chancellor had to announce rafts of new spending, the real questions were ones he can't answer: Will this next round be enough? What does it mean for taxes?

The review covered day-to-day government spending for the next year. Sunak announced 55 billion pounds ($73.6 billion) for tackling the pandemic. There is also a new National Infrastructure Strategy, investments in homebuilding and subsidies for public transport and faster broadband. He increased the minimum wage for those aged 23 and over and allocated money for helping the unemployed back into work. There's a large increase for defense spending and money for the government's environmental agenda. Sunak repeatedly referred to "the people's priorities" in setting out his program. Despite freezing public sector pay for many workers, there was a little something for just about everyone else.

While the scale of spending is making some of Sunak's fellow Conservatives nervous, Britain can afford the largesse for now and indeed has little other choice. Public debt has crossed the 100 per cent of gross domestic product threshold, but low borrowing costs have made that a secondary consideration.

Although the question of how to pay for all this lingers, Sunak was right to postpone any discussion of revenue-raising measures. The government wants people spending, hiring and investing again, and talk of tax increases tends to spoil the party. Some changes to the capital-gains tax structure are expected. But the success of his current spending measures — and what tax hikes the government will consider — still depend on at least three factors beyond Sunak's control.

The first is a UK vaccination program. That seems to be in the bag. Britain has on order 40 million doses of the Pfizer-BioNTech vaccine and 100 million doses of the Oxford University-AstraZeneca shot as well as 5 million doses of Moderna's vaccine. What needs to happen next is regulatory approval followed by a smooth rollout.

Still, there are unanswered questions around the Oxford vaccine's efficacy. If it turns out to be substantially less effective than the Pfizer and Moderna alternatives, that will raise prickly issues: Would Brits be happy with a vaccine that's only 60 per cent or 70 per cent effective if Americans and Germans are getting one that is 95 per cent effective? If not, that could delay uptake.

The second factor is Brexit, a word that isn't mentioned much by the government these days. There are probably only days left in which to conclude a trade deal with the European Union. The bare-bones version that's on offer will have costs for consumers and the U.K. economy generally, but leaving the single market with no deal is a plunge into the unknown.

In testimony before the Commons Treasury committee this week, Bank of England Governor Andrew Bailey said a no-deal exit would cause greater long-term damage than Covid. The OBR says that due to Brexit, UK output will be 4 per cent lower than if Britain had remained an EU member — but leaving with no deal would wipe out another 2 per cent of output initially. While Covid has ravaged hospitality, transport and non-tradable service sectors, it's manufacturing, financial services and other tradable areas that will suffer from leaving without a deal.

The final factor that's important for spending was alluded to in the last part of Sunak's statement: "Today the government has funded the priorities of the British people; now the job of delivering them begins." In other words, it's easy to dish out funds during a crisis, the challenge is spending it well.

This relies on the capabilities of Britain's large public sector and the managerial nous of various ministers and senior civil servants. There are already questions about cronyism in Britain's rushed procurement program for pandemic personal-protective equipment. New investment plans sound promising, but such projects have a history of budget overruns and mismanagement. You only need to look at the delays and costs on the now 100 billion-pound-plus High Speed 2 rail project to see the difficulty of doing big infrastructure properly.

The UK economy may bounce back better than many assume. The OBR forecasts suggest a structural deficit (what's left when the emergency measures are removed) of 4.5 per cent of GDP in four years' time. How much revenue raising is then needed to bring that down will depend in part on the government's fiscal rules, as Bloomberg Economics' Dan Hanson notes.

And any one of these three critical factors — the vaccination program, Brexit and the delivery of public investment programs — could throw the latest budget plan off course yet again. For now, Sunak is right to keep the spending going while postponing talk of taxes. Britain's workers and its economy need all the help they can get. (Bloomberg)