It is likely we will have a new chancellor by the end of this week, after Philip Hammond said yesterday that he intends to resign if Boris Johnson becomes the next prime minister.
Treasury officials have been preparing briefing papers for their new boss. There will piles of the stuff, which the new occupant of No 11 will be expected to master. But what might the officials want to get in front of the new chancellor on day one? What might Sir Tom Scholar, the Treasury’s mandarin-in-chief, say in their first short meeting? Pleasantries aside, it might go something like this.
Chancellor, it is a pleasure to be able to welcome you to the Treasury with some good news. The hard work that we have put in with your two predecessors means that you inherit a deficit that is low by all historic standards, record levels of employment and earnings that are finally growing faster than inflation. You might be surprised to hear this from Treasury officials, but we do believe there is room to end austerity and to start increasing spending again.
By how much will of course depend on your decisions. You will need to decide early on what your fiscal targets are. I hope it’s not too presumptuous to suggest that you will already have decided against implementing your party’s manifesto and that you will not be aiming for budget balance. That is certainly how we have read the statements of the new prime minister. That seems to us a perfectly reasonable position. But as you prepare for a spending review in the autumn you will need to be clear with your cabinet colleagues what the reasonable limits on that additional spending should be. We have prepared detailed briefing on this. To give you a flavour, the Office for Budget Responsibility suggested last week that the maximum fiscal loosening consistent with public debt not rising might be in the order of £25 billion. We would advise strongly against using up all that flexibility. But within those limits you should be the first chancellor in a decade to announce some good news on public spending.
Our preparations for an autumn budget are also well under way. In that context we would urge rather more caution over the tax cuts that the new PM has promised. Of course, it is for you to decide, but substantially raising the higher rate threshold for income tax and/or the national insurance threshold will be expensive. It will also be hard to reverse, and the pressures on some public services are, in our judgment, considerably greater than the economic need for big tax cuts. That said we have worked up some options for some modest tax cuts which you might want to consider.
Of course, before any of this, you will want to know about Brexit. You will have heard that the Treasury is full of remoaners and is dead set on stymieing Brexit. Chancellor, nothing could be further from the truth. We have been working night and day for the last three years to help the government prepare. We have ploughed billions into Brexit preparations. Here at the Treasury we have hundreds of staff working on new customs and trade arrangements. We are genuinely as disappointed as anybody that Brexit has not yet been implemented. The economic costs of the continued uncertainty are significant.
We will do everything we can to work with you and colleagues to ensure that we leave the EU on October 31, or as soon as possible thereafter, with a deal, which I know is what you and the PM want. Should it become government policy to leave without a deal we will naturally support you in preparing for that. But I would caution you, as guardian of the country’s economy and finances, to do everything you can to avoid that outcome. I say that not as a politician, and I understand that politics may force us down that route. But, as permanent head of the Treasury, I do need to tell you that leaving without a deal would risk serious short-term disruption and long-term damage to our economy and to the living standards of our compatriots. Chancellor, I have to say it would also make your job vastly more difficult.
I can see you are looking sceptical. As you will see in your briefing, there is literally not one credible economist or economic institution which would disagree with that diagnosis. And before you say it, the consensus view of economists on the impact of the Brexit vote has played out almost exactly as predicted. National income and living standards are a good 2 per cent, or £40 billion a year, lower than they would have been. The OBR, of course, has just published its report suggesting that leaving without a deal could plunge the economy into recession. It would certainly hit the public finances hard and I’m afraid leave you the task of once again dealing with an excessive deficit and rising debt.
Finally, Chancellor, I know the new PM has suggested we might need a September budget to prepare for a no-deal Brexit and ensure the economy is going “gangbusters” by the end of October. Should you decide that is the course you want to take we can be ready, but I would caution against it in the strongest possible terms. For one thing I’m sorry to say there is little we could do to influence the economy that quickly. In any case it would be dangerous to take big economic decisions of this nature — especially permanent ones — until we actually know where we are headed with Brexit.
We are looking forward to working with you through what will undoubtedly prove a fascinating period for all of us here in Her Majesty’s Treasury.
Paul Johnson is director of the Institute for Fiscal Studies. Follow him on @PJTheEconomist
This article was first published in The Times newspaper and is reproduced here with permission.