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Theresa May faces stark choice: raise taxes or increase borrowing

Date: 10 June 2017
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Publisher: The Times

So what’s it to be? Will the government stick to the spending plans set out in the last parliament; will it be, as its manifesto suggested, more of the same? Or will there be an easing up on austerity?

The manifesto wasn’t exactly full of spending pledges. Quite the reverse. The aim for a balanced budget remains. No new money really for the NHS. No sign that planned benefit cuts won’t happen. More years of pay restraint for public sector workers. A social care policy that gave with one hand to those needing residential care but took with the other from those receiving care in their home. You have to look pretty hard to find any sign of goodies to be dispensed.

So is that it then? Just more years of fiscal grind? To some extent, I’m sure — but there’s more to it than that.

First, the politics. The Labour offer could not have been more different. A large section of the electorate was attracted by the idea of huge spending increases to abolish tuition fees, increase public sector pay and give more to schools, the NHS and much else. Of course all those promises looked attractive because voters were not asked to pay for them, although they would, in fact, have had to. A prime minister without a majority might feel the need to make compromises here.

Second, it’s worth looking at what happened last time. Messrs Cameron and Osborne foug the 2015 election on the promise of more austerity but when the pressures on some of the public services became too much, more money was found.

Perhaps most intriguing, though, is the extent to which the Tory manifesto hinted at being open to a different approach. The deadline for balancing the budget was pushed back into the middle of the next decade. The need for some fiscal wriggle room during the Brexit process was recognised. And the Conservatives carefully avoided ruling out tax increases. They can just about claim that an increase in public spending, financed by more taxes or by more borrowing, is consistent with their manifesto promises.
 
If they are really trying to balance the budget though, their room for manoeuvre will be limited without some fairly serious tax rises. Given the trouble Philip Hammond had with the small increase mooted in his March budget, and given the lack of a majority, serious tax rises don’t look likely.

In which case it may be that the most important decision the government takes will be over whether to stick to that target to get borrowing down to zero, or whether to buy some more fiscal space by accepting a higher level of borrowing in the medium term. As ever there are costs and trade-offs — borrowing is not a free lunch. But that is a feasible option, which could make the next few years a lot easier for the prime minister and chancellor.

One danger of relying on borrowing is that it allows tough choices to be avoided. The Conservative manifesto was a bit of a curate’s egg where tough choices were concerned. On the one hand there was no acknowledgement of the dangers and difficulties of more years of spending restraint, and certainly no tax increases were spelt out. On the other hand it did take some steps towards recognising that intergenerational equity might demand an end to the pension triple lock and, of course, the harsher means-testing of domiciliary care.

Whatever their merits as policies, it was courageous, as Sir Humphrey Appleby would say, to spell them out in a manifesto. Labour not only avoided any such choices but even pledged, at what would be huge future expense, not to implement planned increases in pension age.

No government can avoid tough choices. One is to borrow more. If this government decides against that, and is serious about balancing the budget, the choices will be tough indeed.

This article was first published by The Times and is reproduced here in full with permission. Paul Johnson is director of the Institute for Fiscal Studies. Follow him on twitter @PJTheEconomist.