After the pandemic: Sunak signals the UK’s return to fiscal conservatism

Rishi Sunak’s Budget on March 3 will be drenched in red ink. The UK chancellor has already spent about £280bn on helping the economy through the Covid-19 pandemic and the bill will keep rising next week; Britain is not scheduled to fully reopen until June 21.

Sunak — like finance ministers around the world — is throwing money at fighting coronavirus, scrapping fiscal rules and seizing at the lifeline of historically low interest rates. Like Janet Yellen, US Treasury secretary, Boris Johnson’s government is “acting big” in the crisis.

But in an era when economic orthodoxy has been put on hold — governments from the left and right alike are spending on a massive level to avert catastrophe — Sunak will use his Budget to signal that the borrowing binge cannot last forever. Fiscal discipline is about to become, yet again, a defining battle in British politics.

While economists around the world argue that with historically low interest rates borrowing is not a big concern and vast stimulus packages are the order of the day, Sunak is expected to signal future tax rises — notably a rise in corporation tax — to show that he is serious about closing Britain’s structural deficit.

The policy is controversial with many Conservative MPs, who think businesses have suffered enough. “No tax rises,” said John Redwood, a former Thatcherite cabinet minister. “You can only have a chance of fiscal discipline if you rebuild the economy first.”

Johnson is instinctively nervous of tax rises and tensions with his chancellor could lie ahead. But those close to the Budget process say Sunak could signal an increase in corporation tax from 19p to a rate in the mid-20s over the parliament — still one of the lowest headline rates of any major economy — with warnings of more tough choices to come.

In anticipation of possible trouble, Mark Spencer, government chief whip, has warned Tory MPs that if they vote against any of Sunak’s Budget measures it will be treated as a vote of no confidence in the government: a serious disciplinary offence.

Meanwhile, the chancellor has been preparing the ground for a two-pronged strategy, combining high spending now with a plan to stabilise debt in the medium term.

According to one Tory MP briefed by Sunak ahead of the Budget who declined to be named, the chancellor says: “The one common theme that has seen us win four elections in a row is fiscal credibility. If we lose that, people won’t believe us on other things.” One ally of Sunak says: “Rishi believes there’s not much point to the Conservative party if we don’t want to put the public finances back on a sound footing.”

Why Sunak wants to do it

Sunak’s Budget will therefore be a mixture of huge extra spending in the short term — policies like the furlough job support scheme will be extended into the summer — coupled with a clear warning that a reckoning lies ahead, when the long-term damage to the public finances caused by Covid-19 will have to be repaired.

At the age of just 40, and a little over a year into his job at the Treasury, Sunak is confident that he is making the right call, economically and politically. One business leader with close Treasury connections says: “At a time when everyone else in the world is saying ‘how big is your stimulus?’ he is striking a different note. I think it’s personal — it’s who he is.”

Sunak’s allies say he is not relaxed about the prospect of interest rates staying close to zero. While he is willing to borrow cheaply over the long term to cover Britain’s Covid debts — Tory MPs call them “war bonds” — Sunak wants to bring borrowing under control once the crisis has passed. The Treasury fears that “scarring” caused by the pandemic could leave the economy permanently smaller and create a £40bn hole in the public finances, exacerbating a debt servicing problem if rates start to rise.

“I want to make sure that one day, when the next shock comes along, we can respond comprehensively and generously again,” he said this month. “That will require sustainable public finances in the future and I’ll always be open and honest with people about exactly what that means.”

Sunak also believes this is the right time politically to start talking about fiscal discipline, even if tax rises may not start to bite until later in a parliament which could run until 2024 — hopefully once the pandemic is firmly in the rear-view mirror.

“Our polling shows clearly that people accept that there is a bill to be paid for all of this spending,” says one Conservative strategist. Sunak wants the Tories to fight the next election on a platform of fiscal credibility — putting Labour on the other side of the dividing line. “We have to start now,” said one colleague of the chancellor. “We can’t start talking about it in three years’ time.”

The economics

Sunak has long insisted that his coronavirus spending spree, protecting jobs and livelihoods during the pandemic, was the “fiscally responsible” thing to do, but as virus cases decline, “we should look to return the public finances to a more sustainable footing”.

But with borrowing likely to be about £350bn in 2020-21 and Covid-19 support measures likely to extend into the next financial year, the chances are slim of sticking to the government’s manifesto target of only borrowing to invest in three years’ time, which would imply bringing the overall deficit down below £60bn a year. 

In the unlikely event he chose to stick to the timetable outlined in the manifesto, Sunak would be sailing against a strong tide of international opinion, which says that countries should seek to recover fully from the pandemic before addressing their public finances.

The IMF, World Bank and OECD have all forcefully altered their recommendations for countries, such as the UK, which have few immediate constraints from financial markets in borrowing, arguing that borrowing is not a huge concern when interest rates are at historically low levels.

In its first assessment of the $1.9tn American stimulus plan, worth 9 per cent of gross domestic product, the IMF concluded that it would raise the performance of the US economy without generating inflationary pressures. Predicting that President Joe Biden’s stimulus would raise inflation only to 2.25 per cent in 2022, Gita Gopinath, the IMF chief economist, said this was “nothing to be concerned about”.

The sanguine stance taken by international bodies that have traditionally been fiscal hawks stemmed, Gopinath said, from globalisation, automation and the credibility central banks have built up in inflation control. 

Sunak shares the view that the recovery must be entrenched before tax rises kick in — one minister says “there’s a difference between when you signal things and when you do things” — but the chancellor knows that the latest economic fashions do not protect him from government departments always wanting to spend more and longer-term fiscal concerns.

Torsten Bell, director of the Resolution Foundation and a former Treasury official, says he might be “unfashionable” in understanding the chancellor’s concerns, especially when there will be difficulties reining in health budgets after the pandemic. 

The most likely fiscal target will not be a near-term ambition for the deficit, but one that seeks to stabilise debt in the medium term. But even that will involve tough decisions soon unless it is far into the future, Bell says. 

Problems ahead

Talking tough on tackling the deficit is one thing: Sunak’s problem could be getting tough measures past Tory MPs and his neighbour in Downing Street, Johnson. “It’s pretty clear that Rishi Sunak’s instincts are those of a fiscal conservative and he wants to take action sooner rather than later,” says David Gauke, former Treasury minister. “You also have a prime minister who’s very reluctant to take any difficult decisions before he really has to. That makes it more challenging.”

Johnson has ruled out a return to the public spending austerity programme of David Cameron’s governments from 2010-16 and he has also tied Sunak’s hands when it comes to putting up taxes. “Boris is certainly sceptical on fiscal discipline,” says one Treasury official. Although both sides insist chancellor and prime minister are working together well on the Budget for now, tensions will rise ahead of a second autumn Budget when the tough decisions start to be taken.

Johnson’s penchant for grand projects is well known; his plan for a bridge or tunnel between Scotland and Northern Ireland is viewed in the Treasury as a monumental white elephant. He has also told Sunak he must honour the Tory manifesto commitment not to raise rates of income tax, value added tax or national insurance — the three biggest revenue-raisers for the exchequer.

So far Johnson has sanctioned “difficult choices” by Sunak that — in reality — have been relatively straightforward to deliver, including last November’s £4bn cut to Britain’s overseas aid budget and pay freeze for some public sector workers. A rise in corporation tax is unpopular with Tory MPs but would still leave Britain competitive internationally.

The next round of possible options to deliver Sunak’s fiscal discipline could be much harder for the prime minister to swallow. Freezing income tax allowances — drawing more people into higher tax bands — will concern key Tory voters, as would any rise in fuel duty. Reforms to capital gains tax, property taxes or pensions tax relief would hit traditional Tory voters hard, particularly those in the wealthy south.

One veteran of the Treasury during the post-financial crash austerity era claims Sunak and Johnson will ultimately duck those tough choices: “Sunak will continue to imply that fiscal tightening is around the corner but it will always be pain deferred. Generally, when governments give up on fiscal rectitude, it’s a market crisis that makes them see the error of their ways.”

But Sunak, who represents a northern constituency, insists he can put together a strategy which will help the Conservatives to hold on to the working class former Labour voters who switched to the Tories in large numbers at the 2019 election. It is the battle that could determine the outcome of the next election.

Scrambled politics

Sunak tells Conservative MPs that his party cannot win a straight race with Labour on who can spend the most money — and that is a view shared by many Tories representing northern seats. Richard Holden, MP for North West Durham since 2019, says his dream election message would be: “Economic credibility, promises delivered, more to come in the future.”

Holden says the government must show that its investments in schools, hospitals, police and infrastructure are being delivered and that they can be maintained because the public finances are under control. “Labour didn’t lose the last election because people didn’t like their spending plans,” he says. “They didn’t trust them to deliver them.”

Sunak’s strategy is to try to outflank Labour leader Keir Starmer on both sides: offering high levels of spending, including infrastructure investment funded by long-term borrowing, with a pledge to keep a tight grip on day-to-day spending. Tax rises, if Tory MPs allow them, would largely hit better off voters or businesses.

Starmer is trying to work out how to respond in a transformed political environment, where he could face a party of the right at the next election preaching fiscal discipline having just run up a £350bn deficit after a huge state intervention against coronavirus.

The opposition Labour leader acknowledged the fight ahead in his first big economy speech last week. “I know the value of people’s hard-earned money — I take that incredibly seriously,” he said. “To invest wisely and not to spend money we can’t afford — those are my guiding principles.”

That speech built on the recent annual Mais lecture by Anneliese Dodds, shadow chancellor, which used the word “responsible” 23 times as she pledged a “responsible economic, fiscal and monetary policy.”

Starmer knows he has to establish that credibility — badly tarnished during the leadership of the leftwing Jeremy Corbyn — before he can get a hearing for the kind of spending programmes he has in mind, such as improved housing, social care and action to tackle climate change.

Starmer has sought to make the case that governments should be judged on how they spend money — a jibe at Johnson’s wasteful spending during the Covid crisis on items such as protective equipment and a test and trace system — rather than how much they spend. Leftwing Labour MPs would prefer Starmer just promised to outspend the Tories.

Stewart Wood, once an adviser to former Labour prime minister Gordon Brown, predicts a battle for control of the political narrative in the coming months.

Lord Wood says that 10 years ago the former Tory leadership under Cameron and George Osborne ruthlessly engineered a narrative that the economic crash was the result of Labour’s overspending.

“I suspect that is what Keir’s team want to do, they want to say that of course Boris isn’t responsible for the deaths per se but that years of austerity left the health service in a position where it couldn’t cope with the Covid catastrophe,” he says.

Starmer’s problem is that by the time of a general election in 2024, Cameron and Osborne may feel like ancient history. Johnson, with his enthusiasm for extravagant projects, does not seem like a politician itching to return to austerity, or the “A-word” as he puts it.

At next week’s Budget, Sunak will set the parameters for the next general election, suggesting that voters, particularly in northern marginal seats, can vote for Labour-style spending with Tory-style fiscal discipline.

It is a strategy heavy with political risk — neither Conservative MPs nor Johnson are likely to be comfortable with the some of the tax rises Sunak has in mind — but gradually the contours of post-pandemic British politics are becoming clearer.