The “Spend Now, Tax Later” Budget

Summary

The majority of the CfM panel of experts on the UK economy thinks that the super-deduction for corporate investment announced in the spring budget will moderately aid the UK’s recovery from the Covid recession, but that the announced corporate tax increases will do moderate harm. Most panelists believe that the government is moving too fast on deficit reduction.

Background

The March 2021 CfM survey asked members of its UK panel of experts about tax, spending, and deficit-reduction measures in the spring budget.

The spring budget                                                          

With nearly a third of the UK population having received at least one dose of a vaccine, there is light at the end of the Covid-19 tunnel. Still in partial lockdown, challenges remain for both the public health and the economy. Chancellor Rishi Sunak’s March 3^rd spring budget announcement reflected these two realities. On one hand, the budget extended and expanded expenditure measures aimed to insure and boost the UK economy this year and next. On the other hand, the Chancellor announced increases in both personal and corporate taxation in later years in an attempt to address the deficit that is likely to remain after the pandemic and to help stabilize public debt. The Guardian referred to this as the “spend now pay later” budget and the Financial Times similarly called it the “spend now tax later” budget.

In the short run, the 2021-22 budget allocates an additional £43 billion to extend previously enacted measures aimed to support households and businesses. (Figures from the Office of Budget Responsibility, OBR.) These include the Coronavirus Job Retention Scheme, which provides financial support to businesses that have furloughed employees and was extended for 6 months to September 2021. The self-employed income support scheme and the universal credit uplift of £20 per week were similarly extended. Business tax rates relief for retail, hospitality, and leisure sectors will also continue. The stamp duly holiday will begin to phase out from July 2021.

The budget also allocated £12 billion for a capital investment “super-deduction”, with an additional £13 billion estimated for the following fiscal year. The super-deduction allows companies to deduct 130% of expenses on capital on most investments on plant and equipment. At the prevailing corporate tax rate, this is effectively a 25% government subsidy on qualifying investments. The OBR chair evaluates that the super-deduction “provides a very strong incentive to bring investment forward from future periods, supporting economic recovery over the next two years.” Martin Wolf, writing in the FT, agrees, but emphasizes that “At most, this will bring investment forward” and argues that capital allowances should have been made permanent. Peter Spencer, Paulo Santos Monteiro and Peter Smith concur that the super-deduction merely removes the incentive to postpone investment due to the scheduled increase in corporate tax rates (giving higher tax payments from which to deduct investments).

Overall, the spending measures come to more than £50 billion or around 2.5% of UK GDP. While this figure is large, it is substantially smaller than the US stimulus passed this month, at $1.9 trillion or nearly 9% of US GDP, and most of which reflects assistance to households.

In the longer run, the Chancellor announced several tax measures to address the public deficit and debt. The corporate tax rate will rise from 19% to 25% in 2023, bringing the UK closer to the G7 average of 27%, but above the OECD average of 22%. It comes close to reversing Chancellor George Osborne’s corporate tax cut from 28% to its current rate and is the first time in 40 years that corporate tax rates will have increased. The existing 19% tax rate will still apply to businesses with profits below £50,000. The government predicts that this measure will raise £17 billion or 0.6% of GDP. Personal income taxes will also bear a part of the burden, with the personal allowance frozen at $12,570 and the threshold for the 40% tax rate remaining at £50,270 until 2025-26. This measure will raise an estimated £8-9 billion a year, because of rising incomes.  

Overall, the budget has received mixed reviews, as one might expect from a large policy shift. The Resolution Foundation posits that the Chancellor largely got it right: “the big picture is more support in the next few years and then tax rises later in the decade. That’s the right approach, but the Chancellor is taking some big risks.” The Institute for Fiscal Studies says the budget does a good job in providing continued support to the economy, but is vaguer on how longer-term budgetary and economic (e.g. inequality) challenges will be addressed. Jagjit Chadha agrees that the budget is unclear on what it is attempting to achieve in the long run or how: “Are we trying to nurture growth, level up, level across, or just get public debt down to 40% or less of GDP?” Jonathan Portes argues that the Chancellor was insufficiently bold and overly focused on deficit reduction in the medium term: “The Government can and should spend what is needed to restore our public services and address the legacy of poverty and deprivation left by the past decade, compounded by the pandemic; and at the same time finance its commendable ambitions to ‘level up’ and decarbonise the economy… When and if this spending results in persistently higher inflation, then higher interest rates and tax rises will indeed be necessary. This is a gamble we can afford to take.”

This month’s survey contains three questions, one on the tax side, another on the expenditure side, and the third on the debt and deficit.

Question 1: How will the increase in the corporate tax rate from 19% to 25% affect the UK’s international competitiveness in the medium term?

18 panelists responded to this question. There was a clear majority (61%) that thinks that the increase in corporate taxation would have a moderately negative effect on the UK’s international competitiveness. An additional 11% thought the damage would be large and 22% that there would be no damage.

Panelists who thought the corporate tax increase would be damaging pointed to the contractionary effect of corporate taxation in a globalized economy. Jagjit Chadha (National Institute of Economic and Social Research) argues that the damage would be large, pointing to NIESR research showing that “raising corporate taxes have larger contractionary impact on the economy that either of VAT or income taxes.” David Miles (Imperial College) also believes there are “better ways to raise revenue, for example by a revamp of housing taxation.”

Nevertheless, most panel members thought the damage would be moderate, because of the multitude of factors affecting international competitiveness. As Charles Bean (London School of Economics) puts it: “The corporate tax rate is but one factor that affects companies’ location decisions. Factors such as the stability and reliability of the legal environment, the cost and availability of appropriately skilled labour, the connectedness of transport systems, the height of international trade barriers, etc., are equally important. So the picture needs to be considered in the round.” Further, Costas Milas (University of Liverpool) argues that “the rest of the world will also have to raise its corporation tax to tackle the rising COVID-19 debt.

Brexit was on several panel members’ minds. Francesca Monti (King’s College London) had thought that “lower corporate and personal income taxes would have been part of the UK government's strategy to reverse, to some extent, the damage inflicted by Brexit on the economy.” Thorsten Beck (Cass Business School) and David Cobham (Heriot Watt University) both thought the corporate tax increase would have no effect because its effects would be swamped by the larger damage caused by the UK’s exit from the EU.

Question 2: To what extent will the “super deduction” aid the UK’s recovery from the Covid recession?

18 panel members responded to this question. Nearly all respondents (83%) thought the super-deduction would aid the recovery moderately. An additional 6% thought it will do substantial harm and the remainder expected it to have no effect. The consensus reflects a broad agreement that the super-deduction will cause firms to bring investments forward. Participants gave a variety of reasons why the effects would be merely moderate.

First, several argued that the super-investment deduction was a drop in the bucket when compared to the challenges the UK faces. Wouter den Haan (London School of Economics) believes that “very few things if any will have a truly significant effect on the recovery.” Charles Bean argues that “the dominant determinant of the pace of the recovery will be the speed at which consumption recovers as the health restrictions are lifted.”  Thorsten Beck adds that “Brexit uncertainties work against it and will certainly offset a large part of the [super-deduction’s] positive effect.”

Second, bringing forward investment may harm longer term growth and thus have limited impacts. Martin Ellison (University of Oxford) claims that this is merely “rearranging the deckchairs on the Titanic.” Michael Wickens (Cardiff Business School and University of York) adds that bringing investment forward “is however at the expense of longer term investment when the super deduction ends. I would prefer keeping the super-deduction and leaving open its end date.”

Third, some argued that the investment acceleration would help the recovery only insofar as it improved employment or business confidence. Panicos Demetriades (University of Leicester) opines that the super-deduction will “bring investment forward… That will no doubt expedite the recovery, but unless it creates many new jobs, it will not make a substantial difference.” Jagjit Chadha adds that “The key objective will be to create sufficient confidence or sense of future profitability across sectors and regions, which may need somewhat more than a tax break. But it is a start.” Simon Wren-Lewis (University of Oxford) isn’t optimistic given the firms that are most likely to benefit, viewing the deduction as “a large transfer of funds from the public sector to companies that mostly did well out of the pandemic, with marginal benefits.”

Question 3: Which of the following best characterizes the pace at which the budget addresses UK’s medium term fiscal challenges (deficit and debt)?

18 panel members responded to this question. The panel was nearly evenly split between the 44% that see the budget as reducing deficits too rapidly and those that think the budget reduces deficits at the right pace. Not a single panel member thinks that planned deficit reductions are too slow.

Panelists who viewed the pace of deficit reduction as too rapid cited poor economic performance and low interest rates as important considerations. Francesca Monti opined that “The UK has a poor performance in terms of productivity compared to many advanced economies and it is also facing the Brexit shock. These factors could warrant fiscal stimulus for longer than what is implied in the current budget.” Wouter den Haan added that “in this continued low interest rate environment, the UK shouldn't worry about paying back the debt soon.” Simon Wren-Lewis directly argued that the spring budget inappropriately focused on deficit reduction: “Sunak has failed to learn from the US example. What should have been a budget for enhancing the recovery, greening the economy and helping those most badly hit by the pandemic. Instead it was a budget largely about reducing deficits. A clear indicator of Sunak's failure is that the OBR expect Bank interest rates to be 0.5% or less when fiscal consolidation starts. Osborne's failure is being repeated, with the only difference being a focus on tax rises rather than spending cuts.”

On the other hand, panelists who viewed the pace of deficit reduction as just right focused on the importance of fiscal balance, and the potential for policy adjustments to be made in the future. Michael Wickens commented that: “The main issue is the extent to which removal of lockdown will generate a large increase in activity. It is too soon to know. Therefore, a later budget would have been better. In the meantime, doing little is probably the safest course. In the longer term it will be necessary return to something like fiscal balance. With a strong bounce-back after lockdown and a longer-term framework, this could remove any need for tighter budgets.” Charles Bean also highlighted the necessity and flexibility of deficit reduction measures: “So putting in place a (contingent) plan to close the deficit and put the debt-GDP ratio onto a falling trajectory over the medium/long term while providing continued fiscal support in the near term strikes the right balance in my view. The tax and spending measures necessary to stabilize the public finances can then be adjusted appropriately in the light of how the economy evolves over the next few years.”