Carry On Spending

When I was growing up, an extremely popular sequence of films were the 'Carry On' films. They included a cast of staple actors, playing broadly similar characters, in mildly differing situations. They were a product of their times, and as a child I found them hilarious. In the humourless world of today, the films are denounced as misogynistic, racist, and homophobic - mainly because they are. However, they do occupy a niche in British folk memory that leaves them cherished by many. I was reminded of the Carry On films as I listened to the recent Chancellor's Budget speech.

As an economy, we are in trouble. Activity is currently in deep freeze. We are in yet another lockdown, with the prospects of relaxation not being fulfilled for some months to come. The scientists are warning of further waves of infection, which means that further lockdowns can't be ruled out. The vaccine roll out is going much better than we could have hoped for, but we don't know for how long it remains effective. These are not attractive prospects.

The fiscal response has been to provide financial support to households and businesses. This has been reasonably generous in historical terms. A furlough scheme has been introduced where 80% of salary has been funded by the state. For businesses, a series of very soft loans and grants of 80% of profits have been provided from public funds. And for those who have been made redundant, there has been an uplift to out of work state benefits for the crisis period. There have been some constituencies for whom the support has been less generous - company directors who pay themselves through dividends spring to mind - but there are very few who have received no support at all.

All of this funding was due to expire on March 31st. Many pointed to the sudden end to the support, especially as the country is still in lockdown and the ability to earn is very restricted. The Budget announced that most of the support will be extended into the autumn. This fits nicely into an official future in which all lockdown restrictions will be relaxed during the summer. The plan is to have the adult population vaccinated against the virus by the end of summer, allowing a relaxation of the economic restrictions. This will be followed by a short period in which levels of activity return to normal, and at the end of that, economic support will cease. That's the plan. Reality may turn out a bit different, but that's a conversation for another day.

As the Chancellor was rolling out this plan, many were asking how he intended the country to pay for it? And what would happen to the cost of public borrowing if inflation were to tick upwards in an appreciable way? The Budget went a little way to address these questions. A sequence of tax rises were announced - some explicit, such as a corporation tax rise, some stealthily, such as using fiscal drag to expand the tax base. Tucked into the small print were some proposals for public spending. There is, by and large, to be a public sector pay freeze for a number of years to come. This is using fiscal drag to achieve a reduction in public spending in real terms. 

There is a certain retro quality to the Budget. We are returning to the use of fiscal drag and cash limits, last seen in the 1980s, to restrain the public finances. As prices and salaries rise, and as the threshold at which tax is paid remains constant, and as the amount of public sector pay remains constant in cash terms, the politicians need do nothing. Inflation will impose the fiscal squeeze. The system has inflation at 2% built into it though the mandate for the Bank of England. But what if inflation takes off at an appreciable rate in excess of the policy target?

In many respects, the Chancellor has gambled that this happens. If inflation rises appreciably above the policy rate, the impact of the fiscal drag on taxation and cash limits on public spending will be that much more pronounced. It will help to pay down the public debt that much sooner. Of course, it will have a consequential impact on the cost of servicing that debt if interest rates are also forced to rise, but that may be a problem for another day. The average outstanding term for UK debt is 11.5 years. Rising interest rates are only a problem for future issuance, which is, on average, half a generation today.

And so we have returned to the Carry On farce of Treasury operations. We have a Budget that spends oodles of money immediately (Hooray!), that places tax increases on the villainous corporate sector (Hooray!), that introduces a stealth tax on the general public (Boo!), and which reduces public sector salaries in real terms in future years (Boo!). To top it all, the cost of this largesse is palmed off onto future generations through potentially higher borrowing costs (Aah!). Sometimes, politics is nothing more than a pantomime.

Stephen Aguilar-Millan

© The European Futures Observatory 2021