Matthew Elliott, Senior Political Adviser and Dr Clive Black, Head of Research
Now that the focus of the Coronavirus crisis is transitioning from people’s health to our country’s economic wellbeing, the Government is working out what further measures are needed to keep people in work and assist the recovery. Alongside the phased easing of the lockdown will be further economic measures from HM Treasury and, possibly, the Bank of England. This political note examines what the Chancellor might announce in early July, considers how the Governor might assist him from Threadneedle Street, and looks at the wider impediments to our economic recovery.
At the beginning of the Coronavirus crisis, there was an initial optimism amongst some, albeit we remained much more cautious, that countries across the world might be set for a short, sharp V-shaped recession. The IMF, ECB and European Commission were all suggesting an economic contraction of 8-10 percent (roughly four times worse than 2008). But these forecasts assumed that the lockdowns would be temporary, and by early Q3 there would be the ability to return to normal economic activity. More recent growth forecasts are therefore now pointing to a deeper L-shaped recession. This concern is well understood by the UK Government, hence the additional measures being planned to boost the economy through the summer.
The fiscal response: HM Treasury
When rumours first started to circulate that the Chancellor was planning another fiscal announcement before the summer recess, it was suggested that the statement would contain a mixture of some measures to stimulate the economy alongside some changes designed to ameliorate the deficit. Income tax cuts were being floated to deliver a feel-good boost, plus further R&D support and infrastructure projects to underline the Government’s continued commitment to ‘levelling up’, the pledge from the General Election.
These stimulus measures would be counterbalanced with higher taxes on dividends and an equalisation of National Insurance payments ‘to ensure the self-employed pay their fair share’, plus further changes to pension tax relief for high earners and a ‘Mansion Tax’ (i.e. extra council tax bands on particularly expensive properties) ‘to ensure the greatest burden is placed on the broadest shoulders’. Consideration was also being given to a new ‘Social Care Tax’ to provide a long-term funding stream for social care – a sector which has been shown by the crisis to be woefully under-resourced.
The rumour mill over the past few weeks though suggests that the balance has shifted, with the stimulus measures set to be announced before the summer, and the additional taxes in a formal Budget later in the year. Even amongst the most fiscally hawkish commentators, the feeling is that having borrowed to ‘invest’ in the economic cushion the Government has provided to individuals and businesses, it should now borrow to ‘invest’ in tax cuts and other stimulus measures.
What might these look like? The following are areas we hope the Treasury will consider as it draws up the next fiscal announcement, whether it’s an Emergency Budget or something less formal. Some of the measures are granular immediate fixes to the crisis, others are longer-term more general areas to consider for the wider post-Covid recovery.
A) Stimulating investment:
Many investment decisions have been delayed in recent years, not least due to the Brexit uncertainty arising from Theresa May’s tenure in No10. But following Boris Johnson’s decisive election victory, Britain’s departure from the EU on the 31st January, and the beginning of the transition period, greater certainty was seemingly restored – just as Covid struck. Hence, a crucial element to escape the economic crisis as rapidly as possible is to stimulate investment. This requires both the Government’s investment funds to be operating optimally and other non-Government investment schemes to be re-energised.
The £500m Future Fund has been a very welcome measure to help high-growth British businesses secure investment to see them through the crisis, but it could be supercharged by allowing companies to not only use convertible debt as match funding, but also money from Enterprise Investment Schemes (EISs) and Venture Capital Trusts (VCTs). Convertible debt is relatively expensive to obtain, and beyond the reach of many businesses outside of London, which rely far more on local HNWIs for funding, often via EIS or VCT schemes. It would therefore make sense to alter the terms of the Future Fund to allow EIS and VCT match funding. This would not only open up the scheme to many more businesses, it would also help the Government’s levelling up agenda.
It is also crucial for the Treasury to do as much as it can over the coming year to stimulate investment more generally. It should, therefore, consider temporarily restoring for the current tax year the EIS and VCT income tax relief back up to 40 percent, from its current rate of 30 percent. And as part of HMT’s ongoing objective of simplifying Britain’s tax system, consideration should also be given to standardising the cap for both schemes at £500,000. It is unclear why it is currently £200,000 for VCTs and £1m for EISs. These changes would stimulate further private investment just as the economy needs it, pushing money quickly into companies as they weather the most difficult part of the economic crisis.
B) Simpler, lower taxes:
The indication that the Treasury is considering a cut in income tax to help taxpayers through this difficult period and to stimulate demand is very welcome news. And it is notable that both Gerard Lyons (Boris Johnson’s longstanding informal economic adviser from his time as Mayor of London) and Allister Heath (Britain’s most economically literate national newspaper editor) have both called on the Government to finance tax cuts through borrowing, rather like Ronald Reagan – the Prime Minister’s favourite US President – did in the White House.
Everyone has their favourite tax cut. Some would like to see Stamp Duty slashed to stimulate the housing market. Others have suggested that hiring staff in economically deprived areas should be NIC-free. Or making all business investment immediately expensable. The group which has looked most closely at what a comprehensive tax-cutting, tax-simplifying agenda might look like is the TaxPayers’ Alliance.
In 2012, the TaxPayers’ Alliance and the Institute of Directors convened a ‘2020 Tax Commission’ under the chairmanship of Allister Heath, which culminated in the publication of The Single Income Tax in 2012. This landmark tax reform proposal recommended a substantial, thorough package of tax reforms, not just cutting tax rates, but also jettisoning whole sections of Britain’s enormous 25,000-page tax code – the longest in the world. Overhauling the tax system is obviously not the focus for an Emergency Budget, but the tax cuts the Chancellor makes should be done with one eye to this medium-term objective of structural simplification.
With this in mind, the TaxPayers’ Alliance is proposing two changes to National Insurance, to protect jobs and boost consumer spending. It would like the Chancellor to, first of all, abolish Employer National Insurance with immediate effect, and replace it from October with a temporary payroll tax of 10 percent (above £4,500 per employee). This would cut the typical payroll tax bill by 38 percent, meaning fewer job losses and more recruitment. And, secondly, immediately abolish Employee National Insurance, replacing it next year with a basic rate surcharge of 10 percent on PAYE income tax. This would make a worker on average wages £1,622 better off this year and £300 better off next year, so boosting demand and delivering notable simplification too. These suggestions might not be the ones to transpire, but we hope Rishi Sunak is considering equally bold measures. Now is not the time to be timid.
C) Wider pro-growth measures:
As well as announcing specific tax changes, we expect the Chancellor will also continue painting the picture of what he would like the British economy to look like in the 2020s. He began this in his Budget in mid-March, which drew on key elements from the Conservative Party’s election manifesto and the foundations laid by Sajid Javid, his predecessor, but a reminder and restatement of that vision would be welcome. And the detail must be bold.
- In terms of infrastructure, as well as working out how to bring in 5G without using compromised technology, how about kickstarting proprietary work on 6G? Why not bring forward plans for a nationwide network of rapid electric vehicle chargers, to encourage people to buy electric vehicles, thus stimulating the sale and manufacture of cars in the UK?
- Pace also needs to be injected into the infrastructure policy, so that much talking becomes actions, not least starting work on national high-speed rail and most particularly across the Pennines, plus necessary road building to reduce the burden of the M62. A government that stops prattling and promising but actually builds a credible link from Sheffield to Manchester would make a great difference.
- On R&D,bring together the brightest and most commercial minds to deliver a stepped change in work, involving the UK’s great institutes and universities, to not only boost confidence in the academic research sector but to do so set against the key challenges and opportunities facing the UK; cyber crime, food science (see below), green energy and technologies, new materials, life sciences, sport and the digital & creative industries, where we are still so globally relevant, and doing so by reaching out and working with the best in the world.
- On the British food system, taking the opportunity afforded to the nation from the exit of the EU Common Agricultural Policy to create a genuinely integrated and world-leading entity. Food is a key industry in the UK, from farm to fork. Questions around food security can be addressed, involving the fusion of traditional and new technologies to build domestic productive capability, so import substitution, whilst structurally enhancing the environment, underscoring world-leading animal welfare, which will feed into trade negotiations, boosting the wellbeing of society, so linking to health policy, and allocating resources against the needs and wants of farmers and the wider society; not the ridiculous misallocations of days gone by.
- On regulation, now is the moment when long overdue changes can be brought in. Liberalising planning to build much needed housing, for example, whilst protecting the green belt and dealing proportionately with nimbies. Introducing a fundamental deregulation programme to permit businesses to flourish, whilst genuinely protecting workers, consumers and the environment, activity that must be inclusive, bringing unions, workers and authorities along on the journey of the benefit of appropriate regulation; in doing so, curtailing a compliance industry that has become self-perpetuating to the cost of the economy, wealth generation and public good.
- On the Global Britain agenda, additional bandwidth should be focused on finalising the new trade deals to come into effect in the New Year. The UK should be working flat out to ensure mutually beneficial trade agreements with the EU, India, Japan and the USA. Additionally, it should be focusing upon ensuring the new points-based immigration system welcomes the best and the brightest from across the world. When it comes to Hong Kong, for example, not only is it morally the right thing to offer a fast route to UK citizenship for Hong Kongers, but it would also be greatly to our economic advantage.
- As for a bigger-ticket item, perhaps now is the opportunity to launch a UK sovereign wealth fund. Policymakers have long admired Norway’s £900bn sovereign wealth fund, and Singapore’s Temasek fund, but it never seems to be the right moment to create one for the UK. But with interest rates at zero, people are now essentially paying to lend the Government money. Like the Bank of England, it would need to have operational independence, but it could function within guidelines set out in law. Perhaps its investments might have to include the companies that are strategically important to the country – the ones the Government is currently discussing assisting through ‘Project Birch’ – but it should primarily be future focused, as outlined in the points on R&D above. So, it could fund ongoing research and development of the UK economy around green energy (including the next generation of tidal and wind power), cyber security, food sciences, life sciences, wellbeing and modern materials. It should think big. Creating a UK sovereign wealth fund would turn a series of gloomy stories about the Government bailing out failing industries into an optimistic, forward-looking one, kickstarting the economy back to health.
With the Prime Minister set to make a significant economic speech at the end of June, we hope his overture will reflect some of these themes, which will then be developed by the Chancellor in his statement in early July, before being amplified at the next full Budget and Queen’s Speech.
The monetary response: The Bank of England
When Rishi Sunak unveiled his first package of measures to tackle the Covid economic crisis, his pledge to do “whatever it takes” was reinforced by a cut in interest rates by the Bank of England and the biggest ever round of Quantitative Easing. Will the new Governor step in once again to help the Chancellor? There are two aspects to this: how long will QE be extended for, and might we have negative interest rates?
A) Quantitative Easing:
With the Government borrowing record sums, the Bank’s continued commitment to QE is obviously essential. In his first week as Governor, Andrew Bailey introduced the biggest and fastest Quantitative Easing purchase programme of all time – £200bn – and the Bank is currently buying at the rate of about £14bn a week – the fastest rate it has ever bought assets at. This action, alongside measures by the Federal Reserve, the ECB and other central banks had an important stabilising effect on markets. It calmed things down, albeit fuelling financial asset prices too.
The question is, how long can the Bank of England continue to buy government bonds at this rate? Andrew Bailey clearly thinks that his big problem is not inflation, but deflation – the Bank’s forecasts have inflation going down to zero in the early part of 2021. His challenge therefore is not to stop inflation, it is to prevent deflation. In which case, it makes sense for the Bank to continue to inject money into the economy to expand economic activity. So with the Chancellor needing to borrow money to not only tackle the immediate crisis but to also ensure a speedy recovery, the Governor will likely stand by him in these efforts.
B) Negative interest rates:
There has also been much discussion about interest rates. One of Mark Carney’s last acts as Governor was to cut interest rates to 0.1 percent, and there has been speculation that Andrew Bailey will go one step further and bring in negative interest rates. To say the Governor is sceptical is an understatement. First of all, there is not a common way of implementing negative interest rates. Some central banks have used tiering systems, which means the system becomes inherently more complex. There is also a need to understand the transmission mechanism, to understand the impact upon the financial system, and how that might play back into the economy. Banks have to earn a net interest margin, so how the net interest margin would behave in a world of negative interest rates is critical, and would vary across institutions, and potentially be very problematic for the institutions involved in much lending at the coal face.
Then there is a set of issues around IT systems and how you implement it – not least the IT systems in the Bank of England. And, finally, there is a communication issue about how you explain it to the public. Without careful communication, it would not only let the public down, it would also blunt the effect of introducing the policy. Introducing a negative interest rate is therefore not a quick or easy process, so reports suggesting that the Bank of England is about to implement negative interest rates are wide of the mark.
Wider impediments to economic recovery
The levers to economic recovery are not solely in the hands of the Chancellor and Governor of course. The lockdown is lasting longer than previously anticipated, as policy shifted from releasing pressure on health services and ‘flattening the curve’ (mitigation) to suppression and hopes of eradication, and this has had a consequent knock on growth forecasts. So economic recovery will not come solely from fiscal and monetary measures.
Travel: The new 14-day quarantine for travellers into the UK will undoubtedly have an impact upon the economy, albeit, like New Zealand, where one remains in place, it is seeking to augment the virus eradication move. EU countries are now opening up to international travellers, so there will be intense pressure on the UK Government to follow suit, to assist the tourism sector during its busiest season. With British Airways launching a legal challenge and backbenchers calling for the policy to be abandoned, it is unlikely to be renewed in its current form.
More broadly, though, travel in general is likely to remain depressed as commuters worry about biosecurity and a stepped change in domestic IT supports working in the suburbs. The expansion of video communication and a new mood on nice to have versus necessary is also transforming business travel, which is likely to have structural consequences. This arena is likely to be a key legacy of Coronavirus, but one where the UK needs to work further still for a vaccine as well as seeking to remain a globally accessible and outward-looking country; something that it has, in the main, always been.
Social distancing: As the lockdown is eased, and businesses are allowed to reopen, the Government is rightly keen that social distancing is maintained to keep the R rate down and prevent a second wave. But an overzealous application of social distancing will prevent many businesses from operating effectively, unless the acceptable social distance is reduced from 2m to 1m. A decision on this is likely to come before the summer, which would boost the food & beverage and tourist/travel sectors; maybe schools should re-cast the year too and start the new academic year much earlier?
Unemployment: All recessions see significant declines in discretionary consumer spending during periods of high unemployment, so the Government was smart to introduce the Job Retention Scheme to maintain employment and consumer spending. Now that the Government is rightly beginning to ease it back, unemployment will undoubtedly creep up. The key question is: how high will it go? Assistance in the form of National Insurance cuts (see above) would help with job retention, boost consumer spending and minimise the economic contraction.
Additionally though, maybe it is time to think radically about training and education, to support the newly unemployed, as well as those at school and those homebound, such as carers? A comprehensive review of digital teaching and training opportunities should be a further bold objective that Government should embrace, so using the Coronavirus tragedy as a threshold to shift our nation’s digital capabilities to the right.
Perhaps the BBC could move away from allocating so much energy and profile from pursuing the political and social agendas of its editorial elite to the more functional reward of mass instruction and training from its terrestrial, ‘free-to-air’, capability; doing so may just merit the universal licence fee, which otherwise could be subject to substantial review.
Behaviour: As lockdowns have been eased across the world, some countries have seen fewer people than expected returning to restaurants and retail outlets. The public undoubtedly took the Government’s ‘Stay at Home’ message to heart, so it will be interesting to see whether a new message can be devised to encourage people to go out and spend, whilst staying ‘alert’. The shock of Coronavirus for many British people, notably the vulnerable and the elderly, but also those caring and about to lose their jobs, should not be underestimated.
The key point at the front of the Chancellor’s mind will be that if demand remains low, the economy will not recover anytime soon, and he has an Election to win in 2024. Indeed, if the British economy is 15 percent smaller than it was before the crisis, for example, that would represent a contraction of the scale seen in Greece at the height of the Eurozone crisis. The ‘new normal’ needs to be as buoyant as things were pre-Covid. The Prime Minister once spoke about ‘Boosterism’. That is precisely what is needed now; it is time to be positive, be structural, be ambitious, be hopeful and be clever.
Matthew Elliott tweets @matthew_elliott. He would like to thank Mark Bathgate (@m_bathgate) for being an invaluable sounding board, particularly on the common economic challenges facing all countries in the corona crisis.