Beware of Conservative leadership candidates promising tax cuts

And they’re off. The race to become the next leader of the Conservative Party and the next British prime minister is underway. On the steps of Downing Street, Boris Johnson said he is confident his party will elect someone “dedicated” to cutting taxes because, as he put it, “that is the way to generate growth and the income to pay for great public services”.

On Thursday morning, the government’s own forecaster has been arguing that the evidence demonstrates the opposite is true. According to the Office for Budget Responsibility (OBR), tax cuts leave the public finances in a worse position. They can lead to higher economic activity but the tax revenue that activity generates is not usually enough to offset the direct loss of income they cause to the Treasury. This matters because in the next few weeks a series of would-be prime ministers are likely to make promises to cut taxes a central part of their pitch.

On Thursday morning, the OBR warned that, while in the short term there may be some wiggle room for giveaways, in the long-term the public finances are on an “unsustainable path” with the nation’s stock of debt on course to rise from 90% to 267% of GDP in 50 years time. The Conservatives were elected in 2019 on a manifesto pledge to balance the books and to ensure debt is falling by the end of the parliament.

The next Tory leader, therefore, is likely to have to honour the fiscal rules set by Rishi Sunak.

Business and Economics Editor Joel Hills asks Richard Hughes, Chair of the OBR, how much of the £30 billion "headroom" is left

Back in March, the OBR calculated the chancellor had “headroom” of around £30 billion against those targets to play with. But the economic news has since worsened and that “spare” money is rapidly being eroded. “[The £30 billion of headroom] is increasingly at risk,” Richard Hughes, Chair of the OBR, told ITV News.

“It is at risk from high energy prices, it is at risk from rising interest rates and it’s also at risk from the fact that inflation is putting pressure on departmental budgets.

"Inflation is putting pressure on pay which will erode the nominal value of those budgets which were set back in October when we thought inflation was going to be closer to to 4% rather than the double digits that the Bank of England is now forecasting”.

ITV News' Joel Hills explains the concerns held by the OBR over tax cut promises

The OBR says the public finances are in a “good” position in the short to medium term but only because of the substantial tax rises introduced by the last chancellor, Rishi Sunak, in the wake of the pandemic. By 2023/24, the Health and Social Care Levy (£19 billion), the increase in Corporation Tax (£17 billion) and the freeze to income tax thresholds (£10 billion) will be bringing in very large sums of money each year.

The OBR analysis suggests the next prime minister and their chancellor will find it difficult to unwind any of these tax rises, let alone making substantial tax cuts. The economic outlook is bleak. Inflation is on course to hit 11%, businesses are seeing their profits wiped out, millions of households worry about making ends meet.

Additional tax cuts could be used to support those who are feeling up against it but run the obvious risk of making the inflation problem worse and forcing the government to raise interest rates more aggressively. And, as the OBR points out, in the long-term the pressure on the public finances will only intensify. Future governments will have to find the money to provide for an ageing population, to support the transition to net zero and to replace the fuel duty revenue which will be lost as petrol and diesel cars disappear from the roads. The pound did rise against the dollar on news of Boris Johnson’s resignation but not by much. The muted reaction was probably due, in part, to the ongoing uncertainty about who will replace him and what agenda they will pursue. It also suggests that that the pound’s weakness has more to do with investors’ assessment of the UK’s economic prospects than the chaos in Westminster.

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