Next Wednesday, in a quaint ritual, the Chancellor of the Exchequer will stand up in the House of Commons and announce taxation and public spending levels for the financial year that starts next month. Quaint because, in most essentials, these figures are known already, not because they have been leaked, but because they have been announced. The media’s eager anticipation and saturation coverage of the Budget are outdated. In the past few years, the Budget has become just one stage in a continuous process of projecting ahead plans for the public finances. Last December’s pre-Budget report, the 2003 Budget and the 2002 Comprehensive Spending Review have between them settled most of the public finances for 2004-2005.
It can be tough for the public to follow today’s more incremental style of Budget-making; each speech is laden with pre-announcements and re-announcements. However, it has contributed to one of Gordon Brown’s proudest achievements: long-term stability. Each stage involves gentle nudges on the tiller, rather than furious tacking to and fro in response to changing pressures. This is inconvenient for the media, which thrive on high drama, but makes for good economic management.
For 2004-2005, all personal tax, tax credit and benefit rates have been pre-announced. Income tax and NI rates will remain unchanged, although in the Budget the Chancellor could possibly announce plans to raise NI rates with a year’s notice, as he did two years ago.
As the table shows, changes in other parts of the tax and benefit system have mainly minor effects on incomes in the coming year. Their importance, like much of what is announced these days, lies not in their effect over a single year, but in their cumulative effect over several years.
Take the example of support for families. Last year came the completion of the new tax credit system, in which Brown’s “progressive universalism” gives something to all families, but more to the poor. Now the issue is how the benefits are uprated in future. It has only recently become clear that the “progressive” element (destined for the poor) is about to grow, and the “universal” part of the child tax credit to wither, because it will not be uprated. Brown’s priority is to tackle poverty, and the universal element is designed to buy the middle classes into a sense of solidarity, rather than to become a significant part of their incomes. Yet the crucial “announcement” that the middle-class part of the credit would not be uprated in the years ahead came in a table in an annex to last year’s Budget, which even boffins at the Institute for Fiscal Studies failed to notice.
Similarly, means-tested support for pensioners will grow, at least in line with earnings, while the universal pension merely goes up with inflation. In fact, because average earnings rose slowly in 2003, the “earnings link” this year raised the minimum pension guarantee by only about 50p more than if it had been linked to prices. But if the earnings link with the universal state pension had not been broken in 1980, the pension would now be worth £113 rather than £80, and no means-tested guarantee would be necessary.
Such gradual change over long periods is also shaping the income tax burden. The biggest headlines for Brown’s income tax policy came when he took a penny off the basic rate in 2000, and when he put a penny on NI contributions in 2003. These were eye-catching, but had a very modest effect on incomes, especially when compared to Nigel Lawson’s total cut of 5p off the basic rate and 20p off the highest rate of income tax. Yet the rich pay a growing proportion of the tax bill – the top 10 per cent now pay 52 per cent of all income tax, compared to just 35 per cent in 1979 when, just before Margaret Thatcher came to power, the rich were supposedly being “soaked”. The reason is that tax bands are being raised only in line with prices, so that as the earnings of better-off groups grow ahead of inflation, more of them become subject to the top rate. This “fiscal drag” does not make headlines, yet under Brown alone, the number of higher-rate taxpayers has risen from 2.1 million to 3.3 million.
Budget Day will still bring new decisions on some significant areas of taxation. The Chancellor must set taxes on goods and services, for example. But these are not the big extra revenue-raisers that they were in the days of steep hikes in “sin taxes”. The pre-Budget report hinted that the freeze on duty on spirits would be extended, while taxes on other alcohol, tobacco and petrol have been rising with inflation. A more lucrative area for additional revenues may lie in business taxes.
The real significance of the Budget will relate to the more distant future – and in particular to 2006-2008, the period covered by this summer’s Spending Review, which will mark a critical decision point in the new Labour project. The Chancellor needs to decide the extent to which long-term increases in public spending, initiated in a favourable economic climate, are sustained in a tougher climate in which taxes may have to rise so as to maintain both spending and borrowing objectives. We may see two prudent nudges on the tiller this year, thus avoiding an uncharacteristically sharp tack to avert disaster in the future: the initiation of a gradual future tax increase in the Budget, and a modest reduction in the rate of spending increase in the Spending Review.
The difficulty with this strategy is political. Brown will not be keen to announce a further increase in NI rates this side of an election. Yet a delay until the 2006-2007 tax year would make it all the harder to balance the books.
The answer may be to act now to extend future gains from “stealth taxes”. For example, by freezing personal tax allowances and the thresholds for paying higher-rate tax, rather than increasing them in line with inflation, the Chancellor could raise an extra £8bn between 2005 and 2010. Such a policy would be redistributive: the Institute for Fiscal Studies has calculated that the main impact would be on the better-off half of the population. So on Wednesday, careful analysts will be studying not the more headline-grabbing announcements of the Budget speech, but some obscure tables hidden in the background documentation.
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