Higher borrowing still leaves room for tax cuts, says IEA expert
19 August 2022
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Economic Theory
Matthew Lesh writes for CapX
18 August 2022
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Commenting on the latest ONS public sector finances figures, Julian Jessop, economics fellow at free market think tank the Institute of Economic Affairs, said:
“The latest data on the public finances have provided some more ammunition for those arguing that higher inflation means the UK cannot afford tax cuts, but this is misleading.
“Monthly borrowing in July was £4.7 billion more than the OBR had forecast in March, partly due to an increase in the cost of government debt. But even allowing for this, the overshoot in the fiscal year to date was just £3.0 billion, which is practically a rounding error.
“More importantly, the ratio of debt-to-GDP continued to fall, from 96.1 per cent in June to 95.5 per cent in July.
“The bigger picture is unchanged. Dire forecasts for the public finances tend to take the economic outlook as given. But you do not have to agree that tax cuts can fully pay for themselves in order to believe that they will have some favourable effects on growth and inflation.
“Most of the expected jump in spending is due to the impact of higher RPI inflation on the principal value of index-linked gilts. (This is why the ONS refers to interest ‘payable’, rather than actually ‘paid’). This will only fall due when each bond matures, spread over many years, and is not a real constraint on the scope for tax cuts now. In the meantime, the real interest rate on inflation index-linked debt is still negative.
“Even on the more pessimistic forecasts, the boost to revenues from higher inflation would offset higher spending within a couple of years. Any sensible fiscal policy (and fiscal rules) should be able to look past temporary fluctuations in borrowing, especially during an economic crisis.
“Last but not least, even if the absolute amount of borrowing is higher in cash terms, a greater increase in nominal GDP should still reduce the debt-to-GDP ratio, which is what really matters for the long-run sustainability of the public finances.”
ENDS
Notes to editors
Contact: media@iea.org.uk / 07763 365520IEA spokespeople are available for interview and further comment.
“The latest data on the public finances have provided some more ammunition for those arguing that higher inflation means the UK cannot afford tax cuts, but this is misleading.
“Monthly borrowing in July was £4.7 billion more than the OBR had forecast in March, partly due to an increase in the cost of government debt. But even allowing for this, the overshoot in the fiscal year to date was just £3.0 billion, which is practically a rounding error.
“More importantly, the ratio of debt-to-GDP continued to fall, from 96.1 per cent in June to 95.5 per cent in July.
“The bigger picture is unchanged. Dire forecasts for the public finances tend to take the economic outlook as given. But you do not have to agree that tax cuts can fully pay for themselves in order to believe that they will have some favourable effects on growth and inflation.
“Most of the expected jump in spending is due to the impact of higher RPI inflation on the principal value of index-linked gilts. (This is why the ONS refers to interest ‘payable’, rather than actually ‘paid’). This will only fall due when each bond matures, spread over many years, and is not a real constraint on the scope for tax cuts now. In the meantime, the real interest rate on inflation index-linked debt is still negative.
“Even on the more pessimistic forecasts, the boost to revenues from higher inflation would offset higher spending within a couple of years. Any sensible fiscal policy (and fiscal rules) should be able to look past temporary fluctuations in borrowing, especially during an economic crisis.
“Last but not least, even if the absolute amount of borrowing is higher in cash terms, a greater increase in nominal GDP should still reduce the debt-to-GDP ratio, which is what really matters for the long-run sustainability of the public finances.”
ENDS
Notes to editors
Contact: media@iea.org.uk / 07763 365520IEA spokespeople are available for interview and further comment.
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