The price of the pandemic

James Hambro, Partner, Chairman

Journalists and historians are already busy compiling books on the story of the Covid-19 crisis. The first few chapters have probably been drafted, and – depending on the author’s perspective – blame for policy mistakes has been attributed to politicians, advisers (one in particular, perhaps) and scientists.

What few can disagree over is that there will be a monstrous bill to be paid. Chancellor Rishi Sunak’s March Budget was already expected to take government spending this year to £55 billion more than the government received. Now that figure has ballooned to around £337 billion, bringing overall debt to in excess of £2 trillion. Modern monetary policy cannot magic this away.

When numbers get this big it is hard to comprehend their meaning. In simple terms, by the end of the year the UK government’s debt will be more than the whole country earns in a year. And that has not happened since the 1950s, when we were paying off the costs of the Second World War.

Low interest rates

Some might deny there is a problem. With so many central banks buying debt and investors looking for safety, the government is actually now paying less to service this much bigger debt than it was a few months ago. In May the UK government issued a two-year bond paying negative rates. In other words, it was being paid to borrow. The government needs to lock in these low rates for as long as possible. But even then the debt will still need to be repaid at some point.

Growth and inflation

Economic growth and a big dose of inflation in the 1970s did most of the job paying the post-war debts.

With the country facing the worst recession in 300 years, the Chancellor is doing everything he can just to keep the economic embers glowing. He is expected to unveil plans for infrastructure spending this month that will echo Roosevelt’s New Deal series of public works that helped lift the US economy out of the slough of the Great Depression. Perhaps this is why markets seem to be pricing in a V-shaped recovery. Perhaps they are assuming a vaccination is around the corner, too. We are more sceptical about a bounceback. We have never held so much cash in client accounts.

Can inflation help reduce the debt? Current political trends are towards protectionism and deglobalisation of supply chains. That will drive up costs. In theory so should central bank purchasing – quantitative easing. But the government’s 2% inflation target does not look like being breached soon. That may be because of the deflationary pressure of global recession. When no-one is spending it is hard to put your prices up. Inflation looks unlikely to help any time soon.

It leaves the Treasury with the traditional option of lower expenditure – inevitably labelled as austerity – and higher tax.

Higher taxes

If there was ever a time to remove some of the perceived anachronisms in the current tax system it is now.

In 2017 Philip Hammond failed to get through a change in the national insurance rules to tax the self-employed the same as employees. They currently enjoy a 3% discount on their national insurance rates. The Institute for Fiscal Studies estimates that if this were levelled it would raise £5 billion a year. Sunak will surely find it easier to introduce the change now.

Bringing capital gains tax in line with income tax and scrapping higher-rate pensions tax relief could be passed as tax simplifications that only hit the wealthy and would raise a few billion.

It also seems likely that the Chancellor will use the crisis to unchain himself, Houdini-like, from the pensions triple-lock commitment. This guarantees a minimum increase in the state pension each year of either 2.5%, the rate of inflation or average earnings growth, whichever is the largest. It has meant pensions have risen at almost double the pace of earnings for the average worker since 2010. That is arguably unsustainable.

Corporation tax will remain at 19% (it was due to fall to 17%) – that should save £4.6 billion a year. But the Chancellor is unlikely to lift it higher with Brexit imminent and the need for Britain to remain competitive in attracting investment.

Income tax generates nearly a third of government income. Increasing the basic rate by 1% would raise another £4.7 billion. Raising the higher rate by 1p would generate £980 million. These would seem harder taxes to pass – unless, perhaps, they were tied to protecting the welfare state and funding the long-overdue reform of later-life care.

Wealth taxes are unpopular and complex to enact, but it would be relatively simple to reduce inheritance tax (IHT) thresholds and even increase the rate from 40%. IHT generated over £5 billion last year, but a 1% rise in the IHT rate would generate only £360 million extra over three years. To raise significantly will require radical change.

If there is anything positive in the Covid crisis for the Chancellor it is the increased use of electronic payments. Cash is dirty; it is also a source of fiscal leakage. Cash-in-hand payments that are undeclared cost the government over £3 billion a year. In total the government estimates that it is losing £35 billion a year in taxes that are ducked or unpaid in one way or another. Electronic payments will make it easier to plug the leaks.

Paying the price

In conclusion, a collection of these various tax changes might feasibly raise £10 billion a year. That would ordinarily be a lot of money, but it is a fraction of the Covid bill. The furlough scheme alone is said to be costing £60 billion. And that puts the problem into perspective.

Almost certainly future generations will suffer the effects through low growth, fewer employment opportunities or heavier tax, with the impact felt most severely at the bottom of the social ladder.

Gloomy though it sounds, it is hard to avoid the conclusion that the recovery will be drawn-out and painful – and so will the repayment process.

Jamie Hambro is Chairman of James Hambro & Partners

Posted on 15 June 2020

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The value of your investments and the income received from them can fall as well as rise. You may not get back the amount you invested.