Con SP: "Stability of the public finances" at Institute for Fiscal Studies

[Samuel Gallagher]

 The Chancellor of the Exchequer spoke at a budget event hosted by the Institute of Fiscal Studies.

Thank you, Robert, for your kind invitation. It is a pleasure to be here.

My intention was to start my remarks with a discussion of the macroeconomic framework in which fiscal decisions are made - particularly in today’s climate. However, the bar for a responsible discussion of the economy and public finances appears to have been lowered as of late. I suppose I’ll leave it at this: I won’t debase the currency. I won’t start a run on the pound.

*makes a move almost as if she's walking away from the podium.*

In all seriousness - I do agree with Ms Kinsey on one thing: people are not numbers. And the human costs of debasing the currency are profound. Aside from the fact that the Bank of England does not issue cheques, relying on a central bank to print money and distribute it is unprecedented in a modern, functioning economy. That is the monetary policy of Weimar Germany or, more recently, Zimbabwe. It is a recipe for rampant inflation, for the collapse of the value of the pound.

The catastrophic effects of a run on sterling would devastate ordinary people. There is the inflationary impact, which would see the value of the pound in one’s pocket purchase less. There is the wage impact, which would see real wages decline significantly, if not precipitously. With currency in crisis, it would become easier for foreign purchasers to dominate the housing market, preventing ordinary people from buying homes. These are real consequences that working people would face.

A broader discussion allows us to acknowledge that the consequences of currency destabilisation are far greater than the impact on individuals. It’s not just that the value of money diminishes rapidly: capital flees markets. The value of pension funds, savings accounts, and the like collapse. British financial institutions, already seeking to raise capital, would face exponentially greater pressure in global markets. Any illiquidity in financial markets would be exacerbated by the increased interest rates that a run on the pound necessitates. Crippled by inflation, businesses would find it even more difficult to get loans. These are economy wide effects.

The cost of the Bank of England handing out checks, of reckless monetary policy, is considerable: almost beyond comprehension. Creating free money risks destroying confidence is the pound, with catastrophic consequences. A run on sterling. A cost of living crisis for normal people. A capital flight crisis. And a devastating financial crisis caused, not by illiquid assets, but by political recklessness and populist gamesmanship.

This is not an abstract exercise. The Russian ruble. The Mexican peso. The Asian financial crisis. The Turkish economic crisis. The Argentine economic crisis.These are real financial crises that occurred during my professional life. They are, at their core, currency crises. Many teach us that central banks cannot just print money and hand it out.

And that is what has been proposed by the Opposition. That is what they proposed in their desire to keep the cost of their plans hidden from the public. While a responsible party would admit the cost and add it to the deficit or the debt, they chose to transform monetary policy. To mask the cost of their policies, the Opposition would risk a run on the pound. How can we talk about sound public finances when that is their position?

The rhetoric is that they’re doing this to help people weather the storm. The reality is different. Far from weathering the storm, they seek to make a squall into a cyclone.

So let me state unequivocally the position of this government. We will work with the Bank of England to ensure the stability of the pound. We will preserve the independence of the Bank of England. We will not politicise monetary policy. And, at the same time, we will oppose every effort to politicise it.

Now, I must apologise that recent developments significantly changed the introduction to my comments. I am, after all, here to talk about the work of this government to ensure the stability of the public finances.

As many of you are no doubt aware, the United Kingdom faces the most significant economic challenge in recent history. This economic challenge begets a significant fiscal challenge. The two are, of course, intertwined.

The fiscal challenge we are confronted with is a result of the economic policies of the past ten years. Though it was called a boom, the reality is that the economy we were handed upon taking office was a series of interlocking bubbles: financial services, housing, and public spending. Two of these are, as we now see, tightly related: the financial services boom fed the housing boom and the housing boom fed the financial services boom in a loop.

These bubbles had a large impact on the public finances. When financial services boomed, tax revenues expanded significantly. Instead of putting away some of that money to prepare for an eventual slowdown in financial services growth, every last pound was funneled into expanding public services. Now, the public services are critical - but there are consequences to the fiscal decisions that we make.

We are living with those consequences today. As tax revenues from banks dry up, the funds to pay for public services are no longer there. The policy of the previous government in spending everything they could means that, when faced with even the slightest wobble in the economy, the current accounts slip back into deficit.

It is against this unfavourable fiscal environment that we must both restore the economy to growth and consolidate the public finances: two seemingly contradictory tasks. Yet, we are prepared to accomplish this in a sound, sensible manner.

Restoring growth is the immediate, near-term priority. In coordination with my colleagues in America and Europe, the decision to stimulate was straightforward: stimulus was necessary. Stimulating early was deemed preferable to stimulating late. Simulating, with the goal of a shorter and shallower downturn, has the potential to protect the public finances, preventing the exacerbation of any stress. A shorter, shallower downturn meaning that less is spend on stabilisers and there is a smaller impact on revenues. So this government acted. We brought forward fiscally prudent, economically impactful measures.

As I recently told Jeremy Paxman, our working families tax cut is far more impactful, particularly for those on low income, than a VAT tax cut. We are putting money where it is most likely to be spent. Where it will have the greatest economic impact. And, notably, where it will provide the greatest support for working people.

Yet stimulus cannot be considered in a vacuum. It must be considered in the context of long-term economic policy. We are playing a long strategy with the stimulus package we brought forward.

Our decision to extend full capital allowances to business frees up billions that can be invested in building stronger industries in the United Kingdom. For capital intensive industries, like manufacturing, this will be a boon. For sectors like renewable energy manufacturing, this boon will be turbocharged by our direct investment in green stimulus. It will promote growth, while diversifying the British economy.

And as we discussed earlier, diversification is critical. Diversification - a stronger manufacturing sector, a stronger technology sector - will mean that the economy and the public finances are less dependent on the financial sector in the future. Fiscal policies, such as expensing, can be used to achieve this. And they are.

Importantly, they will also pay for themselves over time. By replacing writing down allowances with full expensing for the next two years, we will see the cost of writing down allowances decline over the full fiscal cycle. This will produce a stimulus that is revenue neutral in the long term. When growth and value added from the investments are factored in, this will be a revenue enhancer.

Additionally, we are pursuing direct fiscal stimulus, bringing forward significant capital spending on essential infrastructure, such as Crossrail, electrifying our railways, and deploying broadband across the nation. These will provide immediate stimulus, while improving the productivity of the economy in the long term.

Of course, long term investment must be maintained. That is why we seek to be transformative in how we budget for investment. Bringing forward a British investment bank, modeled on the German KfW, will allow us to better leverage capital, and capital markets, to finance projects that will transform the country.

More importantly, it will do so at little cost to the public finances. That is the vital importance of leverage in maintaining a healthy economy and health finances. This is the vital importance of investment in maintaining a healthy economy and health finances.

I look forward to, in due course, sharing the results of our investment review with Parliament and the members of the Institute.

Yet, beyond investment and stimulus, there must be a focus on the two primary levers by which the government ensures the stability of the public finances: taxation and current expenditure. These are critical to the long term stability of public finances.

Maintaining a broad tax base is, of course, critical to the stability of the public finances. As we are currently experiencing with the banks, centering the public finances on a single sector is akin to building a house of cards: one wobble and the public purse is placed under immense pressure.

The same logic can be applied to other forms of taxation, such as a wealth tax. France provides an instructive example. The implementation of a wealth tax led, not to a windfall in revenue, but to capital flight. And that is a real risk: incredibly wealthy people are inherently quite mobile. Building the public finances on taxes targeted at a very small segment of the population, like building them on a specific sector, is like building a house of cards: it risks rapid, devastating collapse.

Of course, maintaining a broad tax base inherently involves ensuring our tax laws are enforced. That is why I have increased the resources available to Her Majesty’s Revenue and Customs to enforce our laws. Yet, I acknowledge that we can do better. The government will bring forward proposals to introduce general anti-avoidance rules and other measures to prevent those who seek to avoid paying taxes from succeeding. Ensuring that taxes are paid is a basic duty of government. We will carry out that duty diligently.

Importantly, enforcing tax laws is fundamentally conservative. Conservatism is built on respect for the rule of law, on fulfilling our civic duties. It is not about looking for loopholes. It is not about special treatment. We seek to change our tax laws to build an environment for competitive capitalism, not crony capitalism.

And, finally, we must look at broader taxes where they are appropriate. My inclination is, generally, to avoid taxation where we can. However, where it would serve a broader societal purpose, I am not opposed. It is a high bar to clear, but the Treasury is investigating just how we would clear it. Examples might include countercyclical levies designed to reinforce financial stability or levies charged to non-domiciled individuals who do not pay tax in the United Kingdom, but benefit from our services. I should hope to report back soon on such developments - though as I am fond of saying: budget decisions will be taken at budget.

Tax policy is not the only lever we have at our disposal. Current expenditure must, constantly, be reviewed. Yes, we anticipate current expenditure declining, in the medium term, as we overcome the economic headwinds that we face and people move off benefit and into work. But looking at reduction in spending on stabilisers declining is insufficient.

That is why this government has instituted a sweeping efficiency programme to save the public money. Striving for continued efficiency in government allows us to put money towards reducing the current deficit and spend more on the frontline services.

We will continue to push for efficiencies in government. We owe that to the public.

However, we recognise that there will need to be control of current expenditure. Particularly after the nation overcomes economic turbulence. While I am committed to increasing funding for our frontline services, I cannot say the same about administration broadly. There will come a time when spending limits are firmly enforced on the current account.

That does not mean that we will not spend. It means that we will spend wisely. Spending requests from departments will have pass muster: we will not just spend for the sake of spending. An example of this is rehabilitation expenditure by the Ministry of Justice. Instead of just increasing budgets, we are introducing targeted initiatives that can be assessed for effectiveness. I commend the Home Secretary for her work on this front. 

We will not implement spending limits in a way that hampers our exit from challenging times. Growth will be emphasised in all that we do. And we know that fiscal consolidation, in the long term, can promote growth. Strained, high levels of borrowing raise interest rates, slowing investment. That impacts the growth of the real economy. So we must be cognisant of that.

And we will be. Responsible fiscal policy that moves to stimulate the economy in the near term and consolidate the public finances in the long term is a sound solution for ensuring Britain’s return to productive growth. It is a sound solution for ensuring the stability of the public finances.

That is the course this government is taking. That is the course we will take throughout the squalls ahead.

And it is my mission to ensure that this government succeeds.

Thank you for your time.

*goes into Q&A mode with the audience*