David Gauke: Higher Universal Credit, Public Sector Compensation, State Pensions. And maybe tax cuts. What Sunak should do next.

David Gauke is a former justice secretary and was an independent candidate in South West Hertfordshire in the 2019 general election.

In nine days, Rishi Sunak will deliver his spring declaration. It was clearly his intention for this to be a relatively low-key event. The Office for Budget Responsibility would update its forecast and perhaps some revisions would be announced, but there would be few big announcements on tax or spending policy. Spending issues were addressed last October as part of the Comprehensive Spending Review, and tax announcements have their place in a budget – the next one is due in the fall.

The Treasury likes to have only one big tax event a year. This allows ample time for policies to be properly scrutinized and reduces the opportunity for other parts of government to push for voter-friendly policies that wreak havoc on public finances. Sunak, wary of his Downing Street neighbor who is susceptible to such temptations, is likely to find it highly desirable to limit this tedious process to once a year. On the one hand, it extends the period of time before the Prime Minister learns to spot the various tricks of the Treasury used to thwart any attempt to interfere by outsiders in budgetary matters.

The chancellor was already under pressure to make the spring statement more substantial due to the cost of living squeeze. He preempted this by announcing a council tax refund and energy cost loans, and looked to the upcoming rise in National Insurance contributions. We were heading into a tough spring, but he looked like he could hold the line. And then came Russia’s invasion of Ukraine.

There are some additional immediate expenditure items required in response to the invasion that should not cause the Treasury too much difficulty. Additional emergency defense spending, including arms for Ukraine and NATO allies in the region; humanitarian aid to Ukraine and Ukrainian refugees; targeted interventions to develop domestic energy sources. There is a case (about which I suspect the Treasury is skeptical about the practicalities) for a big push over the next few months in improving home insulation.

It would be understandable for the Treasury to focus now on what we need to do now and address more strategic issues later, when the position with Ukraine becomes clearer. The answer to such questions will almost certainly result in increased defense spending over the medium term, leaving the Treasury with the headache of how to finance it. Long-term expenses and funding can be resolved at a later date.

Where it gets really difficult for the Treasury is the cost of living crisis. Before determining his policy response, the Chancellor will have to consider to what extent the crisis is the consequence of exceptional short-term factors, such as this war, or whether it reveals that the cost of living is permanently higher than expected. thought before. While this is largely the former case, the case for borrowing to intervene is stronger; if it is primarily the latter, the case for meeting these higher costs (preferably while protecting the most vulnerable) is heightened.

We know Sunak is a fiscal conservative. It will not consider it morally acceptable to subsidize the current standard of living at the expense of future generations in normal times. This is an important caveat. After all, Sunak, the fiscal conservative, is also the chancellor who broke peacetime borrowing records in his first year in office. Needs must in exceptional circumstances.

There is a respectable argument that much of the squeeze on living standards is a consequence of the high energy prices that stem from the invasion of Ukraine and our response to it; that it is the price of an economic war in a struggle in which we must win; and that future generations should not oppose the repayment of debts incurred to combat threats to our way of life. In other words, protecting living standards today is to some extent creating a war debt.

The analogy goes no further. We ran up a lot of debt in two world wars and future generations didn’t mind that, but we also spent a lot on defense during the Cold War when debt was generally declining as a percentage of GDP . Are we in a conflict that lasts a few years at most or is this the new normal that can last decades? If the former, we may take a hit to our borrowing, if the latter, we need to worry more about fiscal sustainability.

The situation is also complicated by the fact that much of the pressure predates the Ukrainian war. Energy prices were already high; the standard of living already set to decline. We are poorer than we previously thought, and that is unlikely to be reversed immediately, even if Putin’s regime falls tomorrow and the Ukraine conflict is quickly resolved. This suggests that we cannot avoid at least some damage to the standard of living,

A reasonable response would be to be willing to borrow to ease – but not eliminate – pressure on living standards. Bigger increases in universal credit, state pension and public sector wages than expected, maybe tax cuts (as many Tory MPs are calling for), maybe an extension of the reimbursement of municipal taxes. Even taking into account the fact that tax receipts were higher than the OBR forecast in October, the measures that are only half sufficient to avoid the decline in living standards will lead to a deterioration in public finances.

The Treasury then has two other complications.

First, inflation. The intention may simply be to protect living standards, but borrowing more will provide fiscal stimulus at a time when inflation is approaching double digits. This could cause the Bank of England to raise interest rates faster than it would have otherwise, which will put additional pressure on many mortgage lenders.

Economists disagree on the size of the inflation problem we have and the size of the interest rate hike (another Bank of England hike is widely expected this week). Obviously, prices are rising rapidly, but rising commodity prices are also taking money out of the economy and suppressing demand elsewhere. The risk is that we will see stagnation – inflation and a stagnant economy as we saw after the oil shock of 1973.

The second problem is that temporary fiscal measures intended to deal with temporary cost-of-living pressures will have to be rolled back when circumstances change. The experience of reversing the temporary UC hike was politically difficult and, I suspect, pushed the Treasury towards the bespoke tax refund program, which will be easier to exit in the future. It may be good policy, but it leads to more complexity in our tax and benefit system.

All of this makes next week’s spring declaration much more difficult than previously thought. The Treasury briefing is that he’s going to be politically light, but I’m skeptical. Domestic politics in the coming months will likely be dominated by pressure on living standards and inaction in the face of this will be unsustainable and politically perilous for the Chancellor.

Finding an answer, however, that satisfies the public and Tory MPs but does not further weaken the long-term outlook for inflation or public finances could be Rishi Sunak’s biggest test yet. March 23 will be a great political moment after all.