The spring statement might not be the hero-to-zero moment Rishi Sunak expects

Most politicians encounter a hero-to-zero moment (I speak from experience). I suspect Rishi Sunak may be bracing himself for one now, as he approaches Wednesday’s spring statement. But he should not lose hope.

Even before the Russians invaded Ukraine, the outlook was uncomfortable: 5 per cent consumer inflation; a big rise in the energy price cap; a rise in national insurance to pay for spending on the NHS and social care. The latest YouGov survey of 6,000 households shows consumer confidence to be at its lowest level since records began over a decade ago.

The war makes that outlook even worse. There is uncertainty about how much further punitive measures against Russia will go, but supply disruptions and sanctions amount to a big global tax on oil and gas, cereals, fertilisers and several key metals. The effect will be to aggravate “stagflation”: pushing up costs and prices while simultaneously depressing demand.

The geopolitical earthquake in Ukraine will generate an economic tsunami, sweeping away comforts and orthodoxies with which we have become familiar in recent decades. We don’t yet know the height of the waves, but we know they are on their way.

The era of low interest rates is first to go. Central banks, including our own Bank of England, are becoming alarmed about inflation and are moving to higher rates, which further depresses consumer demand and investment. Despite rate rises, some forecasters believe the UK could hit 10 per cent inflation by the end of the year and be in recession.

Given the chronic uncertainty, and his very public commitment not to undermine the public finances, there is a strong temptation for Sunak to do as little as possible. But then he runs the risk of doing too little, too late, since tax-and-spend measures operate with a time lag. The tax tap takes a long time to run hot; the spending tap takes a long time to shut off. He is also in a stronger position to be generous than he might appear, with government borrowing running £25bn below expected levels.

The chancellor will make a lot of the rising interest cost of servicing government debt, as a justification for not doing more to cut taxes or increase spending. However, that would be a poor excuse. Only about a fifth of government debt is linked to inflation, and the costs of new borrowing are negative in real terms. The level of government debt to GDP is expected to be shown in the statement as falling, and it is not high in historical terms, against the background of war and pandemic.

Sunak’s guilty secret is that higher inflation will actually help the Treasury in budgetary terms. Income tax is set to rise because tax thresholds are being eroded in value by rising prices: so-called fiscal drag. And public spending is squeezed in real terms because departmental spending has been fixed in cash terms over several years. Inflation tax is a big earner.

For that reason, I would expect the chancellor to make some crowd-pleasing gestures after all. There are strong but competing demands to ease the pain of the current cost of living crisis. The best option is to concentrate resources on low-income households, who are the main sufferers from high domestic energy and food costs. The most obvious step would be to increase benefits (and pensions) beyond the 3.1 per cent uplift currently planned. Additionally, the government should improve the generosity of universal credit to help low income working families.

A more politically popular measure with Conservative MPs would be to cut fuel duty. In remote and rural areas without public transport, there is a real issue. But a policy that provides the biggest help to motorists with gas-guzzlers flies in the face of environmental commitments. The same could be said of a cut in the 5 per cent VAT rate on energy – though it would directly help fuel-poor households with gas and electricity bills.

Meanwhile, although an across-the-board cut in VAT tends to benefit big spenders the most, it has both political and economic appeal. Taking VAT temporarily down to 17.5 per cent would be simultaneously disinflationary (slowing the rate of inflation) and reflationary (stimulating spending), offsetting stagflation directly.

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The chancellor will also be expected to boost defence spending, and to ease the pain of energy-intensive industries. And, although he is not relenting on his ill-advised increase in national insurance rates, he could soften the impact on low earners by lifting the national insurance contributions threshold (perhaps with a simultaneous increase in the cap at which higher earners stop making NI contributions).

Finally, there are some tax increases that would be popular – not least taxing windfall profits from North Sea oil, despite the risk of supressing investment in increased production and domestic energy security.

By combining tax hikes for the corporate bogeymen with some spending on a hard-pressed public, Sunak may not hold on to his “hero” status, but he could prove he has some way to go before reaching zero.

Sir Vince Cable’s podcast, ‘Cable Comments with Vince Cable’, is available here