This article is taken from the May 2022 issue of The Critic. To get the full magazine why not subscribe? Right now we’re offering five issues for just £10.

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Rishi Sunak may seem to be Chancellor at a difficult time, dealing with the challenges of Covid-19 and the implications of the Ukraine invasion. But he is a fortunate chancellor in a crucial, if highly disreputable, respect.

He may reflect that inflation is a superb tax collector.

The Bank of England has warned that consumer inflation may be in double digits by the end of the year. As a result, every monthly announcement of the main price indices enacts a large change in the tax take. The increases in the consumer price index (and the retail prices index) are therefore more important to the sustainability of the public finances than the tax increases announced in the recent Spring Statement.

How is Rishi Sunak a lucky chancellor? The answers are two-fold. First, inflation is proceeding at such a rapid pace that the real value of the national debt is being reduced sharply. The public sector net debt is about £2,350 billion — much the same as 2022’s expected nominal national output. Because of the continuing budget deficit, the debt is rising by roughly £100 billion a year. The average figure for the value of the debt can be called at £2,400 billion during the coming financial year.

About a fifth of the debt is index-linked. As a legacy of past arrangements and contracts, it is the RPI — not the CPI — that affects the UK index-linked debt. Inconvenient facts for the government are that increases in the RPI tend to be higher than increases in the CPI and that the nominal returns to holders of index-linked securities increase automatically with the RPI. But the resulting increase in public expenditure — which is enormous — is not my main point here.

Excluding the index-linked debt, 80 per cent of the debt — over £1,900 billion — takes the form of so-called “conventional gilt-edged securities”. Eventual repayment of these securities will be in the same pounds and pennies as specified at issue, and no protection is given against inflation.

Obviously, a 10 per cent rise in the price level is equivalent — as far as the holders of the £1,900 billion of conventional debt are concerned — to a reduction in the real value of their asset of about £190 billion. Indeed, if inflation nudges somewhat above 10 per cent, this expropriation by inflation would be £200 billion.

Savers have not retaliated against the inflation tax

That is the amount that holders of conventional gilts will be worse off in just one year. Moreover, in some sense the government is “better off” and Rishi Sunak can smile, as he does not have to announce a visible and very unpopular tax hike of the same size. Given the media hubbub about the National Insurance increase contained in the Spring Statement, which raises a mere £12 billion a year, he may reflect that inflation is a superb tax collector.

Secondly, savers have not retaliated against the inflation tax by demanding a much higher yield on their government bonds.

In the mid-1970s, when Britain was widely believed to face double-digit inflation into the indefinite future, the yields on long-dated gilts peaked at over 16 per cent. Today they are still under two per cent. Frankly, the yield is so derisory that Mr Sunak and his successors — perhaps in cahoots with the Bank of England — have a pernicious incentive to organise even more inflation. (As index-linked gilts had not been introduced in the 1970s, yields of over 16 per cent were necessary to persuade anyone to put their trust in the British government. With a number like 16 per cent, they had a margin of safety against inflation in the low double digits. Remember that 27 per cent inflation was recorded in summer 1975.)

Suppose that the Bank of England remains as incompetent as it has been in the last two years and continues to allow such fast growth of the quantity of money that double-digit inflation becomes entrenched.

Then investors in UK government debt will again want yields in double digits so that they can secure a positive real return. With the conventional national debt at about £1,900 billion and rising — more or less by £100 billion a year, what would the debt interest bill be if the interest rate were 16 per cent? Clearly, it would be over £300 billion, more than the cost of the National Health Service and over three times all public expenditure on education.

A welcome emphasis in the Spring Statement was on the need for the public finances to be resilient, where the notion of resilience is code for the UK’s future ability to keep deficits down even if the debt interest bill soars into the stratosphere. Every British government should try to maintain a reputation for good housekeeping and financial prudence.

Mr Sunak’s luck will run out if holders of British government debt make a more effective protest against being cheated — as they were in the 1970s — by the inflation that results from shoddy and irresponsible fiscal and monetary policies.

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This column is based on the author’s response to the Spring Statement for the think tank, Politeia