Saving some powder for a pre-election giveaway

This was a bigger Budget than expected, with government spending set to rise by £150bn over the course of this parliament. But the Chancellor still chose to keep back some of the boost in revenues provided by the Office for Budget Responsibility’s (OBR) upgraded economic forecasts. This gives him some tax-cutting ammunition to use before the next general election. 

However, the OBR’s forecast of 6% growth in 2022 looks pretty ambitious to us (we expect growth to be closer to 4.5%), so Mr Sunak may have slightly less room for a pre-election giveaway than he hopes for. 

Lower scarring, higher taxes

Perhaps the most important part of the Budget was barely mentioned in the Chancellor’s speech. 

The OBR previously thought that the pandemic would permanently reduce the size of the UK economy by 3%. Although it’s now dropped that to 2%, the Bank of England is even more optimistic and is assuming of a scar of only 1%. 

A bigger economy means more tax revenues and an improved fiscal position, so the Chancellor could part with some of his OBR windfall. He focused his giveaways on supporting low-income households, which will help ease the upcoming cost of living crisis. The reduction in the rate at which universal credit payments fall as earnings grow from 63% to 55% will provide a boost to consumers of about £2bn. To put this into context, though, the recent cut in universal credit payments reduced payments to consumers by about £6bn – and they’ll have to wait until April before the increase in the National Living Wage to £9.50 kicks in. Consumers will not, however, have to pay more for booze and fuel because the Chancellor froze duties on them.  

The biggest spend of all was on government departments, which will see an increase of £150bn over the course of this parliament, equivalent to a 3.8% increase in real terms each year.

New fiscal rules are older than they appear 

The Chancellor still banked a lot of his OBR jackpot, allowing him to meet the two new fiscal rules he set out:

  • First, underlying public sector net debt, excluding the impact of the Bank of England, must, as a percentage of GDP, have started falling in three years’ time. 
  • Second, in normal times the state should borrow only to invest.

Those of you with relatively long memories might realise that these are essentially the same rules that Gordon Brown had in 1997.

Economists don’t tend to put much faith in self-imposed fiscal rules – after all, more often than not they tend to be altered or discarded on a whim. But, based on the OBR’s economic forecasts, the government will comply with both of these rules during this parliament. Indeed, the OBR thinks the debt-to-GDP ratio will fall from 98.2% of GDP in 2021/22 to 94.7% by 2024/25. Furthermore, the budget deficit will fall below 2% of GDP by 2024. The current budget, which only counts day-to-day spending, could have a surplus of about 1% in 2024/25, giving some scope for a pre-election giveaway. In fact, the Chancellor said as much by suggesting that taxes will be going down by the end of this parliamentary term.

Green initiatives nowhere to be seen

Notable by its absence was any reference to tackling climate change. With Glasgow hosting COP26 in just a few days, we had expected some announcements on funding for green infrastructure to speed the transition to net zero carbon emissions.

The Committee on Climate Change estimates that it will take investment of about £800bn over the next 30 years to hit the government’s target of net zero by 2050 – the government will need to come up with a credible plan for funding this. While we’re on the topic, freezing fuel prices does not seem in line with the government’s ambition to switch to electric vehicles by 2035, even if it does ease the pressure on consumers.   

Space for a pre-election giveaway, despite rising inflation

The Chancellor acknowledged that inflation will remain high over the next year and, combined with rising interest rates, that will put a strain on public finances. Indeed, the OBR estimates that debt serving costs will be about £50bn higher over the next five years than it thought they would be in March, and they’d be even higher if the OBR had incorporated the latest rise in gilt yields.

Using the latest gilt yields, the current budget deficit in 2024/25 could be closer to 0.8% of GDP, reducing the fiscal headroom for pre-election tax giveaways. However, the impact of higher interest rates could be offset if the degree of economic scarring turns out to be closer to 1% (as the Bank of England thinks) or even less (as we suspect).

Overall, the Chancellor was relatively restrained with this Budget. That’s probably not a bad thing from an economic point of view. After all, it’s not a lack of demand that’s holding the economy back at the minute! Had the Chancellor been more generous, the Bank of England may have felt even more pressure to raise interest rates to counter the effect on inflation of his additional spending.