New analysis by researchers at the Institute for Fiscal Studies (IFS) provides a comprehensive assessment of the UK’s public finances and the options available to the Chancellor in his November Budget. It shows that he faces a defining choice: maintain his commitment to a public finance surplus or respond to growing demands for increased public spending.
The government is committed to getting the public finances into surplus by the mid 2020s. If Mr Hammond takes this commitment seriously then a likely significant deterioration in the public finance forecasts means that he will have little space for Budget giveaways. Yet the pressures to spend more are becoming increasingly intense while the parliamentary arithmetic makes tax increases look very difficult. It is hard to see how the Chancellor can both maintain the credibility of his fiscal targets and respond effectively to the growing demands for spending.
A worsened public finance outlook is likely because the Office for Budget Responsibility (OBR) has indicated that it is likely to downgrade its forecast for productivity growth. Downgrading just halfway towards the terrible productivity growth seen over the last seven years could put the deficit on course to be almost £20 billion higher in 2021–22, at around £36 billion, than the £17 billion that was forecast by the OBR in March. In addition, lack of clarity over the nature and impact of our withdrawal from the European Union means that the uncertainty around these forecasts is unusually large.
These are among the main conclusions of a new report by IFS researchers, Autumn 2017 Budget: options for easing the squeeze, published today and funded by the Institute of Chartered Accountants in England and Wales (ICAEW) and the Economic and Social Research Council (ESRC).
In terms of the outlook for the public finances, the report finds that:
- Borrowing last year is currently estimated at £6 billion lower than forecast in the March Budget. Over the first six months of this year, it has continued to run below forecast. As a result, despite weak economic growth, the deficit could come in around £7 billion lower than forecast this year, at around £51 billion.
- Giveaways announced since March will only add modestly to borrowing over the next few years. These include the reversal of the Budget rise in self-employed National Insurance contributions and additional spending pledges in Northern Ireland.
- Were the OBR only to downgrade its growth forecasts in line with other forecasters, including the Bank of England, then the lower borrowing this year could still mean borrowing being forecast to be around £5 billion lower in 2021–22, at around £11 billion, rather than the £17 billion the OBR forecast in March.
But any substantial downgrade to productivity forecasts would easily dwarf the other factors affecting borrowing. In the March Budget, the OBR assumed productivity would grow by 1.6% a year, still below the over 2% a year achieved over the 40 years leading up to the financial crisis. But over the last seven years productivity has grown at just 0.4% a year. The public finances forecasts for the next five years are hugely sensitive to the productivity assumptions the OBR chooses to make.
- Were the OBR to assume productivity growth of 1% a year – i.e. a downgrade halfway towards the terrible growth experienced over the last seven years – borrowing would be forecast to be around £33 billion in 2020–21 rather than the £21 billion forecast in March. In this case, the Chancellor could still expect to meet his fiscal targets for this parliament, but with only a 60% probability. The target to eliminate the deficit by the mid 2020s would look even more difficult than it did in March.
- Were the OBR instead to decide that the terrible productivity growth of the last seven years is now the new normal, borrowing could rise to almost £70 billion in 2021–22. In this case, the Chancellor could not expect to meet his fiscal targets for the current parliament and the ambition to eliminate the deficit entirely by the mid 2020s would seem almost sure to be abandoned.
Current plans imply considerably additional ‘austerity’ over the next few years. Total public spending is due to fall by 1.7% of national income while real day-to-day spending per capita by central government departments was forecast to fall in real terms by almost 5% (£15 billion in aggregate) between this year and 2021–22. This would come on top of falls of 13% (£46 billion) since 2010–11. £12 billion of cuts in benefits for working-age families are still in the pipeline, on top of £29 billion implemented since 2010–11.
With respect to some specific policy options:
- Higher inflation means that manifesto commitments to raise income tax thresholds are now less expensive than expected (just £1.1 billion a year to deliver a personal allowance of £12,500 and a higher-rate threshold of £50,000 in 2019–20). This would be on top of the £12 billion a year spent on raising the personal allowance since 2010.
- Another freeze in fuel duties would cost £¾ billion a year on top of the £5.4 billion cost of having frozen them since 2010.
- The largest cut to benefits to come over the next couple of years is the continued freeze to the rates of most working-age benefits. Cancelling this entirely would cost £4 billion in 2019–20.
- Fully-funding inflation increases in public sector pay would cost £6 billion more in 2019–20 than retaining the 1% cap.
Thomas Pope, a research economist at IFS and an author of the report, said: “The first Budget of a new parliament is often the best chance a Chancellor has to set out his stall. Mr Hammond, though, has been dealt a very tricky hand indeed. The political arithmetic makes any significant tax increase look very hard to deliver. It looks like he will face a substantial deterioration in the projected state of the public finances: were the OBR to downgrade productivity growth halfway towards the terrible experience of the last seven years, this could add £20 billion to borrowing five years out. And, in the known unknowns surrounding both the shape and impact of Brexit, he faces even greater than usual levels of economic uncertainty.”
Carl Emmerson, Deputy Director at IFS and the other author of the report, said: “Public sector workers, the NHS, the prison service, schools and working-age benefit recipients, among others, would like more money. Even if Mr Hammond does find some, unless it did represent a very big change of direction, it won’t mean ‘the end of austerity’. Tight spending settlements, net tax rises and cuts to working-age benefits are all putting significant downward pressure on borrowing over the next two years in particular. Given all the current pressures and uncertainties – and the policy action that these might require – it is perhaps time to admit that a firm commitment to running a budget surplus from the mid 2020s onwards is no longer sensible.”