This year’s Budget will go down as the one that brought an official end to austerity. Although some tax increases from earlier periods have still to work their way through the system, spending increases will mean a return to pre-austerity levels in the next couple of years. Indeed, Robert Chote, the outgoing head of the Office for Budget Responsibility, said the Budget had reminded him more of Gordon Brown’s than any other Chancellor he knew. In a warning shot against complacency, his report also said that GDP was currently 2% below where it would otherwise have been in the absence of the 2016 referendum decision to leave the EU, with a further 4% to come off over the years ahead.
If you had shut your eyes during the announcement you would have been forgiven for thinking you were listening to a Labour Chancellor, such was the amount of spending announced. It was the most significant rise in public spending since 1992 – surprisingly under another Conservative Chancellor, Norman Lamont. Admittedly, he was trying to win an upcoming election, whereas this Chancellor’s party has just won one.
Of course, the priorities in the Budget reflect the realities of today and what the government thinks it needs to do to keep hold, in 5 years’ time, of the swathe of Conservative seats it won in the north of England at the last election.
Lots left out
The Budget was also notable for what was left out. No mention of what contingency plans are in place to deal with any economic fall-out from the UK’s departure from the current ‘unchanged’ trading relationship with the EU to a new one – or none – from 1st January 2021. Surely, it means even more borrowing and spending? No mention of the rapidly rising costs of elderly care, which are fast becoming unsustainable without government intervention. No mention of how to resolve the social housing crisis – people who cannot afford to buy or rent in the private sector. Help to buy schemes are irrelevant for this rising group. Local authorities are resorting to increasingly desperate schemes to keep costs down, but are putting people in wholly unsuitable temporary accommodation as a result. No mention of how to balance increasing demand for public services against a slow growing economy in the long run.
Perhaps these will be in later budgets and spending reviews but, for now, these are important questions left unanswered.
But a joined-up approach of fiscal easing
In a ‘whole of government response’, the Governor of the Bank of England coordinated with the easing of fiscal policy, announcing a cut of ½% in the bank rate to ¼%, the low it reached after the referendum to leave the EU in 2016.
He cited the short term risks to growth from the health crisis and also announced a cut in banks’ reserves requirements and other measures to increase bank liquidity. Moreover, he noted that the economic assumptions in the arithmetic did not take into account the downward revisions to UK economic growth since the coronavirus crisis.
Greater government intervention
So, what are we to make of the Budget? This year an additional £30bn was announced, with £12bn earmarked immediately to support the NHS during the COVID-19 threat. No tax cuts possible here.
On a party political level, it has effectively stolen Labour’s best policies and rendered much of their attacks redundant. On a philosophical level, it suggests a belief in big government and interventionist policies that might make some Conservatives blanch.
In terms of the headline numbers, the direction of travel is clear. Spending will rise faster than taxes so that debt will increase both in absolute terms and as a share of GDP over the next five years. Government department spending will rise from 39.3% of GDP last year to 40.7% in 2025. By the end of 2025, UK debt is forecast to be £2.031 trillion from £1.8 trillion last fiscal year. While debt as a share of GDP is expected to remain near current levels, it could rise if the UK sees lower growth than expected in the economic assumptions.
Assumptions made on shifting foundations
The chances of even higher borrowing than announced in the Budget are quite high as the economic assumptions that underpinned the projections did not take account of the hit to the economy from COVID-19. Estimates suggest that UK economic growth for this year could be ½% lower than the current prediction of 1.1%. This means that debt could rise further as public spending increases, and tax receipts fall amidst a weakening economy. An assumption in the Budget is that tax receipts will increase to 38.5% of GDP over the next five years, from 37.5% in 2018-19, but slower economic growth will undermine that projection.
So, a hostage to fortune is that any UK recession will lead to a sharp rise in government debt from what will be an already high cyclically-adjusted level of some 4% of GDP. The only good news is that low inflation means lower rates for longer and so low debt servicing costs will be sustained.
Ongoing challenge to productivity
With taxes and spending rising as a share of GDP over the five years, there is a risk that government borrowing will ‘crowd out’ the private sector, thus making productivity gains harder to achieve.
Restoring productivity growth is the best way to ensure that the UK’s growth rate picks up in future years from the current five year average of 1 ¼%. Otherwise, the challenge of an ageing population and the requirement for greater funding will be harder to turn into opportunities.
However, moving public sector jobs out of London yet leaving all major decision making to the central government, will not solve the productivity gap in the UK. That’s been tried by successive UK government’s over the last 70 years and has failed. Maybe it is time to try something different.