David Fenton, our Chief Economist, writes for us this week on the 2016 Budget and what the measures mean for the economy and the British public.
Rock and a hard place
The Chancellor delivered his eighth Budget yesterday. It cannot have been easy. Bad news on the economy had left a fairly large hole in the outlook for the public finances. The challenge was to find a way to plug that hole without stirring up any unwanted controversy - among backbenchers or the electorate - ahead of the EU referendum. So changes to pension relief were a non-starter; even a rise in fuel duty was seemingly considered too racy.
So what did the Chancellor do? Quite a lot, as it happens. 77 measures were announced yesterday, which is 'close to a record'*. The headlines may have gone to the "sugar tax", cuts to disability benefits and the new lifetime ISA, but there were other important measures worth mentioning. Before we take a look at them, let's start with the big-picture story on the economy and the public finances.
Rules are made to be broken?
In recent years, UK chancellors have tended to adopt fiscal rules. George Osborne is no different. The government has two legislated fiscal targets:
- To achieve a budget surplus in 2019-20 and beyond (also known as the fiscal mandate)
- To reduce debt as a share of national income every year (also known as the supplementary target)
The UK's independent fiscal watchdog, the Office for Budget Responsibility (OBR), now expects that the debt target will not be met in 2015-16, and said that the deficit target would also be missed if the Chancellor didn't take evasive action. To paraphrase Oscar Wilde: to miss one target may be regarded as a misfortune; to miss both looks like carelessness.
Clouds on the economic horizon
What went wrong? There are many moving parts, but I will of course focus on economic factors. Thanks to revisions and forecast errors, the economy was smaller than expected in 2015. And with the OBR having downgraded the growth outlook for each and every one of the next five years, the economy will be smaller than expected in future. The main reason for the forecast change was a significant downgrade to productivity growth.
This matters for two reasons. First, a smaller economy usually means lower tax receipts. Second, the public finances are often reported in relation to the overall size of the economy; so arithmetically, it makes a given deficit look larger in relative terms.
Measures that matter
The end result of all this bad news was that the £10 billion surplus that had been projected for 2019-20 back in November's Autumn Statement had morphed into a £3 billion deficit. And that's with a £5 billion windfall from the effect of lower interest rates on debt servicing costs.
To put the public finances back on track to meet the fiscal mandate, the Treasury announced a series of spending cuts, which can be summarised as follows:
- £3.5 billion of as-yet unidentified cuts to be generated by an 'efficiency review' that will report in 2018
- an additional £2.0 billion a year squeeze on departments, which is achieved indirectly by raising planned public service pension contributions
- £1.4 billion of reduced welfare spending, largely through a further tightening of the disability benefits system
That's not to say that taxation isn't part of the story, but quite a lot of the measures cancel each other out, one way or another:
- The Treasury will raise £500 million a year from a levy on the soft drinks industry, referred to as the "sugar tax", but this revenue will be spent on school sports.
- There will be a large increase in corporation tax revenue in 2019-20, but this comes from the Government's decision to delay the July Budget measure that brings forward the timing of large firms' quarterly corporation tax payments.
- Sticking with corporation tax, the headline rate was reduced, but various forms of relief have been tightened.
Generally speaking, tax moves tended to favour small companies, most notably on business rates. Last, but by no means least, recent reforms to stamp duty were extended to non-residential properties, raising £500-600 million a year.
A final sting in the tail
As a result of these measures, the OBR thinks that the Government will meet its deficit rule. But the margin for error is pretty thin. The OBR also attaches a probability that there being a surplus in 2019-20: roughly 55%. But if we put that another way, there's a 45% chance that the Chancellor will have to deliver yet more austerity, or miss the deficit target as well.