Chancellor boosts investment despite public borrowing overshoot
24 November 2016
We live in turbulent times, but so far the Brexit vote has not had a major negative effect on UK economic growth. This meant there was no need for the Chancellor to deliver an ‘emergency Budget’ with an immediate large fiscal stimulus to the economy.
It is still early days though and, in its first forecasts since the EU referendum, the Office for Budget Responsibility (OBR) projects that uncertainty related to Brexit will lead to a gradual slowdown in real GDP growth from 2.1% this year to around 1.4% in 2017 and 1.7% in 2018. This is driven primarily by a decline in business investment, but also by a squeeze on real household spending power as the weak pound pushes up inflation to around 2.5% in 2018. Indeed the OBR projections imply that real earnings in 2021 will still be lower than their pre-recession peak in early 2008.
The implication of slower GDP and real earnings growth is that the budget deficit will not fall nearly as fast as projected by the OBR back in March. Indeed, as the table below shows, the cumulative public borrowing overshoot over the five years to 2020/21 is projected to be around £120 billion relative to the March forecast.
For the next few years, the Chancellor has chosen to ignore this borrowing overshoot. Indeed, he has added to it with some carefully targeted support for the economy in the form of increased housing and infrastructure investment. As the table shows, this boosts the projected deficit in 2020/21 by a net amount of around £10 billion relative to the forecast without any new policy measures.
So has the Chancellor given up on prudence? Not really, as he is still aiming to eliminate the current budget deficit (i.e. borrowing excluding net public investment spending) by 2019/20. He is also still aiming to get the overall public debt stock as a share of GDP falling by the end of this Parliament and to continue to keep tight control of non-investment spending. So this is not yet the end of austerity, which will now extend into the 2020s, albeit at a more gradual pace, to allow room for manoeuvre during the uncertain period of the Brexit negotiations.
The giveaways the Chancellor has found room for mostly seem quite well targeted on the supply-side problems of the UK economy – in particular a lack of affordable housing and an ageing transport infrastructure. Extra investment here is welcome as is the additional support for broadband and R&D investment, both of which are important drivers of competitiveness in a modern, knowledge-based global economy.
There are also some more populist measures such as a further freeze in fuel duty. But overall there is actually a small net tax rise due to an increase in insurance premium duty, removing the tax and national insurance advantages of salary sacrifice schemes, and various anti-avoidance measures.
Welfare spending will be slightly higher than previously planned in the medium term due to the decision to taper universal credit awards more slowly, the cost of which will build up to around £700 million by 2021/22. But other planned cuts to welfare spending will largely remain in place and analysis by the Resolution Foundation suggest this will weigh particularly heavily on lower income families (except pensioners who are largely protected from these cuts).
What the Chancellor will be hoping is that the uncertainty surrounding Brexit will not dampen growth as much as the OBR projects, in which case the public finances would improve faster than projected. If this happens, the Chancellor may be able to afford either tax cuts or spending rises in high priority areas like health and education later in the Parliament. But this is far from guaranteed, so the Chancellor was prudent to adopt a relatively cautious approach for now.
This is an edited version of an article that first appeared on the Tax Journal website here