Chancellor walks a narrow tightrope between fiscal prudence and easing austerity

24 November 2017

By John Hawksworth

UK economic growth has slowed this year and this more sluggish performance is now projected to continue for some years to come as productivity growth remains disappointing. This has worsened the medium term public finance outlook and reduced the wriggle room available to the Chancellor. He therefore had to walk a narrow tightrope in his Budget between maintaining a downward path for the budget deficit and responding to widespread pressures for an easing of austerity.

The man from the OBR says ‘no’

The Office for Budget Responsibility (OBR) revised down its 2017 GDP growth forecast from 2% to 1.5% as higher inflation has bitten into consumer spending power and Brexit-related uncertainty has dampened business investment growth. But, despite this slower growth, the OBR also revised down its public borrowing estimate for 2017/18 from around £58 billion to only around £50 billion given better than expected public finance data so far this year (see table).

Comparison of key OBR forecasts for March and November 2017 Budgets

Real GDP growth (%)

2017

2018

2019

2020

2021

2022

Budget (March 2017)

2.0

1.6

1.7

1.9

2.0

N/A

Budget (Nov 2017)

1.5

1.4

1.3

1.3

1.5

1.6

Public sector net borrowing

(£ billion)*

2017/18

2018/19

2019/20

2020/21

2021/22

2022/23

Budget –  (March 2017)

58

41

21

21

17

N/A

Budget – excluding new policy measures (Nov 2017)

49

37

26

29

28

29

Net impact on borrowing of new Budget measures (Nov 2017)

1

3

9

4

2

-3

Budget – including new policy measures (Nov 2017)

50

40

35

33

30

26

*Excluding borrowing of public sector banks.

Source: OBR

However, the OBR judged that this short-term borrowing undershoot is unlikely to persist. Looking further ahead, the OBR has revised down its GDP growth projections significantly for each of the next four years due to slower than previously expected productivity growth. By 2021, the UK economy is now expected to be more than 2% smaller than forecast in March and this gap will only grow in later years if productivity growth remains subdued. Furthermore this forecast is based on assuming a relatively smooth Brexit and continued steady global growth – if either of those assumptions prove too optimistic, the UK growth outlook could be even worse.

If we compare the new OBR forecasts to those published earlier this month in our latest UK Economic Outlook report, we can see that projected UK GDP growth in 2017 and 2018 is the same in both reports at 1.5% and 1.4% respectively. Thereafter the OBR is a bit more gloomy, with projected growth of just 1.3% in 2019 and 2020, whereas we are assuming slightly higher – but still low by historical standards – growth averaging around 1.6% per annum in those two years. But we agree with the OBR that there seems unlikely to be any early return to pre-crisis trend GDP growth rates of over 2%.

Slower economic growth translates to slower projected tax revenue growth and so a higher budget deficit in the medium term – around £30 billion in 2021/22 as opposed to the £17 billion OBR forecast back in March. This is despite a £4 billion public borrowing reduction in that year due to housing associations being reclassified from the public to the private sector following recent regulatory changes.

The Chancellor is still projected to meet his medium term target of getting the structural budget deficit below 2% of GDP in 2020/21 with some margin for error, but his headroom has shrunk since March from around £26 billion then to only around £15 billion now.

How did the Chancellor respond to the bad news from the OBR?

If prudence was his only concern, then the Chancellor might have responded to less favourable OBR forecasts by tightening fiscal policy over the next few years. But the Chancellor also recognised that he needed to respond to political pressures to ease austerity and start to address fundamental economic challenges relating to housing and productivity.

The Budget therefore eased tax and spending policy significantly in the short term, increasing borrowing in 2019/20 by around £9 billion. There were giveaways on housing and infrastructure, health, freezing fuel and alcohol duties and business rate indexation, as well as an extra £3 billion of spending on Brexit preparations over the next two years. But, aside from housing and infrastructure, most of these measures were only temporary and money will be clawed back in the medium term through various tax avoidance measures and a renewed squeeze on day-to-day government spending on both public services and welfare benefits. Austerity has (yet again) been postponed but not cancelled indefinitely.

On the positive side, the Chancellor has put together a broad package of new measures to increase government financial support for new housebuilding and associated infrastructure totalling around £7 billion over the next five years, plus an additional £8 billion of new government guarantees for private sector borrowing to fund more housebuilding (although the details of the latter remain hazy and, as a contingent liability, they conveniently do not score against public borrowing or debt).

The Chancellor also cut or abolished stamp duty for most first time buyers, although this may feed through into higher house prices based on past experience with such measures, as the OBR was quick to point out. If this happens again this time, the main beneficiaries will be existing home owners rather than first time buyers. But while this measure is of debatable economic value, there was some real substance to back it up on the supply side, including some further reforms to planning regimes.

The Chancellor will be hoping that UK growth is not as sluggish over the next few years as the OBR now forecasts, in which case he could have more room for manoeuvre in future Budgets. But it is far from guaranteed that the Brexit negotiation process will go smoothly, so the Chancellor was prudent to adopt a relatively cautious approach for now while doing what he could to address concerns around housing, health and longer term productivity growth.

This blog is an extended version of an article for the Tax Journal.

John Hawksworth:
Read profile | Contact by email | Tel: 020 7213 1650

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