Summer Budget: Less of a spending rollercoaster, but still a lot of pain to come

By John Hawksworth

The Chancellor stuck to his pre-election objective of eliminating the budget deficit before the end of this Parliament, but provided more concrete details of how he would achieve this. In particular, he opted for a smoother profile of real spending cuts over the next four years, which is sensible in allowing affected government departments, local authorities and households more time to adjust. But there is still a lot of pain to come.

The OBR’s view of UK economic prospects has changed little since March. As the table shows, they still expect economic growth to proceed at a steady pace of around 2.3-2.4%, and still expect inflation to rise back gradually towards its 2% target over the next few years.

  Obr

Excluding the new measures announced in the July Budget, which the OBR judges will not have a material net impact on average economic growth over the period to 2020, their underlying public borrowing forecasts have not changed much either since March. Tax receipts are projected to be a little stronger, but this is slightly outweighed in later years by higher public spending due, in particular, to somewhat higher debt interest costs in the latest projections.

The Chancellor’s main strategic shift was to smooth out what OBR had termed the ‘rollercoaster’ profile of planned spending cuts. Rather than being focused on 2016/17 and 2017/18, austerity will now continue until 2019/20, but at a more gradual pace than planned in March.

Welfare cuts totalling £12 billion by 2019/20 will weigh heavily on lower income working age households, although a new national living wage will offset this for some workers by rising to £9 per hour by 2020. Unprotected government departments and local authorities will face a further Parliament on basic rations.

Restricting public pay growth to 1% per annum for the next four years may be needed to get the deficit down, but will pose challenges in attracting and retaining talent to the public sector over a period when private sector earnings are likely to be growing at around 3-4% per annum.

On the tax side, there was the usual complex mix of swings and roundabouts. The biggest giveaways related to cutting corporation tax to 18% by 2020, further increases in personal income tax allowances and extending inheritance tax relief for main residences.

These giveaways were more than outweighed, however, by a series of tax increases relating to dividend taxation, insurance premium tax and vehicle excise duty, as well as restrictions in pensions tax relief and a range of anti-avoidance measures. Overall, therefore, this was a tax-raising Budget, with the OBR estimating that the net tax increase might build up to around £7 billion by 2020, though this is only 0.3% of GDP in that year, so not huge in macroeconomic terms or relative to the scale of the planned spending cuts.

The fact there were some net tax rises, however, is not a surprise as it has been the norm for every post-election Budget since 1993. All Chancellors like to get the bad news out of the way early in a Parliament.

On the overall fiscal strategy, we clearly needed some further tightening to get the budget deficit down and it is good for financial and business confidence that we now have more detail as to how this will be achieved than we did before the election. More details will follow on departmental budgets in the Autumn Spending Review.

It seems prudent for the Chancellor to aim for a budget surplus by 2020 as a buffer against future economic shocks at a time when initial public debt levels are high due to the legacy of the financial crisis. But it may not be sensible to aim to run overall budget surpluses indefinitely as this could unduly restrict the scope for the longer term public sector investment that Britain needs to strengthen its national infrastructure.

The Chancellor’s proposed new fiscal rule to run budget surpluses in all years from 2020 except where real GDP growth is below 1% (a somewhat arbitrary figure) may not therefore prove to be a permanent part of the fiscal policy landscape. But, for now, there seems to be a reasonable post-election political consensus that it is a sensible target to aim for by the end of the current Parliament.

This is a slightly expanded version of an article just published by the Tax Journal here.

John Hawksworth:
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