Favourable borrowing forecasts gave Chancellor some wiggle room

By John Hawksworth

Lower than expected public borrowing forecasts allowed the Chancellor to cancel planned cuts to tax credits next year while boosting spending on transport infrastructure and housing. But he has also pencilled in around £5 billion of extra net tax rises by 2020 to help achieve his target of moving the budget back into surplus by the end of this Parliament.

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

Obr1

The Chancellor did, however, get an early Christmas present from the OBR when they reduced their projections for underlying public borrowing slightly in the medium term, despite signs from data last week that we may be heading for a borrowing overshoot this financial year.

This reflects greater optimism by the OBR about income tax, corporate tax, national insurance and VAT receipts, offset by lower than expected stamp duty receipts from high value transactions. In addition, interest rates on government debt are now expected to be lower than assumed in July, reflecting shifts in market opinion on how quickly the Bank of England will raise interest rates and unwind its past purchases of government bonds.

The OBR’s more favourable public borrowing projections gave the Chancellor some extra wiggle room, most notably by cancelling planned tax credit cuts in 2016/17. He is also raising significant extra sums from the apprenticeship levy (around £3 billion per annum by 2020) and increased stamp duty on second homes (around £0.9 billion by 2020). In total, net tax rises of around £5 billion were pencilled in by 2020, on top of net tax increases of around £7 billion announced in July.

The Chancellor was also able to announce increased spending on transport infrastructure and housebuilding from around 2018 onwards, which is very welcome in supporting longer term economic growth and countering chronic shortages of housing supply. The government’s proposed planning reforms should also have a positive effect in this area. But it will take a long time to make up for the relatively low rates of housebuilding in the UK over the past two decades, so we don’t think this will be enough to stem the rise in ‘generation rent’ over the next five years that we have highlighted in our past research. But it could lead to somewhat higher home ownership rates in the longer term.

Despite the tax credit changes, there is still some pain to come. Welfare cuts totalling around £12 billion by 2020 will still be made, but now with a more gradual phasing in of these cuts over time as people switch from tax credits to the new (and on average less generous) universal credit.

Unprotected government departments will face a further Parliament on basic rations as regards their day-to-day spending, even if these cuts are not quite as severe as expected back in July. Local authorities will be allowed to raise council tax to help fund spending on social care, but will face a continued squeeze on their spending in other areas as central government grants are cut. Some councils will also gain from being able to keep more of any increase in business rates, though the benefits from this will vary considerably across the country.

Overall, the Chancellor has made good use of the more favourable OBR borrowing forecasts to boost capital spending in key areas and ease in his spending cuts more gradually over time, while still keeping to his previous target of a £10 billion budget surplus in 2019/20. But to achieve this he did also announce further net tax rises of around £5 billion, over and above what was announced in July, while cuts to welfare spending have been deferred rather than cancelled altogether.

This is an edited version of an original article published in the Tax Journal, which is available here: http://www.taxjournal.com/tj/articles/2015-economic-view-26112015

John Hawksworth:
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