Budget 2016: Sweeteners now, but pain later to fill hole in public finances

By John Hawksworth

 As the Chancellor was at pains to stress, the global economic outlook has turned stormy since the Autumn Statement in November. Together with a more cautious view on trend productivity growth, this led the OBR to edge down its economic growth and inflation forecasts (see Table 1). This implies lower projected tax receipts and so higher underlying public borrowing forecasts excluding Budget measures, despite some offsetting savings on debt interest payments.

For the next few years, the Chancellor seems to have chosen to ignore this borrowing overshoot, and indeed he has added to it with some sweeteners for the economy in the form of carefully targeted tax cuts for small businesses, savers, drinkers and drivers.

These tax cuts will be good news for the beneficiaries and also make sense in terms of offering the economy some additional support at a time of considerable global economic uncertainty over the next couple of years (not to mention the potential uncertainty related to the EU referendum in June). But it does lead to a projected budget deficit of £21 billion in 2018/19, as compared to the £5 billion deficit forecast by the OBR in November. Public borrowing will still fall over the next three years, but less rapidly than expected last autumn.

  Numbers

So has the Chancellor given up on prudence? Not really, he has just postponed the pain to 2019/20, when there will be around £13-14 billion of additional net tax rises and spending cuts. This leads to a very sharp turnaround in the public finances from a £21 billion deficit in 2018/19 to a £10 billion budget surplus in 2019/20 – exactly the same as the OBR was forecasting in November.

Who will bear this pain? On the spending side, government departments will see a net squeeze of around £4-5 billion in their budgets for 2019/20, partly due to having to contribute more to public service pensions and partly from additional but as yet unspecified efficiency gains. Welfare spending will also be cut by around £1.4 billion, with the main focus of this being on further tightening up the disability benefit system that could prove controversial.

There will also be just over £6 billion of net tax rises in 2019/20, the main burden of which appears to be on large companies through a complex package of measures on corporation tax, though in part this is just shifting payments between years rather than increasing the total amount of tax to be paid.

The Chancellor was also able to announce some additional spending on transport infrastructure, which will be very welcome in supporting longer term economic growth. However, the most significant rise in public investment does not occur until 2020 and beyond, by which time the Chancellor will be hoping that he is spending from a position of budgetary strength after ten long years of austerity.

Overall, the Chancellor faced a tricky challenge in keeping his budget deficit reduction plans on track despite deteriorating economic conditions. He did not want to tighten policy further too soon, which could have further dampened economic growth in the short term and so been self-defeating. He also wanted to throw some modestly priced sweeteners to key target groups such as small businesses, motorists and savers, while pencilling in pain for government departments and big businesses later in the Parliament.

What the Chancellor will be hoping, however, is that the current mood of global economic gloom will pass and the public finances will start to improve faster than currently projected. In that case, he may either be able to scale back the additional fiscal pain planned for 2019/20 or, perhaps more likely, leave room for other tax cuts or spending rises in high priority areas like health and education later in the Parliament.

But there is also a risk that the economic outlook could worsen further, particularly if there is a “leave” vote in the EU Referendum in June, which would be likely to create additional uncertainty and disruption to UK trade and investment. The Chancellor may have to redo his sums in the Autumn Statement depending on how these uncertainties play out between now and November.

This is a revised version of an article that was first published on the Tax Journal website here.

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