Chancellor spends fiscal windfall on increased NHS spending rather than balancing budget

October 31, 2018

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By John Hawksworth

The big question ahead of this Budget was how the Chancellor would pay for the large increase in NHS spending announced by the Prime Minister back in June. Further spending cuts in areas other than health seemed to have been ruled out by the Prime Minister’s later pledge to ‘end austerity’, so it looked like some combination of higher taxes and higher borrowing would be needed.

In fact the Chancellor has been able to avoid significant net tax increases – and even cut some taxes in the short term through increased personal allowances and a freeze on fuel and some alcohol duties – while also keeping projected public borrowing more or less the same in the medium term as the OBR forecast in March. There will be some tax increases in later years, notably on large digital businesses and through tightening up rules on people who work through their own companies, but no large broad-based tax increase of the kind that Gordon Brown, for example, introduced to help to pay for significant NHS spending increases in his 2002 Budget.

The Chancellor was able to pull off this trick because the OBR handed him an unexpectedly large fiscal windfall by projecting that tax revenues in 2022/23 would be around £14 billion higher than they forecast back in March, despite broadly unchanged GDP growth and inflation forecasts. This reflects an apparent rise in the tax-to-GDP ratio this year that the OBR assumes will persist in future years. Added to lower projected debt interest payments and some other smaller forecasting changes, the public finances in 2022/23 are now looking around £20 billion better than in March based on unchanged tax and spending policies (see table below).

Comparison of key OBR forecasts in March and November 2018

Real GDP growth (%)

2017

2018

2019

2020

2021

2022

Spring Statement (March 2018)

1.7

1.5

1.3

1.3

1.4

1.5

Budget (Nov 2018)

1.7

1.3

1.6

1.4

1.4

1.5

CPI inflation (%)

           

Spring Statement (March 2018)

2.7

2.4

1.8

1.9

2.0

2.0

Budget (Nov 2018)

2.7

2.6

2.0

2.0

2.1

2.0

Public sector net borrowing

(£ billion)*

2017/18

2018/19

2019/20

2020/21

2021/22

2022/23

Spring Statement (March 2018)

45

37

34

29

26

21

Budget – unchanged policies (Nov 2018)

40

24

21

16

10

2

Impact of policy changes (Nov 2018)

0

1

11

11

14

19

Budget – with policy changes (Nov 2018)

40

25

32

27

24

21

*Excluding borrowing of public sector banks.

Source: OBR

Had the Chancellor not used this fiscal windfall to fund higher NHS spending, he could have projected a broadly balanced budget by 2022/23, rather than a £21 billion deficit in that year. But, guided by the Prime Minister, he has favoured easing austerity over balancing the budget, while still hitting his key medium term fiscal target of reducing the structural budget deficit to below 2% of GDP with some comfort. The debt to GDP ratio is also projected to fall back gradually over the next five years, but the Chancellor’s longer term target of eliminating the deficit entirely by the mid-2020s now looks difficult, though not impossible, to achieve given there is still a projected deficit of around £20 billion in 2023/24.

Economic growth to remain modest given ongoing Brexit uncertainties

The OBR expects UK economic growth to remain modest by historical standards at 1.3% this year and an average of just 1.5% per annum over the next five years. This is a relatively cautious forecast, somewhat lower than that of the Bank of England and most other forecasters, though such caution may be sensible for fiscal planning purposes given the current uncertainties around Brexit.

If and when a Brexit deal with the EU is agreed, the OBR may revise up its growth forecasts slightly. But we would not expect too much of a ‘deal dividend’ from this source given that the OBR is already assuming an ‘orderly’ Brexit in its central forecasts. Furthermore, modest projected UK growth also reflects underlying problems related to slow productivity growth that were evident well before Brexit and indeed have been common to many other advanced economies in the period since the global financial crisis.

The Chancellor did reaffirm earlier plans to address this productivity challenge through increased investment in infrastructure and technology, but there was not a lot of new money in the Budget for this purpose. Indeed, as the OBR pointed out, planned capital spending by government departments has actually been reduced somewhat in later years of the forecast period relative to the plans set out in March, although local authorities will have more freedom to borrow to fund new housing investment.

Austerity eased, but will it be ended?

In addition to the extra money for the NHS, the Chancellor also allocated an additional £3 billion a year by 2022/23 to planned day-to-day spending by other departments, relative to indicative figures published in March.

This is just enough to keep real day-to-day spending by departments other than health broadly constant in real terms over the next Spending Review period rather than declining, which could meet a minimal definition of ending austerity. But we will have to wait until later next year to see the full details of the Spending Review and, at that point, some departments and local authorities may yet face further real cuts given that areas like defence and overseas aid have been earmarked to receive real spending increases. So austerity is being eased, but arguably not yet ended for all parts of government.

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

 

by John Hawksworth Chief UK Economist

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