Another £65 billion or so of support for the economy this year and next, on top of the £270 billion already announced. Mr Sunak is not stinting on his immediate response to the economic damage caused by the virus and the lockdown. Keeping the furlough scheme going through to September and business rates support and VAT reduction for hospitality still partially in place to the end of 2021-22 is erring on the side of generosity. We have that support to thank for the now remarkably modest OBR forecasts of unemployment. If it really does peak at “only” 6.5% we, and Mr Sunak, can consider that a remarkable triumph.
Add in the capital allowance “super deduction” – essentially a state subsidy for private sector investment in plant and machinery – and this Budget provides a big fiscal stimulus over the next couple of years.
Partly as a result we are in for a second year of record borrowing. Not as high in 2021-22 as it is this fiscal year, but if it does come in at over 10% of national income it will still match its peak during the financial crisis
That was Mr Sunak once again in his role as generous benefactor. But this was of course a tale of two budgets. By the end of the forecast period we are looking at a fiscal tightening of over £30 billion relative to previous plans. Take account of the cuts to planned spending announced in the Autumn and Santa Sunak, purveyor of billions today looks more like Scrooge Sunak cutting spending and raising taxes to the tune of nearly £50 billion relative to his pre-pandemic plans of March 2020.
That’s mostly a result of two big tax increases, both screeching U turns on Conservative policy over the last decade. The long term freezes in various tax allowances and thresholds raise £9 billion or so, mostly from the freeze in the income tax personal allowance. The rise in corporation tax is of historic proportions. If the Budget numbers are to be believed the increase in the main rate to 25% could see revenues rise by more than £17 billion by 2025. That would take the UK well up the international league table for corporation tax revenues and would certainly take revenues well above their level back in 2010 when the coalition government set about its series of rate reductions.
Whether that rise in the corporation tax will actually be delivered without additional concessions we will wait and see. I reckon 50-50 at best. Even if it does, as the OBR expects, raise £17bn in 2025-26, it will raise less over the long run. Then there are the chances of delivering what look like £17 billion of spending cuts relative to March 2020 plans which, broadly speaking, is what Mr Sunak says he is planning. I may be proved wrong, but I’d offer 10 to 1 against that happening.
But those are the numbers in the forecast. If they are all delivered they would get the public finances into current balance – i.e. borrowing only to invest – by 2025-26. The sad truth is that that would be a balance built on the highest sustained tax burden in UK history and yet further cuts in unprotected public service spending. That is perhaps one measure of the difficulties presented by more than a decade of paltry growth followed by the deepest recession in history.
The public finances and spending
Good news on this year’s deficit is more than offset by an increase in borrowing next year. But it is the slightly longer term numbers that really matter. While he didn’t quite tie himself to this, it looks pretty clear that the chancellor wants to achieve two outcomes. First, he’d like to get to current budget balance, only borrowing for investment. That could still involve total borrowing in excess of £70 billion in 2025–26. Second, he’d like debt to be at least stabilised, and preferably on a downward trajectory. That’s not a bad set of aims for the medium term, and it is sensible given uncertainties to be no more specific than that at this stage.
We didn’t hear enough about those uncertainties yesterday. As ever our attention is drawn to central forecasts and scenarios which, according to the OBR, will see national income taking a long term real hit of 3% relative to pre-pandemic forecasts. That’s an important cost, but it is worth remembering that the economy was 11% smaller than previously forecast five years after the financial crisis.
If central forecasts are right, and all policy measures are delivered, then we get to current budget balance. But if we follow the OBR’s downside scenario then even with policies delivered, borrowing would still be at £130bn in 2025-26: a current budget deficit of almost £60 billion.
Let me focus though specifically on the uncertainties about delivering on the spending plans.
One assumption is that the Universal Credit uplift of £20 per week comes to an end in October. If it doesn’t – and the pressure will mount to keep it – then that adds over £6 billion to spending each year going forward. It is, by the way, remarkable that while the Chancellor felt the need for a gradual phase out of furlough, business rates support, stamp duty reductions and VAT reductions he is still set on a cliff edge reduction in UC such that incomes of some of the poorest families will fall by over £80 between one month and the next. Whatever the case for cutting generosity into the longer term, if you’re going to do so the case for doing it gradually rather than all at once looks unanswerable.
The other assumption is that public service spending plans will be delivered. The big story here remains that the Autumn spending review took some £12 bn a year out of pre pandemic plans in real terms. Yesterday the chancellor chose to trim around £4 billion per year from his cash plans for public service spending after next year. Now these are not firm plans, but they are the basis for the future public finance estimates. They are a very shaky basis.
The Treasury argue that as far as this additional £4 billion cut is concerned this is a purely mechanical change because of a lower inflation forecast. Well up to a point, but it is a particular measure of inflation, depressed by current lockdowns. It does not represent any real reduction in cash needs going forward and it’s pretty clear that, if delivered, this additional £4 billion cut in cash spending will cause additional pain. This isn’t just a mechanical change and presenting it as such means the Chancellor isn’t really levelling with people about the choices the government is making to repair the public finances.
The actual costs facing departments are unlikely to have fallen. And since the NHS, schools and the Ministry of Defence all have budgets fixed in cash terms until later in the Parliament, this new £4 billion cut will fall entirely on other, unprotected services. Those areas – including perennially squeezed budgets like justice and local government – are now facing real-terms cuts in 2022–23. That’s a recipe for a very tricky Spending Review in the autumn.
But that’s only if you think these plans will actually be stuck to. Are we really going to spend £16 billion less on public services than we were planning pre-pandemic? Is the NHS really going to revert to its pre-Covid spending plans after April 2022?
In reality, there will be pressures from all sorts of directions. The NHS is perhaps the most obvious. Further top-ups seem near-inevitable. Catching up on lost learning in schools, dealing with the backlog in our courts system, supporting public transport providers, and fixing our system for social care funding would all require additional spending. The Chancellor’s medium-term spending plans simply look implausibly low.
While Mr Sunak told us time and again that he was being honest with us about what needed doing, he managed to find two big tax increases which will be somewhat hidden from most of us.
Freezing the income tax personal allowance is, as he said, a progressive tax increase. But it is the least progressive way of raising income tax. Even four years of freezes though will undo only a fraction of the increases we saw over the 2010s.
Note that those increases in the allowance over the 2010s were key to ensuring the remarkable result that middle earners did not lose out from austerity in terms of higher taxes and lower benefits. This rise will hit “middle England”. A political risk perhaps.
Freezing the higher rate threshold on the other hand will follow something of a pattern. By 2025 we could have over 5 million higher rate taxpayers compared with the 4.1 million we currently have and far higher than the 3 million there were in 2010. Freezing things for a long period makes a big difference. There are, for example, now twice as many people paying the additional 45% rate of income tax as there were when it was introduced in April 2010 because the £150,000 threshold has remained unchanged in nominal terms for over a decade.
The really remarkable policy though was the raising of the corporation tax rate from 19% to 25%. This looks in large part like the act of a chancellor hemmed in by manifesto commitments not to raise the rates of income tax, VAT or NICs. As the OBR says the corporation tax rise “will increase the cost of capital, lowering the desired capital stock and business investment”. It is important to remember that the headline rate is not the only thing that matters. While that has been cut a lot over the last decade the base has been widened. That’s one reason revenues have held up well; and the rate rises will be harsher than they would have been had the base not been broadened. On various measures the effective rate of corporation tax in the UK is currently average rather than low by international standards. Our corporation tax take is certainly healthy. With this increase Mr Sunak is taking a gamble that raising corporate taxes further up the international pecking order won’t have too terrible an effect on investment.
The big rabbit out of the hat was the super deduction for investment. Effectively this is a temporary subsidy for investment in plant and machinery. It has been welcomed as a great boost for investment, but is it a good idea? As a short term fiscal stimulus it might have something going for it. As a tax policy I worry. It will favour investment in physical assets rather than intangibles in ways which will distort behaviour. It will subsidise investments that would not be economically viable without the subsidy. And, to quote the OBR again, by bringing investment forward its positive effects will “go into reverse” in subsequent years.
Finally and briefly on tax I can’t end without mentioning two perennial absurdities. This is the 11th year in a row that a government supposedly committed to net zero greenhouse gas emissions has cut the tax on burning petrol and diesel. And the freeze in the lifetime allowance means that the goalposts have been moved for pension savings yet again – something which has happened at least every other year for the last 12 years. How savers are supposed to make long term plans for their retirement in such circumstances is beyond me.
Mr Sunak had three challenges in this Budget – to ensure the right level of support for the economy over the next few months, to set about fixing the longer term public finances, and to deal with the longer term consequences of the pandemic, especially its unequal consequences.
He has done a decent job of the first, arguably erring on the side of generosity.
He has given us a sense of where he wants to go on the second, but he still has a lot of work to do and his spending plans in particular don’t look deliverable, at least not without considerable pain.
On the third he has been silent. No money to deal with post pandemic priorities. No policies to deal with the inequalities that have opened up over the last year between rich and poor, old and young, more and less well educated. This is a big hole in the chancellor’s and the government’s policies, a hole which needs to be filled and soon if we are not to suffer a much worse hangover from this crisis than need be the case.
IFS Director Paul Johnson said:
"What we can be sure of is that Rishi Sunak has spent big again, extending some support right through 2021 at a cost of an additional £60 billion or more. As a result borrowing is now forecast to again be above 10% of national income in the coming financial year. Whether the big fiscal tightening planned for subsequent years will actually happen is less certain. It continues to depend on spending being lower than planned prior to the pandemic. And it also depends on a large increase in corporation tax actually being implemented without additional measures to at least ease its long-run impact. Make no mistake, this proposed increase in the main rate of corporation tax is a big reversal of decades of policy direction and a significant risk. For all the rhetoric about it leaving the headline rate here below that in other G7 countries, our effective tax rate will be relatively high.
"Mr Sunak made much of his desire to be honest and to level with the British people. The fact that he felt constrained to raise taxes by hitting companies and through freezing allowances, rather than through more explicit rises in people’s taxes, suggests there are limits to how far he wants to level with us as he attempts to raise the overall tax burden to its highest sustained level in history."
Under the OBR’s central scenario the biggest tax-raising Budget since the first Budget of 1993 is forecast to be sufficient to eliminate the current budget deficit in 2025-26. This would mean that the government would only borrow to invest, with day-to-day spending covered by revenues. Around half this consolidation is achieved by the large increase in corporation tax, and around a quarter by the freezing of income tax thresholds. But the outlook for the economy - and with it the outlook for revenues - remains enormously uncertain: Under the OBR’s downside scenario the current budget is forecast to still be running a deficit of something like £85 billion in 2025-26, in which case further tax rises would be likely if the Chancellor is to balance the current budget within this timeframe.
Isabel Stockton, a Research Economist at the Institute for Fiscal Studies, said:
“A healthy economic recovery, combined with a substantial tax increase, would be enough to allow the government to cover its day-to-day spending with revenues by the middle of the decade, borrowing only to invest. This is one definition of ‘balancing the books’, but this success would be at risk if the recovery falters or tight spending plans - or for that matter the large tax rises announced today - prove undeliverable.”
Public service spending was not a central focus of this Budget. The Chancellor set detailed allocations for the coming financial year in the Spending Review last November and he left those plans largely unchanged. Under those plans, Mr Sunak is planning to spend £14 to £17 billion less on public services each year after 2021 than he had planned pre-Covid. Given the mounting pressures on the NHS, schools, courts and other services, the credibility of such a tight settlement is questionable. There will certainly be strong pressure for future top-ups.
Ben Zaranko, a Research Economist at the Institute for Fiscal Studies, said:
“The Chancellor largely stuck to his pre-existing plans for public service spending – plans which imply spending less in the medium-term than the government was planning pre-pandemic, and rest on the assumption that the NHS will revert to its pre-Covid spending plans after March 2022. Given the substantial and mounting pressures on the NHS, schools and other services, one has to wonder whether these spending totals have been set implausibly low so as to flatter the public finance forecasts.”
The government has extended the temporary £20 per week boost to universal credit (UC) and working tax credit by six months, benefiting around 6.5 million families. It delays until October the point at which benefit receipts will fall from month to the next, by more than 20% for some. Clear advance communication of this to families will be crucial before the time comes. Tapering the boost away incrementally over a number of months would have been another way of facilitating a less troublesome adjustment for families.
Those still claiming the out-of-work benefits that preceded UC - most of whom were already out of work before the crisis struck - did not benefit from the temporary boost to benefits last March and the Chancellor did not change that today. Most of the 2.5 million claimants of these benefits have health conditions which limit their ability to work.
Tom Waters, a Senior Research Economist at the Institute for Fiscal Studies said:
“The labour market isn’t much stronger than it was this time last year, so there’s a clear rationale for extending the UC boost a bit longer. But in six months’ time the end of the boost will mean overnight reductions in incomes. As the government has found already, this can create political pressure; but it can also create real difficulties for families in adjusting to the change, especially if their awareness of it is limited. A more gradual removal may have been easier for many, and the government needs to communicate the policy clearly to recipients so they know what to expect.”
The personal allowance has risen by almost 60% in real terms over the past decade, reducing income tax revenue by an eye-watering £25 billion per year and meaning that 40% of adults do not pay any income tax at all. The planned freeze, representing a 7% real-terms cut, undoes only a small share of that rise, and brings another 1.3 million people into the income tax system.
By contrast, the higher-rate threshold is already 9% below its 2009 peak in real terms, and the freeze will bring it 16% below. It has not kept up with earnings growth over recent decades, meaning that steadily more and more people have become subject to it. While fewer than 4% of adults paid higher-rate tax in 1990, by the time the freeze is over that figure will likely be more than 10%.
Tom Waters, a Senior Research Economist at the Institute for Fiscal Studies said:
“Freezing the income tax personal allowance and higher-rate threshold is a straightforward, broad-based and progressive way to raise what, at least in normal times, we would think of as a significant chunk of revenue. It also means that more people will pay higher-rate income tax. The steadily rising number of people subject to the higher rate was of course a concern that Boris Johnson raised during his campaign for the Conservative Party leadership, when he proposed increasing the threshold to £80,000. Freezing it means that, for the first time ever, more than 1 in 10 adults will pay higher-rate income tax.”
Corporation tax will reverse course, rising from 19% to 25% in 2023. This is forecast to raise £17bn per year by 2025–26, pushing corporation tax receipts to 3.2% of national income.
Unfortunately, a small profits rate will be reintroduced. There is no distributional motive for such a rate (because low-profit companies do not correspond to low-income people), and it introduces unnecessary complexities and distortions into the tax system.
In each of the next 2 years, around £13bn will be spent on a massive subsidy to investment, which will help to stimulate the economic recovery. This provides a large incentive to undertake investment – even investment that would not be commercially viable without the subsidy – and to bring forward as much investment as possible, with an inevitable ‘hangover’ afterwards.
The temporary extension of relief for losses is welcome – the pity is that it is only temporary.
Stuart Adam, a Senior Research Economist at the Institute for Fiscal Studies said:
“The UK’s headline rate will be in the middle of the international pack – and still the lowest in the G7 if USA state taxes are included. But the large rate increase will lead firms to invest less in the UK in the medium run, which will in turn depress economic activity and reduce the revenue generated by the tax rise.”
Coronavirus support for households
The welcome extension of the furlough scheme in full until June, and then phasing it out through the summer, means continued support for jobs while restrictions on daily life continue and provides employers with a few months’ transition back to a world without furlough. The OBR expects most of the 4.7 million furloughed people at the end of January to be back in their jobs by then, and is currently forecasting this to fall down to 2.0 million by September.
The self-employed income support scheme (SEISS) has also been extended for a fifth payment covering May to September. The “newly self-employed” who first started self-employment in 2019-20 will also be included in the scheme. Although around 600,000 people could be in this group, many - perhaps a majority of them - will still be ineligible for SEISS as they will have had less than 50% of their income from self employment in 2019-20.
The Chancellor has decided to reduce the SEISS scheme over the summer by giving smaller payments (worth 30%, rather than 80% of pre-pandemic profits) to people whose turnover has fallen by less than 30%.
Jonathan Cribb, a Senior Research Economist at the Institute for Fiscal Studies, said, “It makes sense for the government to extend the furlough and SEISS schemes through to June in full while there are still restrictions on economic activity, and then to phase it out so that by October the schemes are gone, but they are still not including 1.5 million self- employed people who earn over £50,000 or have less than 50% of their income from self employment.”
Podcast: Budget 2021: The road to recovery?
In this episode, Paul Johnson speaks with IFS Deputy Directors, Carl Emmerson and Helen Miller to explore the kinds of things the Chancellor should be thinking about.
Click here to read the disclosures from Citi.