It’s a little too easy in responding to yesterday’s Spring Statement to forget even the very recent past. Remember Covid? The £70 billion furlough scheme only came to an end less than six months ago. The economy is still in recovery mode. That was the biggest economic shock in a century, sent government debt and borrowing spiralling to record levels and involved greater government intervention in the economy than at any moment in peacetime.
And if we can’t remember Covid, what about Brexit? The OBR sees no reason to revise its view that it will have a substantial long-term negative effect on our national income. Then there’s the ever-lengthening shadow of the financial crisis, which resulted in a decade and more of stagnant incomes and flat lining productivity.
All that history matters in assessing both the severity of the current problems and the chancellor’s response to them. Covid left the deficit, and especially the national debt, higher. Public service spending was squeezed tight after 2010 and the working age benefit system was made much less generous. Brexit has slowed growth, on top of the post financial crisis slowdown. Household incomes today are far lower than they would have been in the absence of these shocks. On some measures average earnings could have been as much as £11,000 a year higher had pre-financial crisis trends continued.
So, neither the nation’s finances nor household finances were in great shape when the latest economic shock – the worldwide rise in commodity prices – hit. The expected sharp fall in real household incomes this year is all the more difficult, and all the more shocking, coming off the back of such a long period of feeble growth. And a chancellor looking both to balance the current budget and provide at least a little succour to public services after the austerity years had very little room for manoeuvre.
Public finances
In fact, Mr Sunak has proved to be something of a fiscal illusionist. He told us that he cut taxes yesterday. In a sense he did. He increased the floor for NICs and promised a cut in income tax in 2024. So Mr Sunak’s statement contained big new tax cuts. But it also allowed taxes to rise. He can now expect to raise more in tax as a share of national income by 2025 than he expected last October. In fact, taxes are set to rise to their highest level as a fraction of national income since Clement Attlee was prime minister. Not my comparison, that comes directly from the OBR.
On current plans Mr Sunak’s income tax changes won’t actually depress income tax revenues in 2024-25. Despite the cut in the basic rate planned for that year, the income tax take will stay about the same as in the previous year, and then continue rising. That’s the effect of inflation and fiscal drag. They have magically doubled the scale of the tax rise he announced last year – the four-year freeze in the personal allowance and higher rate threshold. The proposed cut in the basic rate gives back only about half of the additional windfall he is now expecting to enjoy from that measure.
There’s another illusion in there too – the annually repeated illusion that fuel duties will actually rise next year. Not only do the public finance forecasts depend upon the 5p cut being reversed, they assume an increase in line with the RPI on top of that. The odds against the former feel long. I reckon an RPI increase on top is about as likely as my winning the National Lottery. And I don’t play the Lottery.
Given all that, by the end of the forecast period the chancellor supposedly has a little more wriggle room against his fiscal targets than he expected in October despite lower expected economic growth and those tax cuts. That’s because not only is he allowing taxes to rise (he’s not cutting them), he is also effectively cutting spending on public services in real terms relative to previous plans. Yesterday he offered them no extra cash at all to deal with higher inflation. The exact scale of this cut relative to previous plans is a little uncertain, but it is significant. It will almost certainly mean some more hefty real pay cuts across the public sector, coming on top of cuts both in real terms and relative to the private sector over the last 12 years.
Cost of living
The immediate aim of the statement, of course, was to help relieve the squeeze on the cost of living.
What was announced yesterday comes on top of February’s £9 billion giveaway via council tax rebates for 80% of households and the, repayable, rebate on energy bills. But, of course, it also comes on top of the NI increase announced in October and the freezing of the income tax personal allowance and thresholds announced a year ago. Put all those together and the net effect of the measures is a relatively modest giveaway to households of in the order of £5 billion or so in 2022-23.
Against the baseline of normal uprating, it is a pretty progressive giveaway. People in the top 10% or so of the income distribution lose quite heavily. As a fraction of income, gains from the measures are highest at the bottom and gradually fall with income. The council tax and energy bill rebates play an important role here. That is a definition of a progressive set of measures. Those of us who have criticised the Chancellor for failing to do more for benefit recipients should acknowledge that.
The problem is that this will still not be enough to protect poorer households from a significant hit to their living standards. In particular the failure to do more than default indexation for benefits will leave many worse off.
In the long run this year’s giveaway turns into a substantial takeaway. The overall impact of the reforms remains progressive. But the council tax and energy bill rebates disappear leaving only very small gains at the bottom (largely arising from the cut in the UC taper). The NI floor, having been increased sharply this July, is frozen through to March 2026. The impact of freezing income tax allowances and thresholds grows, taking an increasing amount from higher earners. Cutting the basic rate of income tax is regressive but, as we have seen, not as big a change as those freezes. The big increase in National Insurance Contributions remains a big hit on higher earners who are still the big losers. Perhaps surprisingly this continues a trend since 2010: the highest earners have been by a distance the biggest losers from tax changes implemented since then.
In the short term one problem is that this combination of tax cuts and rebates is not enough to offset the fall in real earnings that we expect to see. It looks like a median earner, on around £27,500 a year will be about £360 worse off in the next financial year than in the current year. Someone earning around £40,000 will be getting on for £800 worse off. As I’m sure everyone is now well aware the OBR are forecasting the biggest hit to real household disposable income per person since comparable records began in the 1950s.
The second big problem is that for those dependent on benefits there was nothing in yesterday’s package. The flat rate council tax rebate will benefit the large majority to the tune of £150 and the energy bill rebate will provide £200 in the short term. But that will still not be enough to offset the real fall in the value of benefits for most such households over the coming year. The 3.1% increase needs to be set against OBR expectations of inflation averaging nearly 8% over the year. And the inflation rate experienced by poorer households will be even higher than that. While benefit levels will catch up with inflation next year, that will be of little comfort to those budgeting week to week or to those who are unemployed this year but not next year. It is hard to understand the lack of action on this front.
A couple of additional specific beefs with the policy announcements. First, while the increase in the NI floor is welcome, it is hard to think of any good reason to increase the rate of NI and cut the rate of income tax. That again benefits those living off pensions and unearned incomes at the expense of workers. The Chancellor has also not made the case for cutting the basic rate whilst also cutting the value of the personal allowance and it is certainly a regressive policy combination.
Second, the absurdity of the idea that the NI increase, which will become the health and social care levy, is in any way hypothecated to health and social care was laid even more bare yesterday. The cut in NI receipts from yesterday’s new measure is not leading to, and of course should not lead to, a cut in funding for the NHS and social care.
Third, while promising some changes to business taxation in his Autumn Budget Mr Sunak has done nothing to shield them from this year’s planned rise in employer NICs. That will add to their costs and to the downward pressure on real wages.
One additional point worth making. The impact of the change to the student loan repayment system on the public finances was laid out in the OBR’s report. This will effectively act as an increase in taxes on middle earning recent graduates.
Assessment
To be fair to Mr Sunak he has been caught in a bind. We are worse off than we expected and he could never protect us all. What he has proposed will offer substantial protection to low earners and, from last month’s measures, some significant protection to those on benefits. His policies are overall progressive and will take significantly more from those on the highest incomes. He continues to, just about, meet his fiscal rules.
However. He has not taken the opportunity to protect the poorest more fully simply by uprating their benefits more closely in line with actual inflation. His choice to increase NI rates and reduce the basic rate of income tax looks indefensible from an economic point of view, though one can see the political attractions. He continues, despite his rhetoric, to be a chancellor presiding over a very big increase in the tax burden. What he did yesterday was not enough even to stop the expected tax burden rising yet further.
He is sharing the inevitable pain of continued bad news between public services and taxpayers, with benefit recipients suffering in the short term. He had tough decisions to make. Other choices were available.
