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Podcast | Spring Statement: inflation, living standards and uncertainty

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The current economic environment is shaped by inflation and a rising cost of living crisis. During this period of uncertainty, the Chancellor gave his Spring Statement, outlining his plans for the public finances and responding to the shocks facing the economy.

In this episode, Paul speaks with Carl Emmerson, and Rob Joyce, Deputy Directors at IFS, about the Chancellor’s statement and the implications going forward.

Zooming In: discussion questions >>>

Transcript >>>

 

Zooming In: discussion questions

Every week, we share a set of questions designed for A Level economics students to discuss, written by teacher Will Haines.

  1. One of the Chancellor's stated aims in his Spring Statement was to help vulnerable households with rising costs. However, in real terms, this group will be worst hit. Why is this the case?

  2. Real earnings are on average £11,000 below trend growth and at the same level as they were in 2008. How can economic policy address this?

  3. Assess the overall outlook for the UK economy. Are there any reasons for optimism?

  4. Why are government tax revenues due to rise despite the freeze in income tax thresholds?

Transcript

Paul Johnson

Welcome to this special post Spring Statement edition of the IFS Zooms In, I’m Paul Johnson director of the IFS. I’m joined today, in person for the first time on the IFS Zooms In by two of my colleagues, Carl Emmerson and Robert Joyce who are both deputy directors here at the IFS and it’s just over twenty-four hours since Rishi Sunak sat down and we’ve had a little bit of time to digest what he said and what the impact of his changes are likely to be. We’ve looked at the consequences for the public finances, the public spending, and of course for household budgets. Been an awful lot of coverage of it, not very much very positive, it has to be said, over the last several hours. Carl, do you think that negative response is in entirely justified? Did the chancellor really fail to achieve anything useful yesterday?

Carl Emmerson

Well, I guess the first point is that the outlook for the economy is worse than it was in October and it’s predominantly worse because of events which were entirely outside of the chancellors control. The huge increase in energy prices that occurred up until January in fact and the even larger increase that occurred since then with Russia’s invasion of Ukraine, so thats essentially pushing up the price of oil, of gas, of the UK imports from overseas, it makes us poorer, the chancellor couldn’t wave the magic wand and make that difficulty go away. All he could do was choose between borrowing more money now to try an ease some of the pain in the near run, or allocate the pain differently between public services, business and different types of households. But it wasn’t an exercise where he could say, “don’t worry, I can make all these difficulties go away.”

Paul Johnson

But overall, Rob, I think your analysis suggests that both in the short run and in the medium run, if you take everything in the round, everything that’s going to come in over the next year and over the next several years, this was a pretty progressive package of measures?

Robert Joyce

It is, broadly in terms of the things the government is explicitly choosing to do, it is a broadly progressive package, and that’s essentially because we have some increases to direct taxes, the NICs rate increase in particular, and freezes to income tax threshold and the losses from that tend to be concentrated higher up the income distribution which is where most of the earnings and incomes are. And there’s also the broadly universal flat rate package of support for energy cost that was announced last month which is, as I say, broadly a flat rate give-away across the income distribution, therefore more proportionally for those on lower incomes. And also, we just had an increase as well to universal credit for those in work. If you put those factors together along with a few other things coming into play as well that that a broadly progressive package.  

I think the main thing to say about that is that income ways, the least progressive aspect of what’s happening is what the government isn’t doing. Because what all of that misses, is that the default way that the government sets policy for those on benefits and hence predominantly on lower incomes, involves a big real benefit cut this year, and the reason for that is because the government uprates benefits in line with a somewhat lagged measure of inflation. So, when inflation’s increasing, that’s not enough to keep pace in real time with what’s happening to prices.

So that’s not a reform, that’s what the government has always done, but they have the effect right now of cutting real incomes of many of the poorest, and the government has chosen not to anything, or not to do much about that beside the flat rate support package that I mentioned.

Paul Johnson

And for me, that’s one of the big puzzles in this whole package. The chancellor knew that the real value of benefits for this coming financial year was going to be a lot lower, I mean he knew it, officials would have been telling him, we’ve been telling him, virtually every think tank in the country has been telling him that, it wouldn’t have cost him anything in the long run to have increased benefits this time around, and it would have saved him an awful lot of flack today and probably over the next few weeks as well as helping some of the poorest people around. I mean have you got a sense as to why he chose not to do what frankly seems to me to be a pretty obvious policy?

Robert Joyce

It’s a little difficult to put my finger on it, there’s couple of thoughts that come to mind, one thought is, it seems given that they introduced this flat rate package of support which equates to about £350 for most households, over the coming financial year, through a couple of grants, one of which, by the way, will be recouped subsequently. Given that they announced that almost universal package of support and it seems like he wanted to help more than just the smaller group on benefits with these cost increases. Now having done that, through this fairly universalists approach, had they also done something to benefits then I suppose benefits recipients would have seen overall a real increase became they’d have gotten an inflationary uprate in their benefits, as one might think they should get, plus this grant, maybe he thought he didn’t want to do that.

Another point is that there is an awkwardness here in that for those not on universal credit, which is the new means tested benefit that we have in the UK, for slightly arcane operational administrative reasons it appears that it’s very difficult to change the older benefits and indeed pensions quickly. And there are still people on those older working age benefits as well as obviously people receiving pensions and so there may have been some awkwardness if the government had said, “well we’re able to quickly adjust universal credit amounts to keep pace with the picture of what’s happening with inflation, but we can’t do that for you, for you people on the other benefits.” Now it would seem a shame to me if you can’t help millions of people just because there are others, just because there are others wouldn’t be able to be helped in the same way, but perhaps that is playing into the political calculus in some way here. But it is a bit of a mystery to me why they don’t just do what would seem sensible.

Paul Johnson

Good effort, a good effort at a defence, but I’m not sure I buy it. I tell you, I mean let’s not forget that universal credit was increased by £20 a week over the pandemic but the so called legacy benefits weren’t. And indeed, the sooner you announce this stuff, the sooner it can actually happen. So, it seems, it’s difficult to know, but that seems like an odd choice.

Now this was overall a progressive package but, Carl, if were looking into the future, this is still very much a chancellor who’s going to be presiding over some pretty big tax rises.

Carl Emmerson

Yes, and that might seem a peculiar statement in the sense you just looked at the measures announced on Wednesday in the Spring Statement by Mr Sunak, you would see some pretty sizeable tax cuts and indeed comparing historically you have to go all the way back to Autumn of 1995 to see a bigger set of tax cuts in a statement. So that raises a question why, why are people taking about tax burden going up and Mr Sunak pushing taxes up? And the answer is that in the last calendar year, the combined effect of the policies the government set out was the biggest set of tax raises measures in any calendar year announced, all the way back to - since 1993. And not only that, those tax raising measures, I mean this new environment where inflation is much higher, are actually expected to raise lots more money than was thought a year ago. So, Mr Sunak has said the point at which you start to pay income tax, the point to which you start to pay higher rate of income tax, are both going to be frozen for four years. In a high inflation world that raises the government much more money than it would have done, it also hits households much more than it would have done. And the overall effect there is the pretty sizable tax cuts we heard about yesterday, are essentially just taking the edge off the fact that the tax rises are even bigger than had previously been intended. And so, as a result, the tax burden is expected to be bigger than what it was thought to be in October, it’s increasing faster and it’s going to reach the highest level since roughly 1950.

Paul Johnson

I think one of the quite remarkable findings from your analysis was that the basic rate of tax is falling in 2024, it’s going down one pence, that costs about six or seven billion pounds, but that’s not going to reduce the amount of income tax revenue that comes in at all, because of this freezing in the personal allowance thresholds.

Carl Emmerson

Indeed, I think Mr Sunak would be hard pushed to be able to claim he was even reducing the overall burden of income tax, let alone the burden of taxes overall, and that’s despite, as you say, the fact that he’s planning to cut at least one of the key parameters in income tax, taking that basis rate down from 20p to 19p in April 2024. And it’s purely because in that same year, he is planning to freeze again the point at which you start to pay income tax, the point at which you start to pay higher rate tax; given higher inflation that’s having an upwards pressure on minimal income, more people will be brought into tax, and that’s just about getting him enough money in that year to pay for that basic rate cut.

Paul Johnson

And the consequences of all this, Rob, is some really quite big tax rises, particularly for people towards the top of the income distribution. I mean what sort of scale of tax raises are we looking at here?

Robert Joyce

Well if we take the analysis all the way out to 2025, so we’re incorporating there the fact that these income tax thresholds would have been frozen for four years at a time of high inflation, which means under current inflation forecasts, a real cut those thresholds of about 16%, so if we’re including the effect of all of that up to about 2025, then we’re now looking at for example, for anyone on more than about £50,000 a year that the increased in direct tax liabilities overall, from combining both national insurance and income tax changes, is well over a £1,000 a year for pretty much all of that group. For basic rate taxpayers, it’s now an increase of something £250 to £300 per year by 2025, depending on exactly what their earnings are, so it’s pretty substantial. And that is in a large part again, unintended in the sense that it’s because these income tax threshold freezes are much bigger than was originally planned.

Paul Johnson

I suppose originally unintended but of course the chancellor could have undone it.

Robert Joyce

He knows now.

Paul Johnson

Done it yesterday, so in that sense it is intended. Interesting fact that I think, as it were, not many people know this but if you look over the period since 2010, there have been some quite big tax rises in general on people at the top of the income distribution. Particularly just the top few percent of the income distribution.

Robert Joyce

Yeah, that’s right, and I think maybe that’s still a little under appreciated. If we look at the decade of the 2010s and the distributional effects of changes to personal taxes and benefits over that period, you’ve got a pretty broad group in the bottom third or so, concentrated on the working age portion of that group who lost a lot proportionally because of all the benefit cuts over that period. And the other group, who lost a lot proportionally were the very top and as you said, not really even the top decile, particularly, it was really the top 1% or so where much of that was concentrated, there was a lot of changes there to top rates of income tax, treatment of pension contributions of the very high-income people and so on. So, what’s happening now in some way continues that pattern in that, broadly speaking, higher earners are being hit quite a lot by tax rises. Although what we’re saying now is more broad based, it’s not so finely concentrated just on that top 1% or so, it’s, you know, the top decile and the top fifth in general who tend to pay most of the extra income tax when you do that, use broad based income tax increases.

Paul Johnson

And I think that’s one of the interesting differences between what’s happening at the moment and what’s happening in the 2010s. In the 2010s the poor got seriously clobbered with some big benefits cuts, and the very rich got seriously clobbered with some big tax increase and people broadly in the middle and the upper part of the middle were quite well protected in a period of austerity, it was quite remarkable. I think what politically might be difficult for Mr Sunak this time around, is that quite a lot of people in the upper middle and the middle are going to get hit quite hard.

Robert Joyce

Yeah, that is an important difference, and of course people around the middle over the last decade were still suffering often in other ways, in particular from a terrible performance in real earnings. But that’s still going to be true now, if anything even more so in the next year or so.

Paul Johnson

I think this may be one of the political difficulties that the government faces over the next few years. Carl, we’ve talked so far a lot about taxes and living standards, the chancellor didn’t say anything about spending yesterday, did he, but in saying nothing, actually quite a lot has changed.

Carl Emmerson

Indeed and the coming year is a bit like the story Rob was telling about benefits, by not talking about it, it means you’ve made the system a bit less generous than what you’ve intended and what I mean by that is that back in October, the chancellor set out a set of spending plans for different public services, so we found out about health, schools, defence, etc, and that was all predicated on expectations of inflation at the time, and I presume the treasury also took a view about what was likely to be required in terms of paying public sector workers over the next three to four years. Now, inflation as we’ve been talking has increased substantially and is expected, or will be, very high for some time to come, the Chancellor in the Spring Statement could have choose to top those spending plans up – he chose not to. That means that in real terms those spending plans won’t go as far, it’s hard to say exactly how big a deal that is, it will depend exactly on what each department is planning to spend their money on, but you could clearly imagine some departments with obviously many public sector workers, are they going to try and keep to kind of pay growth they were planning back last October and therefore public sector workers will be facing yet another real term squeeze in their pay, on top of the squeeze that they’ve had over the last decade. And other departments, or some departments will have pretty substantial energy bills - schools and hospitals and obviously also the defence budget and that’s going to eat into their budgets by more than what would have been expected in October. So it doesn’t mean that spending plans overall imply a return to austerity or cuts, but it’s certainly a lower growth rate of spending in real terms than what was intended, I think it pretty much guarantees that while public sector workers are likely to see some cash increase in their salaries over the next few years, they’re unlikely to keep pace, perhaps, with even what the private sectors getting, let alone what you see in terms of inflation and the economy.

Paul Johnson

And that I think is going to be another political headache for the government, as you say public sector workers have fallen behind the private sector over the last decade, indeed and had a real small terms loss since 2010, whilst the private sector have seen at least a small real increase over that period and if we get further big, potentially big real terms cuts then there’s going to be a lot of unhappy nurses, teachers, soldiers, civil servants and so on.

Carl Emmerson

One thing the chancellor maybe planning here of course, through the pandemic we saw him return again and again outside of standard fiscal events and maybe what he’s got in the back of his mind is well, maybe when we get closer to say October we find out what’s going to happen to household energy bills then, we find out a bit more about how uncertain the economy is playing out, you get more evidence in the pay review bodies. Perhaps at that point he’s thinking, “well I’ll make decisions then about what to do for, on the one hand low-income households, on the other hand, what to do about these public service settlements, and whether to top them up.” But he certainly gave no indication that that’s what he was planning yesterday.

Paul Johnson

And it strikes me it will be a bit of political – certainly on the sort of, in terms of benefit recipients, to come back now, or indeed any time before the budget and say he’s going to do more for them, given that we know quite a lot about what’s happening to inflation, would be, I think politically would just be an admission of a mistake and maybe he should just come back and admit he’s made a mistake. So, what we’ve heard is there’s some big tax rises and the spending is not going up in real terms as much as intended. So where are we in terms of the public finances?

Carl Emmerson

Well in terms of the deficit, the gap between the amount the government gets in revenue and the amount it’s spending, in the current financial year the governments had some good news in recent months, unemployment has been lower than what it’s been expected and receipts have come in pretty strongly so borrowing is going to be a bit lower than they thought, quite a bit lower than they thought, although still at a relatively high level. In the coming financial year, while it is true that this higher inflation combined with those frozen thresholds is going to mean lots more revenue in cash terms coming into the exchequer, despite the fact they’re not topping up spending plans for public services, they’re expected to spend a lot more on debt interest, and that’s because getting on for a quarter of the government debt is automatically linked to a relatively poor measure of inflation, the RPI, that’s going to be running very, very high at the moment, it means that we’re going to spend almost twice as much on dept interest in the coming year than what we expected just in October. Now the good news is if when inflation returns back to normal levels, that part of the debt interest bill will come down again to more normal levels.  

There’s another part of the debt interest bill which is to do with the way in which the Bank of England manages quantitative easing, that part is becoming a bit more expensive for government, essentially as the bank of England pushes up the bank rate, it makes the financing of that a bit more expensive. So, we are going to be spending a bit more on debt interest over coming years. The government is getting bit more on receipts, we’ve talked about that rise in the tax burden, overall what that means is that the chancellor remains compliant with his two fiscal targets, not with a huge amount of wiggle room, but he’s getting the deficit back down to the kind of levels he’s comfortable with, and in terms of the overall debt stock, that is just about set to start falling again having risen sharply during the pandemic.

Paul Johnson

And put all that together I mean come back to what I was saying right at the beginning which is this is the sort of balancing act the chancellors had to put in place. In order to get to what he feels is a suitable fiscal situation, not too much borrowing in the future, he’s had to raise taxes, even if he’s called himself a tax cutting chancellor, he’s had no choice but to raise taxes. And he’s taken some money in real terms out of the public services, all of which reflecting the fact that we are, as a country, as you said right at the beginning, we are just poorer than we thought we were going to be. And if we’re just poorer, then that going to mean less money for us and less money for public services.

But let’s, Rob, just delve a little bit more into that issue of we are just poorer, there was a very striking statement, wasn’t there, in the Office for Budget Responsibility documents saying that we’re likely to see a bigger fall in income this coming year than in any single year since the late 1950s, that sounds pretty dramatic.

Robert Joyce

That’s right, yeah. And of the earnings of those in work, probably the biggest single year fall in earnings since the ‘70s and as you say, for a measure of disposable household income, that the OBR looks at, the biggest single year fall wince the ‘50s. Now, during the financial crisis of the late 2000s there was a period where earnings fell for several years, it maybe that we don’t see that. So, it maybe that the cumulative fall that we’re about to see isn’t quite as severe in total as the more prolonged one that we saw in the late 2000s recession. But in terms of a sharp adjustment over a single year, certainly what we’re about to see given this very high inflation is close to unprecedented in recent decades in the UK.

Paul Johnson

And comes off the back of some pretty dreadful income and earnings growth for quite a long period.

Robert Joyce

Exactly, so if you zoom out a little bit and put this together with what we’ve already seen happening since around 2008, it means that according to the latest estimates, really even by the mid 2020s we’re still going to be barely nudging about the levels of real earnings that we had before the financial crisis in 2008. So, we had this period where earnings were growing pretty consistently, and reasonably robustly for the 90s and the 2000s up until 2008, then we saw real terms falls in earnings, we then saw very stuttering recoveries, one of them just about getting going in the mid 2010s before the Brexit vote and the rise in inflation after that chocked it off. Another one just about looking like it was getting going before the pandemic hit, and now of course what we’re seeing now with the rapid rise in inflation meaning another fall in real earnings. So yeah, you put all that together we’ve got this extraordinary long period, almost twenty years it looks like it will be, with basically no change overall in real earnings.

Paul Johnson

Twenty years, I mean that’s, I think that’s the first time I’ve heard someone say twenty years with no increase in real earnings, that really is deeply depressing. And to put that in historical context, I think it’s fair to say, nothing remotely like that has ever happened before in recorded history of this country, at least not since the industrial revolution when earnings really stated to increase. And we can look at the unprecedented one year hit this year, but the bigger story of earnings and incomes not really rising is perhaps, well is certainly the more important one over a long period.

And just to end up, I mean that takes us to another issue that people have raised with respect to what we saw yesterday and what we’ve seen over the last year or so, which is this issue about which generations are winning and losing here? Because there’s been an increase, such was announced a month or so ago, to repayments for recent graduates on their student loans, an increase on National Insurance contributions which really only effects people of working age, and of course this reduction in the basic rate of income tax effects everyone. Put that on top of a long period, as you say Rob, of no increase in earnings, whilst pensioner incomes have actually have been rising. And then ultra-low interest rates for more than a decade, this other thing that’s happening, and is continuing to happen, isn’t it, is this move towards the older generation being more economically powerful relative to the younger?

Robert Joyce

Yeah, that right. And I think that the really major shifts there if were talking about over a period now of maybe a couple of decades or so, maybe a bit more, are as you said, the stalling of earnings growth, which is something that’s obviously effecting the working age population, combined with trends in wealth accumulation in particular in terms of what’s been happening in the housing market, and that is partly related to the low interest rate environment that you mentioned, but we’ve had this trend now for a while where home ownership rates among younger generations have been plummeting, whereas they are still, of course, much, much higher amongst older generations, and have benefited from these huge increases in house prices that we’ve seen over a long period - which themselves make it harder for many of those younger generations to get on the housing ladder. And the low interest rate environment more generally, just makes it harder for young people to accumulate wealth with what earnings they have. So, I think those are the sort of major things, as you say. If anything though, policy changes in terms of what’s been happening to taxes and benefits have tended to reinforce that further in shifting the balance of support away from the working age relative to those above pension age.

Paul Johnson

And that’s strikes me of one of the failures of the last decade is that monetary policy has pushed in one direction, supporting the old relative to the young, not the intention of it, but the effect of it; and then fiscal policy has come in and doubled up behind that. But Carl, pensioners are not protected fully from inflation by any means, are they? I mean there is an issue here, this inflationary issue, also does effect negatively a lot of people over pension age?

Carl Emmerson

Indeed it does, and if you’re a low income pensioner you will be reliant on the state for your income, it might come from pension credit, it might come from the state pension, and you’re going to get exactly the same issue as what Rob described for working age benefit recipients, the state pension works in a similar way. You’re going to see an increase of cash terms of 3.1% this April, and then you’ll probably be facing an inflation rate much higher than that. We know that pensioners on low-income pensions spend a very large share of their budgets on energy and fuel.

But even if you took middle- and higher-income pensioners and you say, “well where do they get their resources from, how are they indexed?” Well, if they retired a few years ago and they bought an annuity with a pension pot, that’s almost certainly going to be cash fixed, so they really loose out when inflation is higher than what they had anticipated, if they’ve retired more recently with a defined contribution pension, they’re in a world of what’s called pension freedoms where they have to manage that pot themselves, they chose how to invest it, how to draw it down. Now that gives them a lot of flexibility a lot of possibilities for potentially making good choices but it’s much harder to make those choices in a high inflation world, it’s much harder to get investments that will deliver real returns, and you might find that people who are reliant on those pots will be drawing the pots down and perhaps in a few years’ time we night find that they’ve exhausted the pots or drawn them down too quickly.

And then finally we’ve got a group of people who generally are relatively well off, those that have got defined benefit pensions, perhaps because they were someone who got one in the private sector years ago when they were more common or they were a retired public sector worker, and those pensions won’t be keeping up with inflation in the coming year either, the private sector ones are often indexed by inflation but only if inflation is below something like 2.5%, so a 2.5% increase of your income with inflation rates much higher than that, that’s a real cut. And if you’ve got a public sector pension, again you may well be relatively well off relative to your peers, but that will be increase by a lagged measure of inflation too. So, pensioners as a whole are going to have a very difficult year. I guess those with private sector defined benefit pensions, those with personal pensions it could be several years of quite a lot of pain.

Paul Johnson

And the fact is actually, that if this kind of shock were to happen in ten- or twenty-years time, then it would be even more difficult because very few would even have the protection that they get within defined benefit pensions at the moment. Something that we at the IFS are thinking about quite hard is what we see as quite big holes in the pension policy as we go forward that are really opened up by inflation and essentially a lot of what we’ve been talking about today has been about the impacts of inflation on living standards, on how government should respond on what it does for benefits, on what it does to tax receipts, on what it does to real value spending, we’ve just talked about inflation as it effects pensions, something that actually we’ve not talked about much in my working lifetime, actually, because information is now at its highest level now for forty years. And that changes, as we’ve seen, everything about how a chancellor needs to respond, and about how we’re thinking about changes that he’s making.

Anyway, I think we’ve come to the end of our half hour or so of podcasting, thank you so much to Carl and to Rob, it’s been a very long twenty-four or thirty-six hours for us, none of us got a great deal of sleep, but we very much enjoyed making this podcast and analysing what Mr Sunak has to say. We’ll be back with a regular edition of the IFS Zooms In very soon. Until then, thank you very much indeed for listening.

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