New Chancellor set for a modest fiscal windfall – but tough choices remain

The Office for Budget Responsibility (OBR) is on course to deliver a modest fiscal windfall of around £8 billion on Budget day, but the Chancellor still faces tough choices over raising taxes or watering down his fiscal rules, according to new research published today (Monday) by the Resolution Foundation.

With just over a fortnight left until the crucial first Budget of the new parliament, The trillion-pound question assesses the outlook for the economy and public finances, and the options available to the new Chancellor.

The report finds that the OBR is likely to downgrade its outlook for the size of the economy by around 0.5 per cent by the end of 2022, with the Bank of England and independent economists having already reduced their forecasts since the OBR’s last projections back in March 2019.

However, the Foundation’s analysis shows that the Chancellor may actually be in line for good news on the public finances, with the fiscal hit from weaker growth likely to be more than offset by lower interest rates and inflation reducing the cost of government debt.

Together this could lead to an overall modest fiscal windfall of around £8bn in 2022-23, leaving the Chancellor with fiscal headroom of around £10bn against his target of achieving a current balance in that year.

While changes to those fiscal rules have been much debated in recent weeks, the Foundation says that pushing this current balance target back to 2024-25 would only increase the Chancellor’s fiscal headroom to around £15bn in that year.

The report notes however that this tweak to the fiscal rules would not provide a realistic way for the Chancellor to pay for spending pressures because it would still be less headroom than previous Chancellors have held against their fiscal rules.

Focusing on what the Chancellor is planning to announce, The trillion-pound question says that the Budget will confirm plans for a bigger state. Total government expenditure is set to rise to 40 per cent of GDP – higher than at any point while Tony Blair was Prime Minister.

This spending increase, which includes up to £100bn of extra capital spending and the fastest increase in day-to-day departmental spending since the early 2000s, would take the government’s total managed expenditure above £1 trillion a year for the first time by 2023-24. It would also mark a turning point on borrowing, which is set to rise from £41bn in 2018-19 to £64bn by 2021-22, after a decade of falls.

However, the report warns that this extra spending alone cannot ‘level up’ the country, and the fact that austerity has been ended does not mean it has been reversed. The big question for the Chancellor is the extent to which he undoes big spending cuts to day-to-day public services, and how that is paid for.

With departments including Justice, DEFRA and Transport having experienced cuts of at least 30 per cent since 2009-10, the Foundation notes that even reversing half of the cuts to non-health departments would cost around £24bn. Additional spending on welfare to prevent further rises in child poverty would cost around £5bn.

With tax raises the only way to sustainably fund additional day-to-day spending, the Foundation notes that the Chancellor has options to raise revenue in this Budget. £3bn can be raised by scrapping Entrepreneurs Relief, while freezing income tax thresholds would bring in over £8bn, potentially funding the commitment to National Insurance tax cuts.

Finally, the Foundation adds that the Chancellor should also use the unique opportunity of the first Budget of the new majority government to fire the starting gun on more fundamental tax reforms, allowing firm revenue-raising proposals to be included in his Budget this Autumn. These could include:

• Reforming the UK’s highly regressive pensions tax relief system, which costs £35bn a year. Over £2bn could be raised by capping the tax-free lump sum at £42,000.
• Repairing the UK’s notoriously leaky inheritance tax system, including reducing agricultural and business property relief.
• Rebooting council tax in England – which taxes properties in the North East over twice as much as those in London. Introducing the same modest changes to council tax introduced in Scotland would raise over £1bn.

Jack Leslie, Economist at the Resolution Foundation, said:

“The decisions taken by the Chancellor in the new government’s first Budget will help shape the economic policy backdrop to this whole parliament.

“The Chancellor’s big-spending plans to ‘level up’ the country through infrastructure projects will lead to a bigger state than at any point under Tony Blair, and marks a big shift for a traditionally small state Conservative Party.

“But new roads and rail lines are only part of the story for a government wishing to turn the corner on a decade of austerity. If the Chancellor wants to increase spending on day-to-day public services in a fiscally responsible way he will have to change another of his party’s traditional priorities – lower taxes.

“Good news on the public finances from the Office for Budget Responsibility will still be too modest to change the big picture decisions of this parliament. Higher spending will require higher taxes.”