Big Budget breakdown

Afternoon all, and happy Budget week to those who observe…

This whole TOTC thing looks like fun (apart from anything, that strikethrough shortcut Torsten showed me will finally come in handy be massively overused). Although, I’m not sure how I feel about getting my hands on it the week I’ve decided to go without sleep…

So there’s plenty going on in the world this week, but here we’re strictly focused on the Budget – so if you’re looking for some long reads for the weekend I’m afraid now is the time to bug out… You can get the benefit of our nocturnal number-crunching here, (huge thanks to the amazing RF team who pulled out all the stops to provide a comprehensive take on the Budget), and you can also catch up on the suspiciously lively event with OBR chair Richard Hughes and the always-impressive IfG Chief Economist, Gemma Tetlow (full disclosure: heavy caffeine doping was involved…).

This was a BIG Budget. The biggest in a generation for spending, and the biggest *ever* for tax. We’ve seen lots of rows about whether there was too much tax, or not enough spending. But, given the scale of the thing, I’ve decided to zoom out on the big stories we should be talking about.

James Smith,

Research Director
Resolution Foundation

The size of the state – not growing why you think it’s growing…

With nearly £350 billion of extra spending on public services, it’s no surprise that the state is set to grow. The OBR is forecasting the largest sustained size of the state in more than 100 years (8 years of spending over 44.5% of national income). The reality here is that we’re finally locking in the post-Covid increase in the size of the state, instead of pretending we can shrink it again. A key reason why the size of the state has been growing in recent years is because of the higher cost of debt interest. Before the pandemic, low interest rates were helping to keep public-services afloat despite weak growth. That coping mechanism has been pulled out from under us – and it seems unlikely we’ll return to the rock-bottom interest rates we enjoyed for so long any time soon. And that’s going to be a problem, with the OBR forecasting for the first time that we are going to spend more than £100 billion servicing our debts in every year of the forecast.

Tax tightening amidst fiscal loosening…

While fellow fiscal nerds comb through the minutiae of tax changes, macroeconomists (another group who don’t have fun at parties) generally don’t think of Budgets as being a big deal – for them, monetary policy is the only game in town. But this one is different. Rachel Reeves has launched the biggest (net) fiscal loosening in more than 30 years (outside of major crises). This loosening is equivalent to 1% of national income, and will provide a major sugar-rush for the economy. The OBR expects annual growth to be the highest outside of the pandemic recovery since 2017 – so not party time, but a lot stronger than what we have generally become used to. As we have said, that could mean interest rates being as much as 1 percentage points higher – although in practice the Bank of England *will* be cutting rates next week, despite this Budget. But there are definite Biden-vibes about this Budget – a big expansion of borrowing, to invest in growth.

The market says… meh

A lot has been made of the reaction in markets to the Budget with CCHQ alarmists drawing parallels to the mini-budget debacle. Yes, borrowing costs have gone up. But there are two things going on here. First, the big fiscal loosening will boost the economy, meaning the Bank of England will not cut its policy rate as quickly as it would otherwise have done. Second, investors in UK bonds will demand a premium to compensate them for holding more debt. The former tends to affect short-term borrowing costs, the latter longer-term ones. The chart below shows that the rise in borrowing costs has been confined to shorter-term, with the jump in longer-term rates seen after the mini-budget notably absent.

Not much redistribution in the tax and benefits system…

We’ve already used this chart in our Budget response – but it’s a good un’, so bears repeating. It’s our attempt to figure out who (across the income spectrum) wins, and who loses, off the back of the Budget. The black line shows you how – in percentage terms – this is basically a dead heat: everyone’s a loser. In cash terms, it is very concentrated at the top.

Quick health warning: we’re about to get into the weeds – wrap a wet towel around your head if it’s all too much… A key reason why there isn’t much of a percentage difference across the distribution is that the threshold for starting to pay employER National Insurance has been cut from £9,100 to £5,000. This hits low-paying jobs the hardest. Now the Government might say – aha! you haven’t included Inheritance Tax (welcome reforms there), or CGT (a little tinkering!). That’s true, and if you include the effect of those (very difficult to model, and I am already *so* sleep-deprived) you would almost certainly have a bigger impact on the rich. Still, while it was always clear that taxes were going up at this Budget, the tax ‘red lines’ Labour committed themselves to during the election campaign have left us with a set of tax rises that hit low-paying jobs particularly hard.

….which instead came from public-service provision

So, while the Chancellor popped over to the Two Chairmen, RF stayed up all night (did I mention that already?) to analyse who lost out from the Budget – and who lost out even more. But other distributional analyses are available. This one comes direct from the Treasury. As they’ve got it – it’s happy days – everyone’s a winner! They get to that answer by leaving out employer NI (not a tax on working people, you see…), and including the impact that their spending on public services should have on living standards.

Below we put that in context. It shows what happens when we add Government day-to-day spending (the blue bars) to real, household disposable income (RHDI – the red bars), added to. It does look as though planned increases in government spending will reinforce living standards growth – so while wallets grow fatter we will also feel better as public services improve. This is an important blind-spot in the type of analysis we do at RF. But the big question for this government is: will this really make enough of a difference (before the next election) to make people feel better off?

Ending stagnation?

I don’t know if anyone has picked this up (e.g. here, here and here), but apparently this government would like some growth… An approach we fully endorse at RF – growth has been sadly lacking since the financial crisis, which is why increases in living standards have been so puny. The new government wants the fastest growth in the G7 – quite an ambition. Sadly, despite a colossal investment splurge, the Chancellor had to explain to the world on Thursday why the OBR *still* hadn’t marked up its growth forecast. A fundamental awkwardness here is that the OBR’s outlook is already sunny. The chart below shows its growth forecast, which is already quite a lot higher than the IMF’s. But the OBR does expect that the UK will be solidly mid-table among the G7 over the next few years. Our view is that some of the measures announced by the Government should help us move up the league. But there is clearly a lot more to do to get us to the top.

So, one of the most anticipated fiscal events in years very much lived up to the hype. The big choice being made here is that getting growth, and fixing public services, is the way to the nation’s hearts. That’s a welcome change – apart from anything, it’s good to see a UK government focused on good old-fashioned deliverism. The risk for this government is that an election will turn up before growth does.