Inflation Nation

It’s hard to overstate the scale of the cost of living crisis that’s coming in 2022-23, with the highest inflation in 40 years and the worst income squeeze on record lying ahead of us. Against that backdrop, and with fiscal ammunition thanks to the Office for Budget Responsibility’s (OBR’s) borrowing forecasts improving by £42.4 billion over five years, the Chancellor set himself two tasks at Spring Statement 2022: to offer the public some protection against the surging cost of living, and to show the Conservative Party that he is a tax cutter. He set out significant packages on both fronts. But an indefensible refusal to target support at low- and middle-income households next year, and previously announced tax rises, meant he has fallen well short of both goals.

The stronger than expected recovery from the pandemic is about to be undermined by surging inflation

The British economy has continued its stronger-than-expected recovery from the pandemic, with the economy now around 0.5 per cent larger, and unemployment almost 400,000 lower, than projected in October 2021. But surging inflation is the main economic news, with the OBR doubling its forecast for 2022’s inflation peak to 8.7 per cent. Rising costs for firms and falling incomes for consumers mean that growth for 2022 has been revised down from 6 per cent to 3.8 per cent, although (unlike the Bank of England) the OBR assume there is no lasting damage to the size of the economy.

There is, however, significant damage to real wages, which are projected to fall by 3.6 per cent over the course of 2022. The slow recovery from this fall, on the back of the disastrous wage stagnation of the past decade, means that by 2027, real wages are set to have grown by just £18 a week since the financial crisis, compared to £240 a week if they had grown in line with the pre-financial crisis trend.

Immediate support has done little for the low- and middle- income households worst affected by the rising cost of living

The Chancellor has responded to surging inflation with a significant, but poorly targeted, package of support for 2022-23, choosing to rebuild his tax-cutting credentials rather than target the households worst affected by the rising cost of living. Measures include raising the National Insurance threshold from £9,880 to £12,570 in July, a 5p cut to Fuel Duty rates, and a £500 million increase to the Household Support Fund.

Only £1 in every £3 for the measures announced yesterday will go to the bottom half of the income distribution. Households in the top half gain an average of £475, compared to just £136 for the poorest fifth of households. If we consider these measures alongside previously announced support for energy bills and (larger) tax rises, the Treasury is only offering limited support to household budgets next year: an average boost of £110. That average hides big losses amongst higher income households from tax increases: a typical household gains £323, but policy changes will actually make households in the top half of the income worse off, on average, by £169 a year.

Even taking into account the support measures announced by the Chancellor yesterday, the typical working-age household faces an income fall of 4 per cent or £1,100 in 2022-23. But the greatest falls will be felt by the poorest quarter of households who are set to see their real incomes drop by 6 per cent as benefits fail to keep pace with the rising prices. As a result, a further 1.3 million people will fall into absolute poverty next year including 500,000 children – the first time Britain has seen such a rise in poverty outside of recessions.

This scale of income shock is not one the country is projected to recovery swiftly from. Incomes are on course to be lower at the next election (2024-25) than they were at the previous (2019), with typical non-pensioner income projected to be 2 per cent lower. Such an outcome would make this the worst parliament on record for living standards growth.

Despite the headlines, taxes are going up not down

Looking further ahead, the Chancellor also announced a 1p cut in the basic rate of Income Tax for April 2024 which looks set to save the average earner £243 a year. But the gains of this and the lasting impact of a higher National Insurance threshold are more than wiped out by previously announced tax rises: the Health and Care Levy combined with the freeze to Income Tax thresholds.

In 2024-25, when the income tax cut comes into effect, 27 million out of the 31 million people in work will pay more Income Tax and NI as a result of personal tax changes announced by Rishi Sunak. Households in the middle of the income distribution will on average be £535 a year worse off, while losses among the richest ten percent will average over £2,000. Cutting the basic Income Tax rate while raising that for National Insurance (via the Health and Care Levy) also makes little sense. It widens the gaps in marginal tax rates paid by many working-age people versus those in retirement, or workers versus landlords, on the same level of income.

Looking beyond just personal income taxes, the Chancellor set out his intention to support capital and R&D investment by British firms, but the big picture is taxes going up, not down. Tax receipts as a share of the economy are set to reach their highest level since 1982-83 – the equivalent of a £3,000 rise per household since the 2019 election.

The Chancellor did not offer protection for public services from rising inflation

Although the Chancellor stepped in to offer households some protection from higher than expected inflation, he chose not to do so for public services. This in part reflects the fact that costs of production in the UK are not rising as fast as the costs of consumption, with the latter driven by the cost of imports (particularly energy). As a result, the 3.3 per cent annualised real increase in non-Covid day-to-day spending between 2021-22 and 2024-25 that was planned in Autumn 2021 has fallen, but only to 2.9 per cent. Real day-to-day spending on defence will now decline by 5.7 per cent between 2021-22 and 2024-25, up from the 4.3 per cent fall expected in October.

Unlike household finances, the public finances have improved

While household finances are taking a hammering, the public finances have actually been on the up: tax receipts have come in much stronger in 2021-22 than expected and the OBR expects a lasting improvement on that front that averages to around £35 billion a year. This is only partially offset by higher benefit and (largely temporary) debt interest spending as a result of higher inflation, leaving borrowing across the forecast period projected to be £25.6 billion lower than expected in the Autumn even accounting for the significant tax cuts announced yesterday.

This contributes to a staggeringly quick fiscal consolidation, with borrowing falling from 14.8 per cent in 2020-21 to just 1.3 per cent in 2024-25. That would amount to three-times the fall seen over the same length of time post-financial crisis, taking the deficit to well below where it had been expected to reach before the pandemic, and to its lowest levels since the surpluses of the early Gordon Brown chancellorship. As a result, the Chancellor’s headroom against his fiscal rules (the binding rule that requires him to have debt falling in 2024-25) has increased to £28 billion from the £18 billion forecast in October 2021. That is the equivalent to a further 4p to 5p cut in the basic rate of Income Tax.

This Spring Statement saw the Chancellor prioritise rebuilding his tax-cutting credentials over supporting the low-to-middle income households who will be hardest hit from the surging cost of living, but while also leaving himself fiscal flexibility in the years ahead. The package of measures announced offered some immediate support to households and laid the ground for a 2024 election. But on both counts it looks likely to be far from the last word.