"The pacing of tax rises is more moderate than many had feared. But pessimism about the economic outlook risks becoming self-fulfilling, confining the UK to the economic slow lane at a time when the risks from raising taxes too late are far less than going too early."
The relatively gradual withdrawal of fiscal support from the economy shows the government has learned something from the premature tightening in 2010. On today’s plans only emergency support is phased out over the coming year. 2022 will be light on tax rises and then the tightening begins to bite from 2023 when, by the OBR’s projection, the recovery will be largely complete. This is a better pacing of consolidation than many expected before the announcement and will give the economy support to recover in the short term. If one buys the OBR’s view that the economy will converge at a level 3% below its pre-pandemic trajectory, this is a reasonable path of fiscal tightening.
The problem is that the watchdog’s view may become a self-fulfilling prophecy of macroeconomic pessimism. There are asymmetric risks from tightening fiscal policy too early versus too late. Tightening too early leaves the economy smaller than it could have been, making us all poorer and increasing the debt burden relative to national income. Tightening too late, on the other hand, poses no such risk: debt is still historically cheap, and too much fiscal juice could easily be reined in by monetary policy. By assuming that running the economy hot for a while won’t raise the economy’s speed limit, the OBR’s forecast runs the risk of confirming a fiscally conservative chancellor in his decision to take the economic low road.
"The fiscal policy principles the Chancellor set out in his speech seem to have had little impact on the policies he announced. For all the talk of taking advantage of low interest rates to invest in capital projects to drive growth, no increase in public investment was announced and he kept within his predecessor’s limit of 3% of GDP. Our fiscal framework, which explicitly allows higher deficits when interest rates are low, would allow about £25 billion a year more investment while rates remain at today’s levels."
The Chancellor delayed announcing new fiscal rules until later in the year, but outlined a set of principles underlying his decisions in his speech. First, as with the rules outlined in last year’s Budget, there should be no borrowing to pay for day-to-day spending in the medium term. Secondly, he wants debt to stop rising as a share of national income. These are both set to be achieved: under the OBR’s forecasts, the current budget will be in balance by the end of the forecast period, and debt excluding Bank of England interventions will stabilise at around 97% of GDP. Thirdly, he stated a desire to take advantage of low interest rates to increased public investment.
However, there was little evidence of the last of these playing a part in the Budget decisions. For all the talk of an infrastructure-led green recovery, no increase in investment was announced despite the government’s ability to borrow at ultra-low rates for long periods. Instead, the Chancellor kept investment within the previous limit of 3% of GDP, which itself had little economic rationale. In designing a new set of fiscal rules, the Chancellor should pay attention to our fiscal framework, which explicitly allows for higher deficits when interest rates are lower. Following our framework would allow him to increase investment spending by about £25 billion a year so long as interest rates remain at today’s levels, though he would have to cut back again if they were to rise to more normal levels.
"The revival of mortgage guarantees makes sense in a world where mortgage rates for FTBs have ballooned compared to other mortgagors, threatening a further fall in home ownership. The policy is unlikely to have a significant effect on house prices."
The chancellor has revived the Help to Buy mortgage guarantee scheme that ran from 2013 to 2017 (not to be confused with the more questionable Help to buy equity loans scheme for new build sales). The scheme will extend availability of mortgages to people with only a 5% deposit by having the taxpayer guarantee the next 5%.
Concerns about stoking house price inflation are overblown. At its height last time around, in 2016, the Help to Buy mortgage guarantee scheme guaranteed around £650m of lending supporting a total of £4.5bn in mortgage lending, only a small portion of which is likely to have been additional. It’s hard to see how that could have a significant impact on prices in a £7 trillion asset market.
In fact it’s a reasonable solution to a pressing problem. Since the pandemic struck the cost of a mortgage for first time buyers with a small deposit has doubled, while for buyers with a substantial amount of equity that cost has plumbed new record lows. This reflects the fact that lenders, seeking to reduce their exposure to possible house price falls, are diverting lending away from FTBs and towards people with equity – an effect that will strengthen once the stamp duty holiday ends. The dominant effect of the guarantee is therefore likely to be one of reallocating who gets the credit, rather than how much gets pumped into the housing market. In doing so it should limit the fall in home ownership that we may otherwise see.
Mortgage Rates by LTV, 2018-2021
"Freezing housing benefits comes at a moment when rent arrears statistics are staggering. If the freeze persists until 2024 we expect it to take around £1,000 per year off claimants over a period when many will still be looking for work. To make matters worse it’s doubtful that the exchequer will see the savings he hopes for."
The Chancellor’s decision to freeze the Local Housing allowance (LHA) comes at a moment when housing debt built up over the pandemic totals an estimated £375 million affecting 2.3 million households, 700,000 of which already in arrears. Delinking LHA rates from rents will open a widening gap between housing costs and actual support, affecting mostly those in places where rents are set to rise. The 2016 freeze had by 2019 resulted in a £1240 per year shortfall for the average two-bedroom property at the 30th percentile. With renters disproportionately employed in struggling sectors and unemployment not set to peak until the middle of 2021, this may end up quite a sizeable portion of renters’ income and force many to choose between food and paying rent.
We estimate that if rents increase in line with inflation, freezing LHA will, by 2024, lead to a £948 cut to the income of the typical claimant family rising to £1244 if rents rise in line with earnings.
Annual gap between housing costs and housing benefit for a two-bedroom house at the 30th percentile
Even worse, freezing housing benefits is most likely a false economy. The OBR estimates the freeze will bring the £1 billion cost of increasing the rates in 2020-2021 down to £0.3 billion by 2025-26. But the cuts introduced in the 2010s failed to achieve their projected savings: due to the spike in local authority spending to protect affected families from rising evictions, homelessness and living in insecure accommodation, for every pound central government saved, local government spending increased by 53 pence. With housing climbing up the public’s priorities for additional government spending even pre COVID and poverty rates due to see the biggest year-on-year rise since the 1980s scaling back on housing support is a questionable gamble.
"Keeping fuel duty down avoids a short-term political problem – but the Chancellor was silent on the strategic challenge of falling fuel duty revenues as we deploy electric vehicles. Without clarity on our strategy, we face a £30 billion hole in the public finances, more congestion, and increased inequality as motoring becomes much cheaper for those who can afford electric vehicles."
The Chancellor has today announced keeping fuel duty flat for 11th year in a row. Restoring indexation would be equivalent to taking almost 400,000 cars off the road by the end of this Parliament – and if the freeze is continued, we estimate that vehicle emissions could be around 1 million tonnes of CO2 higher per year by 2024.
Car-equivalent reduction per year -RPI indexation vs freeze
But the Chancellor said nothing about the more fundamental challenge we need to address: the fiscal effect of the rapid and welcome deployment of electric vehicles. Failing to plan for that transition will mean a £30 billion hole in the public finances, worsening congestion as motoring gets cheaper, and severe impacts for those on lower incomes, who are less likely to be able to afford an electric vehicle to avoid fuel duty.
The Government should urgently explore options for road pricing – enabling an approach which is fair, avoids gridlock on our streets, and ensures a rapid and fiscally sustainable transition to zero emission cars.
"Delivering net zero will require us to ramp up to £50 billion of investment per year, and offers the prospect of millions of green jobs – but the measures set out today don’t get us close to those ambitions. While there are some positive proposals in the Budget, the reality on net zero doesn’t yet match the rhetoric. Time is running short for the UK to demonstrate its credibility ahead of COP26"
The Chancellor has today announced some limited measures to support the net zero transition, including support for offshore wind port infrastructure, a new green retail savings product, and a National Infrastructure Bank with a net zero remit.
While these proposals are welcome, this Budget is an opportunity missed on net zero, particularly with the eyes of the world on the UK ahead of COP26. The 10 point plan last November offered a promising start – this Budget was a chance to double down on a green recovery. But in addition to the freezing of fuel duty for the 11th year in a row, it was silent on increasing support for decarbonisation of our buildings, industry, and agriculture.
In a Budget which sought to drive up infrastructure investment, the absence of new funding to cut emissions from for our buildings was notable – in particular, the lack of any commitment to continued support for the troubled Green Homes Grant. As we’ve set out previously, the fundamentals of the scheme are good, but it has been hamstrung by delivery and concerns about funding – damaging confidence for consumers and the supply chain.
Failure to invest in energy efficiency and low carbon heating means missing out on the most jobs-rich element of the net zero transition – and that the government has no clear pathway to meeting its climate targets.
To illustrate the gap between rhetoric and reality with one example – the Government has a target to deploy 600,000 heat pumps a year by 2028. We are currently deploying around 30,000. While more policy is promised, it’s clear that there is an urgent investment gap which needs to be filled – on heat pumps, and much else besides.
Heat pump installations - Budget 2021
"While an infrastructure bank was long-overdue, it is baffling why the Government has chosen to give it only a fraction of the funding recommended by the National Infrastructure Commission. The Chancellor’s lack of ambition means the Infrastructure Bank could struggle to attract the private-sector investment needed to address the scale of our net-zero and levelling up challenges."
The Chancellor has announced an initial £12bn of funding for a new National Infrastructure Bank, including £8bn that will co-invest in transport, energy, and digital infrastructure across the UK and £4bn in funding for local government. In addition, the National Infrastructure Bank will be able to provide £10 billion in loan guarantees. Its initial remit will be to support ‘high value and complex projects’ to foster regional growth and tackle climate change.
Despite the Chair of the National Infrastructure Commission calling for an investment bank with a minimum asset base of £20bn over five years, the government has set a bank up with considerably less capital. This lack of ambition means the new Infrastructure Bank will also invest less in the UK every year than the £7 billion per year the European Investment Bank did.
The Government has also failed to provide sufficient clarity on whether the bank has a mandate to invest in longer-term relatively riskier projects, on the political independence of its decision-making structure, or on how much of its investments will be dedicated to digital, net-zero and transport infrastructure. The lack of certainty on the Bank’s longevity will also be a cause of concern for private investors worried that the new Bank, like the Green Investment Bank, will be privatised after a few years.
More reaction coming soon