Chancellor of the Exchequer Jeremy Hunt positioned his Autumn Statement as a pivot point for the government. With inflation having halved from its 41-year high and with difficult decisions made to keep a lid on public-sector pay, this was the moment when the government could turn the page and be more optimistic about the economic outlook. Or at least, that was the pitch.
The reality is somewhat different. The fight against inflation is far from over – as the governor of the Bank of England warned this week. Updated forecasts from the Office for Budget Responsibility (OBR) show inflation averaging 3.6 per cent next year – well above the 2 per cent target and four times as high as the OBR had predicted just six months ago.
Growth prospects have also been cut. The OBR expects growth of just 0.7 per cent next year – less than half the 1.8 per cent rate expected in March. And even these updated projections look optimistic compared to those from independent forecasters, who expect growth of 0.4 per cent in 2024, and the Bank of England, which is gloomier still and expects no growth at all.
Given this grim backdrop, the chancellor needed a big set of announcements to convince the public that the UK really had turned a corner. He did not disappoint – announcing a package of more than 100 policy measures. These included a range of structural reforms, including to pensions, planning and public-sector productivity, which reflect many of the policy proposals the Tony Blair Institute for Global Change (TBI) has put forward in recent months. There was also an array of more conventional changes to tax and spending policy, including substantial uplifts to working-age benefits (by 6.7 per cent), pensions (by 8.5 per cent), and various new pots of funding and tax breaks to support innovation and growth. And then there were two big headline-grabbing tax cuts: a cut for businesses to make full expensing permanent – a shrewd move that should largely pay for itself – and a much more controversial and politically motivated cut to national-insurance contributions (NICs).
The net impact of all these measures – particularly the big tax cuts – is that the Autumn Statement is the third largest fiscal-stimulus package since 2010. It is only exceeded by the March and June 2020 pandemic budgets and follows directly after the March 2023 budget, which was the fourth largest. This was a big pre-election giveaway.
The Autumn Statement was the third largest fiscal stimulus since 2010
Source: Office for Budget Responsibility – Economic and Fiscal Outlook – November 2023
An Early Election?
The timing of the tax cuts hint at the possibility of an election being called in May. The cut to NICs is slated to come into force in January rather than April (which would be more typical), while a planned rise in alcohol duty has been delayed from April to August. This, plus the timing of the budget in March – which will likely be the last big fiscal moment before the election, offers a potential window for the government to announce more headline-grabbing policies just ahead of a campaign.
Whether an early election would be a smart move or not remains to be seen. The economy is unlikely to have turned a corner by May. Indeed, high inflation and weak growth mean that households are still living through the largest fall in real living standards since records began. The OBR forecasts household disposable income to be 3.5 per cent lower in real terms at the end of this parliament than at the start. Moreover, the tax burden – already at a 70-year high – is expected to rise further despite the recent tax cuts. This impact is particularly noticeable for workers. In 2019, the effective tax rate on labour income was 35.5 per cent – that is to say, in total workers paid just over a third of their wages in income tax and NICs. This year, that figure is projected to be 41.1 per cent and by 2028–29 it could rise to 44 per cent. That’s four out of every nine pounds of workers’ salaries that will be taken in tax. The reason taxes need to rise so much is because the fiscal situation is very tight.
How Did the Chancellor Afford Such a Big Pre-Election Giveaway?
First, higher inflation has swelled tax revenues. This is through conventional channels like higher value-added tax (VAT) receipts, which rise in cash terms as prices go up, but also via substantial increases in income tax and NIC receipts caused by “fiscal drag”: high inflation and the freeze on income-tax and NIC thresholds will rake in an additional £12 billion of tax revenue this fiscal year as rising wages pull ever greater numbers of workers into higher tax rates. The impact of fiscal drag will rise to £27 billion in 2024–25 – more than offsetting the impact of the NICs cut – and will rise to £44.6 billion by 2028–29 given forecast inflation. At that point, 4 million additional workers will be paying the basic rate of income tax, 3 million more will be paying the higher rate and 400,000 more will have moved onto the additional rate. Despite cuts announced in the Autumn Statement, taxes are still going up, not down.
Second, the chancellor continues to run his fiscal plans close to the wire. In March, he met his fiscal rules by the thinnest of margins – just £6.5 billion. If he had announced no new policy changes at the Autumn Statement, rising tax receipts would have helped extend this margin to £30.9 billion – close to the average level of headroom adopted by successive chancellors since 2010. Instead, the chancellor opted to spend £18 billion of the windfall, leaving only a £13 billion margin to deal with future shocks.
The chancellor’s current fiscal headroom is very tight compared to previous years
Source: Office for Budget Responsibility – Economic and Fiscal Outlook – November 2023
Third, the chancellor has pencilled in some implausible tax and spending plans beyond the election, which give the illusion of fiscal space. The fiscal reality is actually much worse:
Fuel duty: The chancellor assumes that fuel duty will rise by 5p on 23 March next year and then rise in line with the retail-prices index from April 2024 onwards. In practice, the government has not increased fuel duty since 2011. If we assume that freeze continues, tax receipts will be lower to the tune of £6.2 billion by 2028–29.
Departmental spending: The government does not have detailed spending plans beyond 2024–25, but has said that current departmental spending will rise by only 0.9 per cent a year in real terms between 2025-26 and 2028-29 and that capital spending will be frozen in cash terms. If health spending increases by 3.5 per cent a year in real terms as planned, defence spending is maintained at 2 per cent of gross domestic product (GDP), overseas aid remains at 0.5 per cent of GDP and core schools spending per pupil remains constant in real terms, this implies significant real-term cuts – of the order of 10 per cent over four years for day-to-day spending and even larger cuts for capital spending – for the remaining departments. The scale of these cuts will be challenging to achieve, particularly when public services are stretched. For example, the backlog in crown courts reached a record high of 65,000 in August. When governments have faced the reality of having to formally plan for a Spending Review in the past, they have had to top up their projections by as much as £39 billion a year. If history repeats itself after the election, borrowing would increase considerably.
Lower productivity: The OBR’s medium-term growth forecasts are relatively upbeat compared with other forecasters because they assume productivity growth will rise by around 1 per cent a year, or roughly double the rate seen in the decade after the global financial crisis. The OBR has been persistently over-optimistic on productivity growth since 2010. If instead the 2010s trend persists and productivity only grows by 0.5 per cent a year, tax receipts would decrease and debt-interest spending would increase, implying a rise in borrowing of £42.2 billion. This shows how important growth is to the fiscal arithmetic.
Defence spending: The government has pledged to increase defence spending to 2.5 per cent of GDP, up from the current 2 per cent NATO target. If the government makes good on this pledge, it will cost another £16 billion by 2028–29.
Overseas aid: The government has also pledged to return the Official Development Assistance (ODA) budget from 0.5 per cent of GDP back to 0.7 per cent in the future, which would cost another £6.3 billion by 2028-29.
The sum of all the above costs implies the chancellor not only had no space to cut taxes in the Autumn Statement, but by doing so he would have missed his borrowing target by almost £50 billion or 2 per cent of GDP. One can argue about what the “right” assumptions should be for each of the above areas, but even if some of the alternative assumptions are more plausible than the current ones, the Autumn Statement was partly built on wishful thinking.
How much fiscal space did the chancellor really have?
Public-sector net borrowing: headroom in 2028-29
Source: Office for Budget Responsibility – Economic and Fiscal Outlook (EFO) – November 2023
Overall, while there was much to agree with in the chancellor’s statement this week – including the raft of structural reforms on pensions, planning and public-sector productivity as well as the policy to make full expensing permanent – this was not the shift to long-term thinking that the chancellor claimed. Cutting NICs was clearly a short-term political fix based on an illusion of fiscal headroom that does not exist. This pre-election giveaway will put further pressure on the public finances in the future.
Whoever holds the keys to Number 11 after the election will face a stark choice between steep cuts to public services or more tax rises to restore them.
A true long-term reform agenda would have acknowledged the fiscal realities and aimed to harness the power of new technologies to reimagine the state. To do so will require up-front investment but it will help unlock growth, limit the cost of public services and improve outcomes in the long run. This would have been a far better use of any windfall in the public-finance forecasts.