Budget summary

It was billed as a difficult Budget to navigate. Growing spending pressures that were in play before the pandemic have been compounded by Covid-19-related catch-up demands, including health and education. Interest rates have been inching up, too, making debt repayments a bit pricier. Throw in a brewing cost of living crisis amid building inflationary pressures and looming tax hikes, and it looked like very tricky terrain indeed. So how was the Chancellor going to navigate it?

The answer came from the economy. Simply put, its performance has far outpaced expectations compared to the last Budget back in March. That released some extra cash. As ever, the decision was to whether use it pay down debt or spend it. Surprise, surprise, the latter prevailed, or mostly.

Forecast help. Back in March the Office for Budget Responsibility estimated the economy was due for a walloping 4% decline in Q1 amidst the last lockdown. Business adaptation meant that decline was less than half that. The super strong rebound amidst reopening and the growing return to normality means growth this year is forecast to be 6.5%. Back in March the estimate was 4%. Granted that rebound has slowed, as it inevitably would as the economy converged on its pre-pandemic level of output. The OBR still thinks growth will be 6% next year, settling at 1.6/1.7% by 2025/26.

What a difference seven months makes! At the time of the last Budget in March the fear was joblessness as furlough expired. Since then the UK has experienced a jobs boom. Around 5.5k employees were added to UK payrolls per day between March and September. And so furlough’s expiry last month is being viewed as a much needed shot in the arm to labour supply. A modest rise in unemployment to 5.2% is now forecast by the OBR (the current rate is 4.5%), a marked improvement from the 6.5% estimate in March (and the 7.5% last November!). That estimate is similar to the wider view amongst forecasters. And the OBR thinks job growth will remain robust through ’22, with an extra 300k employees at the end of 2022 compared to what it thought back in March.

Scar tissue. All those upgrades mean there’s a bit more optimism on the degree of permanent damage Covid will ultimately inflict (scarring, as it’s referred to). The OBR’s latest estimate is 2% of GDP, compared to 3% back in March. That’s still above the Bank of England’s view of 1%, but remarkable when compared to the initial estimates on the damage the pandemic would wreak. That matters to the public finances as it speaks to the economy’s medium-term ability to generate tax revenue.

Inflation. As widely reported the inflation squeeze is the fly in the ointment. It’sforecast to average 4% over the coming year – double what was expected in March. Wot’s dun it?  Global energy markets and supply problems associated with economies reopening. Factors beyond our control in other words, which, to a large extent is true. Domestically generated inflation pressure are contained, for now at least. The OBR is also in the ‘transient inflation’ camp, but it’s a slow retreat, only falling back close to 2% in late 2023. That’ll put the squeeze on household disposable incomes. Those Covid savings dividends might come in handy!

Less is more. A thundering upgrade to growth and the labour market is the tonic for public finances.  So there were some striking improvements in this area, too. Public sector net borrowing for the year is set to be £51bn less than in March. The budget deficit is set to be 7.9% of GDP this year, moving back close to 3% as soon as the next financial year (’22-’23). That amounts to a big fiscal tightening. Taking its place, hopefully, is the consumer, with assumed normalisation of our savings habits keeping spending well supported.

Taking stock. Lower deficit means a lower public debt. It’s expected to peak out at 85.7% of GDP. That’s around 10 percentage points above pre-Covid levels, but ten percentage points less than what the OBR thought back in March. Good, bad, indifferent?  Well the US is already above 100% of GDP, while Japan’s is closer to 170%. 

Hefty increases in public spending plans are the prime beneficiary of the Chancellor’s windfall.  Annual departmental budgets will now be around £30bn more than planned. That adds up to 3.8% pa. real growth over the Parliament, which is similar to the last Labour government. Every single department gets a real terms increase; evidence that austerity is now well and truly behind us.  A £32bn uplift by 2024-25 means that health spending will consume 40% of day-to-day government spending, up from just 27% at the turn of the millennium.  Still, it’s Local Government that benefits from the most rapid growth in funding (+9.4% p.a.). 

Giveaways don’t end there. Alongside a 6.6% rise in the National Living Wage from April, low-income working households will benefit from a big reduction in the Universal Credit taper rate.  From December, benefits will be withdrawn at a rate of 55p in every £1 of extra earnings, down from 63p at present.  This will put almost £200m per month in the pockets of the lowest earners at a time when the cost of living is rising. 

Setting new fiscal rules is easier done if you’re on course to meet them. So it’s no surprise that new targets to ‘borrow only to invest’ and reduce public debt as a share of GDP three years’ hence are forecast to be comfortably met: by a margin of £25bn (0.9% of GDP). Billed as a sensible precaution against future shocks, this ‘war chest’ may yet pave the way for tax cuts later in the Parliament. That’s certainly the stated aim of a Chancellor who doesn’t want his legacy to be the highest tax burden since the 1950s.

No time like the present.  Speaking of tax cuts, canceling a planned fuel duty rise saves households £1.5bn next year. Tweaks to the Business Rates regime will cut companies’ bills by £850m while providing greater incentives to invest in green technologies and other property improvements.  Most firms in the retail, hospitality and leisure sectors will also benefit from a 50% reduction in Rates over the coming year, worth £1.9bn. And if that doesn’t excite you then perhaps raise a glass to the shake-up of alcohol duties which should keep the price of your favourite tipple down.

Progressive. Taken together, these measures, along with others announced since the last Spending Review are highly redistributive.  Households on the lowest incomes gain most from increased public services spending – worth 5% of net income to the bottom decile – and changes to Universal Credit (benefiting those in deciles 2 and 3 the most). The top 30% of earners, who are disproportionately hit by tax rises, actually lose out overall.  Still searching. In the week leading up to COP 26, not to mention one that saw Tesla join the esteemed company of the $1trn company valuation club as its Model 3 was announced as the biggest selling car in Europe, it feels like a Budget that helped the economy move more decisively toward net zero might have been the focus. Instead we got lower Air Passenger Duty for domestic flights, where in many instances rail is a credible alternative, the aforementioned cancellation of the rise in fuel duty a lack of fresh support to support retrofitting homes to enable cleaner forms of heating. The climate transition is going to require funneling substantial sums into infrastructure and innovation, at some point.

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