Good morning from New Economy Brief.
Tomorrow the Chancellor will lay out his decisions on tax and spending for the coming year.
Commentators and think tanks have debated how much fiscal ‘headroom’ he has available against the fiscal rules he set himself in November, whilst pressure is mounting for additional spending across the board to help counter the effect inflation is having on household finances, wages, and departmental budgets.
Can the Chancellor afford not to invest in structural solutions to the cost of living crisis? Read on for our analysis.
The ‘war chest’ replaces the ‘black hole’. The fiscal mood music around this budget is significantly more positive than it was in November for a number of reasons, with GDP more resilient than feared and positive signs that inflation is receding. This adds up to a £30bn ‘improvement’ in the public finances compared to November according to the ONS. Whereas the last fiscal event was preceded by frantic briefing about the size of the ‘fiscal black hole’, this one has been dominated by a very different kind of fiscal context.
Important economic decisions should not be based on such uncertain forecasts. As right-wing economist Julian Jessop argued: “it’s bonkers that the Treasury places such weight on projections that are known to be unreliable. This leaves very little room for Chancellors to make their own judgements.”
Spending pressures. Pressure is growing from Conservative voices to use the Treasury’s extra headroom to cut taxes, particularly to prevent the planned rise in corporation tax from 19% to 25% in April. The Institute for Fiscal Studies (IFS) notes that the long term economic outlook is “too ‘murky’ to wave through a bunch of tax cuts.” (Reminder: there is a lack of evidence that tax cuts generate economic growth.) However, many economists are arguing that there is a strong case for increasing government spending now in a variety of ways that could boost GDP growth and make the public finances even more resilient to future shocks.
- The cost of living crisis is still eating away disposable incomes. The Bank of England expects inflation to fall to 4% by the end of the year, but even in this scenario, people will still be permanently poorer than last year as the cost of essentials like food (see last week’s Digest on food price inflation) and energy continues to rise faster than wages; the Energy Climate Intelligence Unit (ECIU) calculated that even if the government extends the Energy Price Guarantee, households will still be paying £285 more than last year. Real pay is falling steeply and in cash terms average real pay is still £110 a month below where it was in 2008. Trades Union Congress (TUC) General Secretary Paul Nowak argued the government “must put pay rises at the heart of next month’s budget” as this will increase disposable incomes and prop up demand for goods and services in the economy. They recommend giving all public service workers a real-terms pay rise, moving towards a £15 minimum wage “as soon as possible” and more.
- Public services need investment. According to analysis by the New Economics Foundation (NEF), the government is hiding £28 billion of “stealth cuts” to public services, despite promising in the Autumn Statement to increase spending by 1% a year. This is because previous assumptions were based on low and even negative inflation in the years ahead, which seems to suggest that the Bank of England would not intervene to try and hit their 2% target. Alfie Stirling explains: “If inflation rests closer to 2% from 2024/25 onwards, the government will need to commit a further *£28bn/yr* (2022/23 prices) to preserve the real terms value of spending plans by 2027/28.” PEF recently calculated that more than half a trillion pounds have been taken out of public spending over 2010-19. A lack of investment in public services and public sector workforce that deliver them is driving workforce shortages, particularly in the NHS.
- Growing support for boosting investment. A recent editorial by the Financial Times argued that “It is time for a UK-wide growth strategy”, where “the government must boost public investment, which has proportionally been among the lowest in the OECD over the past two decades…Next week’s Budget is an opportunity to begin addressing these issues.” Various funding sources exist for ambitious plans to boost growth. Even former US Treasury Secretary Larry Summers now believes “There is capacity to raise revenue from the wealthy on a quite substantial scale – far more than is politically imaginable – without doing any appreciable damage to economic growth”. A new report and video from the Social Guarantee’s Isaac Stanley explains how £92.6bn can be raised from increasing tax on wealth and passive income, taxing big businesses (especially energy companies) and through progressive consumption taxes. They propose this can fund “a limited suite of universal basic services”.
- What is expected? The pre-briefed announcements from the Budget suggest that that it will be a relatively low-key affair, with some temporary help for households in the form of an extension of the Energy Price Guarantee, some action on childcare, a refreezing of the fuel duty permafrost, and some additional spending on defence to attempt to compensate for inflationary pressures.
Choices and gambles. The government story around this budget is very much ‘steady as she goes’ with the improved public finances a vindication of prudence and a mark of restored ‘stability’. The assumption of many in Westminster is that the Chancellor will attempt to ‘bank’ his additional headroom and use it to store up a “war chest” for pre-election tax cuts. This would enable a narrative going into the election that ‘the plan had worked’. Taking this approach is a choice, and it is also a big political and economic gamble. The idea that the economy has returned to ‘stability’ might be true from the perspective of the bond markets, but seems tone deaf when millions of people are finding their personal finances more unstable than ever. When people’s incomes are so insecure, can the government really afford (politically, and economically) to avoid using the fiscal space to solve the cost of living crisis?
- Stagnation nation. There is a fine line between being stable and being rudderless. There is a real risk that an empty Budget red box this week will lead the public, and investors, to conclude that Britain is closer to the latter than the former. With the USA and EU embarking on new economic strategies based on encouraging public and private investment in the green transition, and the Labour Party echoing this rhetoric, the lack of a similar vision or strategy from the UK government is all the more striking.
- No alternative? The government’s pre-budget briefing has been that they are unable to act because any additional spending would break fiscal rules or risk fuelling greater inflation. The Stop the Squeeze campaign have released a pre-budget briefing addressing these arguments head on, and conclude that they do not stand up to scrutiny.
- Broken Britain. More profoundly, there is a deep sense across the country that things are going in the wrong direction. Public services are at breaking point, strikes are continuing, energy bills are still sky high, and growth is nowhere to be seen. The public, unsurprisingly, continue to put the cost of living crisis at the top of their list of concerns. From an economic point of view, deciding not to act now risks prolonging economic stagnation, deepening the crisis in public services, and leaving the UK lagging behind on green investment. From a political point of view, it risks deepening the impression that the government lacks a plan to deal with the cost of living crisis or the economy - an impression that no amount of pre-election tax cuts will be able to shake.