Getting public finances under control will not be easy

The Spending Review and Autumn Budget will mark the first step in the Chancellor’s plan to bring the public finances back under control following the pandemic. There are significant challenges to be overcome if he wants to do so.

Area chart showing fiscal pressures from 2025-26 to 2050-51, with health going up to around 3½% of GDP, with adult social care adding another half a percent, the state pension another 1½% and tax at risk from decarbonisation adding a further 1½% to reach approximately 7% in total in 2050-51.


Tucked away on page 91 of HM Treasury’s Net Zero Review Final Report published on 19 October is a chart illustrating the main long-term pressures on the public finances. This describes how fiscal pressures from health, adult social care, the state pension and tax at risk from decarbonisation could amount to 7% of GDP by 2050-51, equivalent to over £150bn a year in ‘today’s money’.

The majority of the fiscal pressures identified (5.5% of GDP in 2050-51) relate to structural factors, or what can better be described as more people living longer, sometimes less healthy lives. This will add significantly to the costs of healthcare, adult social care, and the state pension over the coming decades – big drivers of public spending.

The pay-as-you-go nature of the UK welfare state means that the tax and national insurance contributions made by people through their working lives to fund these services are not saved up and invested but are instead spent on previous generations. Consequently, there is (unlike some other countries) no pot of money from which to draw on to fund retiree pensions, health, or social care. Instead, taxpayers will be called on to cover these costs as they arise.

More spending cuts are unlikely to be sufficient to close the gap

One option might be to offset rising costs by cutting public spending in other areas, as has already happened with the defence budget, where cuts from over 10% of GDP half a century ago to under 2% of GDP today have helped to offset increases in the funding allocated to the National Health Service.

However, with defence and security spending together hovering just above the 2% NATO minimum, and a decade of austerity that has seen significant cuts in both public services and welfare budgets, the unfortunate reality is that there are no other significant budget headings that the Chancellor might look to dip into to meet these long-term fiscal pressures. At least not without a very radical restructuring of the state, which does not appear to be on the cards.

In practice, Rishi Sunak will have a hard enough time addressing short-term fiscal pressures in other areas. A key example is the criminal justice system, where cuts in spending in recent years on the police, courts, prosecutors, and legal aid have together contributed to significant delays and lost opportunities to prosecute criminals, just as crime levels rise and it returns to the political agenda. A backlog of cases built up over the course of the pandemic doesn’t help. More money beyond that already allocated to restore police numbers is likely to be needed, but where can it be found?

Everywhere the Chancellor looks there are difficult choices between the spending needed to meet policy priorities such as levelling up (local authorities, education and transport), Global Britain (FCDO and international trade), and Build Back Greener (energy and transport), as well ensuring the day-to-day operations of both central and local government continue – from collecting the bins to repairing the roads to defending the country.

There are opportunities to save money through being more efficient, but it is important to understand that administration costs are a relatively small proportion of overall public spending and that many UK public services such as the NHS are fairly cost-effective when compared with equivalents in other countries. Technological change including AI and medical developments could have a significant impact in reducing costs, but it is unclear that they could produce anywhere near the level of service improvement that would offset the long-term fiscal pressures. Ironically, medical developments could also increase those pressures, with savings in the cost of healthcare treatments being offset by helping us live even longer lives. Good news but adding to the public finance challenge.

The demands from across government for more money are intense, putting the Chancellor under severe pressure to increase the overall spending envelope – not just in the next financial year or three, but permanently adding to budgets forevermore.

Can the long-term fiscal pressures be avoided?

The main driver for most of the long-term fiscal pressures identified by HM Treasury is longevity, with the number of people aged over 70 expected to increase by 58% over the next 25 years at the same time as the number of people under the age of 70 (including those of working age who pay most of the taxes) is expected to increase by only 2% or potentially fall by 7% if inward migration falls.

There are some things that can be done to mitigate these increases to a certain extent, such as permanently abandoning the triple lock that has driven substantial increases in the level of the state pension over the last decade. However, this could be politically difficult, as well as not necessarily achieving the intended goal of saving money if more pensioners end up needing support from the welfare system. A more likely approach would be to further increase retirement ages as recently recommended by the OECD.

Other options that have been suggested include greater rationing of health care or introducing charges for some medical procedures. Such moves could help offset some of the pressures on health care spending but would be politically difficult as well as adding an extra layer of complexity to the welfare state. Those who can afford to pay would not only pay more, but there would still be a need to pay more in taxes to fund those on low incomes who wouldn’t be able to afford the additional costs without help.

One of the long-term pressures identified by the government – the effect of decarbonisation on tax receipts – is not really a pressure and arguably should not be included in the list.

While in theory the £37bn a year raised in fuel duty, vehicle excise duty and other taxes will disappear if transport is successfully decarbonised, this is a tax burden already being incurred by road users. All that is likely to happen is a change in the tax used to collect that money, with road charging the most likely option identified so far. This may be seen as a tax rise by some, particularly those hoping that the low tax status of electric cars and other zero emission vehicles might continue into the future, but the net effect is likely to be a temporary tax rise over the course of the transition as the existing taxes co-exist with the new, hopefully adding to the incentive to decarbonise without having to increase taxes in other areas.

Borrowing has a role, but can’t take all the strain

The benefit of being a sovereign nation is the ability to raise money from debt markets at much lower interest rates than those available to businesses or individuals. This is invaluable, as there are often good reasons to borrow to fund capital investment, which in turn will often generate more economic activity and enhance future tax revenues.

However, governments in developed countries have routinely used borrowing to make up for shortfalls between revenues and current spending in the hope that growth in the size of the economy will inflate away the debts built up this way.

The financial firepower provided by borrowing has enabled the UK to support the economy and fund public services and welfare through the financial crisis just over a decade ago and the pandemic in 2020 and 2021. However, the consequence has been to increase public sector net debt from around less than £0.5tn or 35% of GDP in 2008 to £1.8tn or 80% in 2019 and to £2.2tn or just over 95% of GDP as of today.

This excludes £2.5tn or so of other liabilities in the public balance sheet, such as for unfunded public sector pension obligations, nuclear decommissioning obligations and clinical negligence liabilities. When added to debt these take public sector liabilities to more than double the size of the economy.

Countries such as Japan have even higher levels of debt than the UK which, in theory at least, might indicate that the UK government has headroom to borrow even more, this is dependent on the continued confidence of capital markets. The Chancellor is therefore aiming to bring down the ratio of debt to GDP gradually over time, with new fiscal rules designed to ensure that the government targets a balanced current budget by the middle of the decade so that borrowing is only used to fund investment spending.

A particular concern for the Chancellor will be the increased exposure of the public finances to higher inflation and interest rates, which has the potential to claw back any savings he does manage to find in his search for a more efficient government machine.

This is because the current scale and profile of public debt makes it more difficult for the government to ‘inflate away’ debt over time, with the higher interest rates that would be expected to accompany higher levels of economic growth resulting in higher debt-interest costs. Similarly, the effect of higher inflation in increasing nominal GDP and hence reducing the debt to GDP ratio will be offset by the associated uplift in the amounts owed to holders of index-linked gilts.

Economic growth should generate higher tax revenues, but by how much?

The favoured route to bring in more money through the tax line would be through faster economic growth, and the OBR’s October 2021 forecasts are likely to reflect a sharper rebound from the pandemic than was expected in March – providing the Chancellor with more room for manoeuvre, at least in the short term.

Improving productivity is a challenge for governments across the world, while economists have suggested that the combination of Brexit and COVID-19 will make the UK economy permanently 3% smaller than it would have been otherwise. Despite that, higher levels of capital investment within the existing spending plans should have a positive effect on growth, especially if the substantial additional private investment envisaged as part of the Net Zero Strategy is successfully obtained.

The good news is that even moderate levels of economic growth will help put the public finances in a better place, providing capacity for the Chancellor or his successors to be slightly more generous on spending or perhaps fund some limited pre-election tax cuts. The bad news is that even healthy periods of economic growth tend to be punctuated by recessions every decade or so.

Hence the need for prudence in spending plans – if we don’t know how much we (as a country) are going to earn, it makes sense to be careful in our outgoings.

But, there is a risk that too much prudence could result in cutting back on the spending that is needed to drive future prosperity, whether that be funding for education and apprenticeships to enhance skills, or investment in infrastructure to drive regional economic growth. And spending restraint in other areas, such as policing and the criminal justice system, can have other adverse consequences too.

Economic growth is needed to ensure the public finances are brought back under control. Absent an unexpected economic boom, growth on its own is unlikely to provide sufficient tax receipts to fund all of the long-term fiscal pressures identified by the Treasury.

Can further tax rises be avoided?

The introduction of the health and social care levy on top of the tax rises announced in the March 2021 Spring Budget shouldn’t have been a surprise given the long-term pressures on the public finances. The pandemic may have accelerated the arrival of new taxes, but more funding from taxpayers was always the most likely outcome at some point over the next few years.

This is not just because the pandemic has exacerbated the financial situation, but because only very strong levels of economic growth would have enabled any government to avoid putting up taxes. Indeed, the Institute for Fiscal Studies believes that the health and social care levy may have to be increased further by the end of the current decade from 1.25% to 3.15%.

There are some actions the government can take to delay the inevitable, such as increasing labour participation rates, so increasing the pool of taxpayers. But, in the medium- to long-term, the government needs to acknowledge the pressures on public spending and think about how it should go about increasing taxes in a gradual and stable way rather than the current approach of deferring the problem until the pressures become too great.

One thing the government could do better at is developing a long-term tax strategy setting out how it plans to increase taxes gradually over time, avoiding the need for sudden changes, such as the introduction of the health and social care levy with only six months’ notice or the almost one-third rise in the corporation tax rate from 19% to 25% that comes into force on 1 April 2023.

A long-term fiscal strategy is needed to put the public finances on a sustainable path

Tax is not the only aspect of the public finances that would benefit from a longer-term approach. A fiscal strategy encompassing tax, spending, borrowing, debt, and the wider public balance sheet is essential if the government is to improve resilience of the public finances to future economic shocks and put them on a sustainable path.

Such a strategy should address the long-term pressures on public spending as part of a practical vision for the public finances over the next 25 to 50 years. It would consider how best to fund public services over time and how to strengthen the public balance sheet.

At a more granular level it would look at issues such as the unfunded nature of many public sector liabilities, for example considering whether premiums could be levied to fund investments to cover clinical negligence liabilities, rather than rely on there being capacity in future health budgets to cover these costs. Another example would be to consider whether there is a role for sovereign wealth funds, similar to Australia’s Future Fund or Norway’s Oil Fund. It could be argued that some of the savings to the exchequer from ultra-low borrowing rates might have been better used to fund investments for the benefit of future generations instead of being used to cover day-to-day spending, avoiding difficult decisions that should have been addressed earlier.

More significantly, a fiscal strategy would consider how to introduce more long-term thinking into the public finances, moving beyond short-term fiscal rules that have often been broken and prioritising investment that provides positive economic, social and environmental benefits to all of us. It could also provide a framework within which to tackle some of the structural problems in the public finances, such as tax devolution and the complexity of funding streams within and between central and local government, or in clarifying the often misunderstood financial compact between government and citizens.

Reasons to be cheerful

The challenges facing the public finances are significant. According to the Office for Budget Responsibility they are on an unsustainable path. Public debt has increased from less than £0.5tn to more than £2.2tn in less than a decade and a half. Other public sector liabilities amount to least as much again. Cuts in public spending have affected some public services adversely, and the pressure for more spending is intense. Poverty remains and many families struggle financially, further adding to pressures on the government to help. The productivity puzzle remains unresolved and there are significant uncertainties about the health of both the UK and global economies. Tax rises appear inevitable.

However, government has demonstrated in both the financial crisis and the pandemic just how much it can do to support business, individuals, and public services through difficult times when it needs to. Public investment is increasing. Technological developments are helping to improve public services and increase efficiency. The government now knows what is in the public sector balance sheet and is taking steps to improve how it is managed. There is a strategy for tackling net zero. Borrowing costs remain extremely low even if they are starting to rise. The UK continues to be one of the most prosperous countries in the world. And relatively small changes can have a big impact over a 25 to 50-year timeframe.

Getting the public finances back under control will not be easy. But it can be done.

Alison Ring OBE FCA, Director of Public Sector and Taxation at ICAEW, commented: “The challenges facing the public finances are immense and I don’t envy Rishi Sunak the difficult choices he has to make in balancing the demands on the public purse with the real-world impact of decisions to increase, maintain or cut spending across both central and local government.

“Much of the focus on the Spending Review and Autumn Budget will be on how the Chancellor plans to tackle the immediate challenges facing the country this winter and how he plans to balance competing demands over the three years of the Spending Review. However, setting out a fiscal strategy to address long-term fiscal pressures and put the public finances on a sustainable path will be even more important.”

Martin Wheatcroft FCA, external advisor on public finances to ICAEW, added: “There are signs that the government is starting to think more strategically about the public finances, such as in starting to plan for the tax consequences of decarbonisation, identifying the major pressures on public spending that flow from more people living longer, and biting the bullet by increasing taxes to fund those pressures.

“The Spending Review and Autumn Budget on 27 October provide an opportunity for the government to develop that thinking further and to set out an approach that looks beyond the current parliamentary cycle to strengthening the capacity and resilience of the public finances over the longer term.”

This article was originally published by ICAEW.

Chief Secretary brands Treasury ‘new radicals in government’

3 August 2020: Chief Secretary to the Treasury Steve Barclay delivered his first speech last week, providing fresh detail on the plan for the Spending Review.

Steve Barclay’s first speech as Chief Secretary, delivered to thinktank Onward on Tuesday 28 July 2020, set out how he believes Treasury can be an accelerator of change in government.

He sees the Spending Review as a significant moment in the lifecycle of any government, but with the current review being conducted against the backdrop of the most challenging peacetime economic circumstances in living memory.

Despite that, the Government believes the recovery from this pandemic can be a moment for national renewal, with the Spending Review acting as the mechanism to deliver the Prime Minister’s ambition to ‘level up’ the country.

As a constituency MP, Barclay said he has run up against a system that is slow and siloed. By way of an example, he asked why there is a seven-year gap between funding being agreed for a road scheme and the first digger arriving? Or why it takes a decade to decide to produce a full business case on whether to re-open eight miles of railway track?

The lack of upfront clarity on outcomes, the slow speed of delivery and the variable quality of data within government are all areas the Spending Review provides an opportunity to challenge.

The Chief Secretary stressed that to ‘level up’ the country properly, the Government needs to ensure that Treasury decision-making better reflects the UK’s economic geography, with more balanced judgments taking into consideration the transformative potential of investment to drive localised growth.

He drew on the speed of change during the pandemic, with the furlough scheme taking just one month from being announced to being opened for applications when normally such schemes take months – years even – to deliver.

He asked if the wheels of government can be made to spin this fast in a crisis, with all the added pressures of lockdown, why can’t it happen routinely?

Time to level up

The Chief Secretary stated that the actions being taken to support businesses and jobs during the pandemic are the right thing to do, even though it comes at a cost. The cost of inaction would be far greater, he claimed.

Even though the Prime Minister has made it clear that austerity is not the answer to navigating a much-changed economic landscape, departments will have to make tough choices in the months ahead.

The commitment to reviewing the Green Book investment manual was reiterated with changes planned to allow room for more balanced judgments on investments to reduce inequality and drive localised growth.

During the speech, Barclay listed several priorities for government in the Spending Review:

  • accelerating the UK’s economic recovery;
  • levelling-up opportunity across the country;
  • improving public services; and
  • making the UK a scientific superpower.

Outcomes, speed and data

To achieve these objectives, the Chief Secretary focused on three key approaches: outcomes, speed and data.

On outcomes, the Spending Review would try to tie expenditure and performance more closely together, with Treasury having clearer sight of both intended outcomes and subsequent evaluation of their delivery. 

For some of the most complex policy challenges, this will involve breaking the silos between departments, and pilot projects are currently being used to test innovative ways of bringing the public sector together.

On speed, Barclay noted that this is a ‘hallmark of the digital era’. Programmes need to start with robust goals and the temptation to repeatedly change plans has to be resisted if the UK is to bring down capital costs that are typically between 10% and 30% higher than in other European countries. A new Infrastructure Delivery Task Force (known as Project Speed) will be established to cut down the time it takes to develop, design and deliver vital projects.

This will involve more standardisation and modularisation between projects, for example in speeding housing construction. The Spending Review will seek to accelerate the adoption of Modern Methods of Construction and explicitly link funding decisions to schemes that priorities it.

On data, the Chief Secretary believes that government is behind the curve when it comes to obtaining, analysing, and enabling access to open data. It remains the case that decisions still rely heavily on spreadsheets from departments rather than data directly sourced in real time. Work has already begun to incentivise departments and arms-length bodies to supply higher quality standardised data and to support the Treasury to better interrogate this data.

Building this will involve sorting out the data architecture as well as the data sets, and the Spending Review will focus on addressing legacy IT and investing in the data infrastructure needed to become a “truly digital government”.

The new radicals

Barclay concluded with stressing the importance of taking risks, setting ambitious goals and experimenting with ways of delivery, even if failure is a possibility. He wants to move beyond a simple yes/no approach to public spending and instead bring together people, ideas and best practice from inside and outside government.

He concluded: “This is an opportunity for the Treasury to capture the ‘can do’ attitude shown by civil servants during the COVID pandemic and make it permanent. To be the new radicals, leading change across government.

“Done well, we can move on from an era of spreadsheets. We can create a smarter and faster culture in Whitehall. And we can ensure that Britain does indeed bounce back from this crisis stronger and better than before.”

Speech by Steve Barclay MP, Chief Secretary to the Treasury, on 28 July 2020.

This article was originally published by ICAEW.

OBR: Pandemic worsens long-term outlook for public finances

20 July 2020: The Office for Budget Responsibility suggests tax rises or spending cuts of more than £60bn a year may be needed if the UK public finances are to be put onto a sustainable path.

The Office for Budget Responsibility (OBR) has reported that the public finances are unsustainable over the next 25 to 50 years, given expected levels of economic growth and pressures on public spending from more people living longer. Fiscal risks have also increased significantly with two ‘once-in-a-lifetime’ economic shocks occurring in just over a decade.

Without action to increase taxes or cut spending over the next few decades, the OBR projects that the gap between receipts and public spending before interest will widen from around 1% of GDP in 2019-20 to between 10% and 15% in 2069-70, depending on how quickly the UK recovers from the coronavirus pandemic. Public sector net debt could increase to between 320% of GDP and 520% of GDP, based on the assumptions made.

The OBR has highlighted how the coronavirus pandemic has not only worsened the immediate prospects for the UK and global economies, but ‘economic scarring’ will permanently damage the expected level of tax receipts over the next 50 years. The vulnerability of the public finances to potential future economic shocks has also increased significantly.

The OBR believes that a V-shaped economy is still possible, but this is now considered to be an upside scenario, with the OBR’s central scenario based on a much slower recovery from the pandemic. The downside scenario takes even longer for the economy to recover.

Economic activity, as measured by GDP, and tax receipts are both expected to be lower in all scenarios than in previous forecasts.

Prospects for the public finances in the current financial year have continued to deteriorate with the OBR now forecasting a fiscal deficit between 15% and 23% of GDP, with a central scenario of £372bn (19% of GDP). This reflects a total of £192bn in fiscal interventions in 2020-21 announced by the Government to date to support the UK economy through the pandemic.

The OBR projects that in its central scenario the gap between receipts and expenditure excluding interest will widen to almost 13% of GDP by 2069-70 if no actions are taken, equivalent to almost £300bn in 2019-20 terms. With much higher levels of debt, and interest rates likely to be higher in the medium to long-term, this could cause the fiscal deficit to increase to over 30% of GDP in 50 years time.

The OBR has calculated that ‘fiscal tightening’ in the order of 2.9% of GDP (£64bn a year) would be required based on a target level for public sector net debt of 75% of GDP. This is subject to a number of fiscal risks, including that no further significant changes are made to the planned profile of spending on health and social care – a key source of policy risk.

Closing this gap could require potentially very significant levels of tax increases or cuts in public spending, especially if difficult decisions, such as on how to fund social care, continue to be deferred.

Martin Wheatcroft FCA, adviser to ICAEW on public finances, commented: “The Office for Budget Responsibility has yet again assessed the public finances and concluded that they are not sustainable, even before taking account of the eye-watering levels of borrowing being added to the national debt as a consequence of the coronavirus pandemic.

Although we should expect tax cuts and spending increases in the immediate future as the Government looks to provide stimulus to the economy, the need to reduce the gap between tax receipts and public spending over the medium- to long-term means that tax rises or further cuts in public spending are likely in the years to come.

Despite this, there are actions that could be taken to improve the outlook for the public finances by developing a long-term fiscal strategy to put the public finances onto a sustainable path.”

Table 1 – OBR projections for the public finances: central scenario

CENTRAL SCENARIO2019-20
% OF GDP
2020-21
% OF GDP
2024-25
% OF GDP
2044-45
% OF GDP
2069-70
% OF GDP
Receipts excluding interest36.136.336.636.636.4
Expenditure excluding interest(37.2)(54.4)(40.3)(43.9)(49.1)
Primary deficit(1.1)(18.1)(3.7)(7.3)(12.7)
Net interest(1.5)(0.8)(0.9)(6.2)(17.8)
Fiscal deficit(2.6)(18.9)(4.6)(13.5)(30.5)

Public sector net debt

(88.5)

(106.6)

(102.1)

(173.7)

(418.4)

Source: OBR, ‘Fiscal sustainability report July 2020’.  2020-21 amounts adjusted for £50bn (2.5% of GDP) of additional fiscal interventions announced on 8 July 2020. Subsequent periods not adjusted.

Table 2 – OBR projections for the public finances: upside and downside scenarios

DIFFERENCES FROM     
CENTRAL SCENARIO       
                2020-21
% OF GDP
2024-25
% OF GDP
2044-45
% OF GDP
2069-70
% OF GDP
Upside scenario
Primary deficit3.62.12.22.3
Fiscal deficit3.62.23.86.5
Public sector net debt9.314.145.798.2
Downside scenario
Primary deficit(4.3)(2.2)(2.3)(2.4)
Fiscal deficit(4.3)(2.2)(3.9)(6.9)
Public sector net debt(9.1)(14.5)(47.9)(103.5)

Sources: OBR, ‘Fiscal sustainability report July 2020’; ICAEW calculations.
Positive differences = lower deficit or lower debt in percentage points of GDP; (negative) differences = higher deficit or higher debt.

This article was originally published by ICAEW.

Spending Review suspension sensible, but avoid more delays

2 April 2020: ICAEW has called the delay to the UK Government’s 2020 Spending Review a ‘sensible move’ in the current climate, but warned that any further delays pose a major risk to infrastructure projects and economic recovery.

The 2020 Spending Review, scheduled to be completed by July this year, has been delayed to enable the government to remain focused on responding to the ongoing coronavirus outbreak. It is likely that the 2020 Spending Review will now be moved to November to coincide with the Autumn Budget, adding a further delay of at least four months to the process.
 
The last three-year Spending Review was in 2015, covering the financial years 2016-17, 2017-18 and 2018-19. The anticipated 2018 Spending Review never took place and departmental budgets were instead ‘rolled over’ into 2019-20, while the Spending Review in 2019 was also cancelled and replaced by an interim Spending Round that set out current spending by departments for one financial year (2020-21) and capital investment plans for two financial years (2020-21 and 2021-22).
 
Based on the overall spending envelope set out in the Spring Budget 2020, the Spending Review this year is expected to set out detailed financial budgets for each government department for a three-year period (from 2021-22 to 2023-24) and four years for capital investment (to 2024-25), enabling public bodies to plan ahead and get the best value for money for the taxpayer.
 
Alison Ring, Director, Public Sector for ICAEW said: “The latest delay is completely understandable given the huge ramifications for the economy and the public finances of the coronavirus emergency. It makes sense for the Chancellor and the Treasury to redeploy resources to deal with the coronavirus now and to re-evaluate spending plans later when there is a clearer view on the financial impact.
 
One concern is the risk this further delay poses to infrastructure projects, given how important they will be to a successful economic recovery. The need to plan and design infrastructure well in advance means that delays in authorising funding could have a significant knock-on effect to when projects are eventually delivered, and to the boost they can give to the economy. 
 
The Chancellor should give some thought to providing assurances to departments about capital funding in 2021-22 and 2022-23 so that they have sufficient certainty to green-light projects sooner rather than later.
 
The Chancellor should also consider the Government’s approach to Spending Reviews. There are many arguments in favour of holding five-year Spending Reviews every three years, rather than three-year Spending Reviews every five years.”
 
For more information:

This article was originally published by ICAEW.

Spring Budget 2020: Hey big spender, spend a little infrastructure with me

12 March 2020: Rishi Sunak’s first Budget as Chancellor of the Exchequer provided a sharp change in direction for the public finances – something that will please and surprise many, according to ICAEW’s Public Sector team.

Spring Budget 2020 combined a short-term fiscal stimulus to fight the coronavirus with higher spending on public services and new infrastructure investment to increase borrowing significantly. Fortunately, ultra-low interest rates will keep financing costs down on the more than £330bn in borrowing planned to finance these plans (not including short-term fiscal stimulus measures), with public sector net debt expected to exceed £2.0tn by 2025.

This Budget is particularly important as it sets the spending envelope for the three-year Spending Review expected to be published later this year. With a higher base for spending following the Spending Round 2019 announced by the previous Chancellor in October, this signals an end to the austerity policies of recent administrations. 

Key headlines for 2020-21:

  • Fiscal deficit up from £40bn to £55bn (2.4% of GDP), before coronavirus measures.
  • No significant tax changes beyond corporation tax remaining at 19%.
  • £14bn extra current spending and £5bn extra investment before coronavirus measures.
  • £12bn in tax and spending measures to respond to the coronavirus.
  • Gross financing requirement of £162bn, including £98bn to cover debt repayments.
  • No reflection of uncertain adverse economic effect of the coronavirus on tax revenues.

Key headlines for the four subsequent years to 2024-25:

  • Fiscal deficit of £62bn (2.5% of GDP) on average over the subsequent four years.
  • Tax policy measures to generate an additional £7bn per year.
  • Extra current spending of £27bn a year and extra investment of £19bn a year.
  • Gross financing requirement of £595bn (£149bn a year) including £315bn to cover repayments.
  • Significant economic uncertainty with coronavirus, global economic conditions and changes in UK trading relationships with the EU and other countries.

The existing plans already incorporated a significant ramp-up in infrastructure and other investment spending with public sector net investment forecast to increase from 2.2% of GDP in 2019-20 to 3.0% by 2022-23. The challenge for the Government will be to deliver and ‘get things done’, especially as capital investment by government departments is expected to increase by 25% in 2020-21 and by a further 35% over the subsequent four years. Will there be sufficient construction capacity and project management expertise to deliver such a rapid expansion and still deliver value for money for taxpayers?

The Budget also contained some important developments in the framework for the public finances, with a specific commitment to review the investment criteria in the Government’s ‘Green Book’ to ensure regions outside London and the South East benefit from the additional infrastructure spend proposed in the Budget. The focus on looking at the effect on investments on the public balance sheet was also welcome with new approaches planned for how to appraise public spending.

One surprise in the Budget announcement was that the OBR did not revise the economic forecasts down as much as had been expected. This was partly because of the economic benefits of higher public spending and investment, but also reflected an improved outlook for productivity. The benefit of this for the Chancellor was that he was able to announce additional current spending on public services, while still remaining within the fiscal rules set out in the Conservative party manifesto.

Unfortunately, the scale of the impact of the coronavirus on the economy is still unclear and so the forecasts for tax revenues may need to be revised downwards, potentially significantly, in the Autumn Budget later this year.

Commenting on Spring Budget 2020, Alison Ring, Director, Public Sector, at ICAEW said: “The Chancellor has announced a major loosening of the taps on spending and investment in his first Budget, with a combination of a short-term fiscal stimulus to fight the coronavirus, higher spending on public services, and a major programme of new infrastructure investment.

Those wondering where all the funding for this planned spending will come from may be surprised to discover that the Chancellor has not followed the custom of post-general election tax rises, but instead has decided to take advantage of ultra-low interest rates to borrow more than £330bn over the next five years. Public sector net debt is expected to exceed £2.0tn by 2025, although the Government hopes that this will then be falling as a ratio to the size of the economy.

Nevertheless, it is a Budget that many will be pleased with, even if a little surprising coming from the traditional champions of small government.”

This article was originally published by ICAEW.