December’s deficit of £16.8bn saw both a rise in tax revenues and in interest on inflation-linked debt as pressure grows on the Chancellor to address energy price hikes and rising prices in the shops. The public sector finances for December 2021 released on Tuesday 25 January 2022 reported a monthly deficit of £16.8bn. This was £7.6bn lower than the £24.4bn reported for December 2020 but £11bn higher than the £5.8bn deficit reported for December 2019.
This brings the cumulative deficit for the first nine months of the financial year to £146.8bn compared with £276.1bn and £58.4bn for the same period last year and the year before that respectively.
Public sector net debt increased from £2,321.8bn at the end of November to £2,339.9bn or 96% of GDP at the end of December. This is £205.5bn higher than at the start of the financial year and an increase of £546.8bn from March 2020. As a proportion of GDP, debt is the highest it has been since March 1963, almost 60 years ago.
The deficit for the month was in line with the revised forecast for 2021/22, published by the Office for Budget Responsibility (OBR) alongside last October’s Autumn Budget and Spending Review 2021, although higher than forecast interest charges on index-linked debt offset the benefit of higher than forecast tax revenues.
Cumulative receipts in the first three quarters of the 2021/22 financial year amounted to £641.4bn, £82.8bn or 15% higher than a year previously, but only £44.2bn or 7% above the level seen in the first three quarters of 2019/20. At the same time, cumulative expenditure excluding interest of £700.5bn was £52.4bn or 7% lower than the first nine months of 2020/21, but £113.4bn or 19% higher than the same period two years ago.
Interest amounted to £53bn in the nine months to December 2021, £20.5bn or 63% higher than the same period in 2020/21, principally because of the effect of higher inflation on index-linked gilts. Interest costs were £10.6bn or 25% more than in the equivalent nine months ended 31 December 2019.
Cumulative net public sector investment in the three quarters to December 2021 was £34.7bn. This was £14.6bn or 30% less than the £49.3bn reported for the first nine months of last year, which included around £17bn of COVID-19-related lending that the government does not expect to recover. Investment was £8.6bn or 33% more than two years ago, principally reflecting greater capital expenditures, including on HS2.
The increase in debt of £205.5bn since the start of the financial year comprises the deficit of £146.8bn and £58.7bn in other borrowing. The latter was used to fund lending to banks through the Bank of England’s Term Funding Scheme, lending to businesses overseen by the British Business Bank (including bounce-back and other coronavirus loans), student loans, and other cash requirements, net of the receipt of taxes deferred last year and loan repayments.
Martin Wheatcroft FCA, external advisor on public finances to ICAEW, said: “Today’s numbers highlight the impact inflation is having on the public finances, with higher tax revenues collected in December offset by the rising cost of index-linked debt. We expect interest charges to increase further in the next few months as the time lag on index-linked debt catches up with the current 7.5% rate of RPI.
“With borrowing costs low and headroom in forecasts for the next financial year, the temptation will be to delay fixing the public finances in order to tackle the immediate hit to household budgets from anticipated energy prices hikes and higher prices in the shops, so pressure on the Chancellor to postpone or phase in April’s national insurance rise is likely to grow.”
Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled.
The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates. These had the effect of decreasing the reported fiscal deficit for the eight months to November 2021 from £136bn to £130bn and the deficit for the year ended 31 March 2021 from £321.9bn to £321.8bn.
Our first chart of 2022 highlights how the cost of government borrowing remains extremely low for most of the 21 largest economies in the world, despite the huge expansion in public debt driven by the pandemic.
Our chart of the week illustrates how borrowing costs are still at historically low rates for most of the 21 largest national economies in the world, with negative yields on 10-year government bonds on 5 January 2022 for Germany (-0.13%) and Switzerland (-0.07%), approximately zero for the Netherlands, and yields of sub-2.5% for Japan (0.09%), France (0.23%), Spain (0.60%), the UK (1.08%), Italy (1.23%), Canada (1.59%), the USA (1.65%), Australia (1.79%) and South Korea (2.38%).
This is despite the trillions added to public debt burdens across the world over the past couple of years as a consequence of the pandemic, including the $5trn added to US government debt since March 2020 (up from $17.6trn to $22.6trn owed to external parties) and the more than £500bn borrowed by the UK government (public sector net debt up from £1.8trn to £2.3trn) for example.
Yields in developing economies are higher, although China (2.82%) and Poland (3.87%) can borrow at much lower rates than Indonesia (6.38%), India (6.51%), Mexico (8.03%), Russia (8.37%) and Brazil (10.73%). The outlier is Turkey (24.21%), which is experiencing some difficult economic conditions at the moment. Data was not available for Saudi Arabia, the 19th or 20th largest economy in the world, which has net cash reserves.
With inflation higher than it has been for several years, real borrowing rates are negative for most developed countries, meaning that in theory it would make sense for most countries to continue to borrow as much as they can while funding is so cheap. However, in practice fiscal discipline appears to be reasserting itself, with Germany, for example, planning on returning to a fully balanced budget by the start of next year and the UK targeting a current budget surplus within three years.
For many policymakers, the concern is not so much about how easy it is to borrow today, but the prospect of higher interest rates multiplied by much higher levels of debt eating into spending budgets just as they are looking to invest to grow their economies over the rest of the decade. Despite that, with the pandemic still raging and an emerging cost of living crisis, there may well be a temptation to borrow ‘just one more time’ to support struggling households over what is likely to be a difficult start to 2022.
While November’s deficit of £17.4bn is in line with expectations, public sector net debt is up by more than half a trillion pounds since the start of the pandemic and as a proportion of GDP, debt is the highest it has been since March 1963.
The public sector finances for November 2021 released on Tuesday 21 December reported a monthly deficit of £17.4bn – £4.8bn lower than the £22.2bn reported for November 2020 but £11.8bn higher than the £5.6bn deficit reported for November 2019.
This brings the cumulative deficit for the first eight months of the financial year to £136.0bn compared with £251.7bn and £52.5bn for the same period last year and the year before that respectively.
Public sector net debt increased from £2,283.0bn at the end of October to £2,317.7bn or 96.1% of GDP at the end of November. This is £183.3bn higher than at the start of the financial year and an increase of £524.6bn over March 2020. As a proportion of GDP, debt is the highest it has been since March 1963, almost 60 years ago.
The increase in public sector net debt of £34.7bn in the month reflects borrowing to finance the deficit of £17.4bn and £26.9bn in the final tranche of the Bank of England’s Term Funding Scheme, offset by repayments in coronavirus lending as well as other net movements.
As in previous months this financial year, the deficit came in below the forecast for 2021-22 prepared by the Office for Budget Responsibility (OBR) in March 2021 but was in line with the OBR’s revised forecast issued in October 2021 alongside the Autumn Budget and Spending Review 2021.
Cumulative receipts in the first eight months of the 2021-22 financial year amounted to £560.7bn, £71.4bn or 15% higher than a year previously, but only £31.2bn or 6% above the level seen a year before that in 2019-20. At the same time cumulative expenditure excluding interest of £622.7bn was £44.4bn or 7% lower than the first eight months of 2020-21, but £102.1bn or 20% higher than the same period two years ago.
Interest amounted to £44.2bn in the eight months to October 2021, £14.6bn or 49% higher than the same period in 2020-21, principally because of higher inflation affecting index-linked gilts. Despite debt being 29% higher than two years ago, interest costs were only £5.0bn or 13% more than the equivalent eight months ended 30 November 2019.
Cumulative net public sector investment in the eight months to November 2021 was £29.8bn. This was £14.5bn less than the £44.3bn reported for the first eight months of last year, which included around £17bn or so of coronavirus lending that is not expected to be recovered. Investment was £7.6bn or 34% more than two years ago, principally reflecting a higher level of capital expenditure, in particular on investment in HS2.
Debt increased by £183.3bn since the start of the financial year, £47.3bn more than the deficit. This reflects funding to cover outflows on lending, including to banks through the Term Funding Scheme, lending to businesses through the British Business Bank, and student loans, offset by the receipt of taxes deferred last year and the repayment of coronavirus loans taken out during the pandemic.
Commenting on the figures Alison Ring, ICAEW Public Sector and Taxation Director, said: “While the numbers for November are in line with expectations, it’s notable that debt has risen both in cash terms and as a proportion of GDP, and at 96.1% is the highest it has been for almost 60 years. The monthly deficit of £17.4bn is below the peaks of last year but still substantially above the pre-pandemic position.
“Despite the rise in interest rates earlier this month, the Chancellor is still able to take advantage of historically-low borrowing costs if he wants to provide support to businesses adversely affected by the Omicron variant and prevent further scarring to the economy. His concern will be how to do so without stoking inflation, which is expected to head even higher over the next few months.”
Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled.
The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates. These had the effect of decreasing the reported fiscal deficit for the seven months to October 2021 from £127.3bn to £118.6bn and the deficit for the year ended 31 March 2021 from £323.1bn to £321.9bn.
My chart this week is on Bounce Back Loans, one of the principal sources of financial support for businesses during the first year of the pandemic and the subject of a recent investigation by the National Audit Office.
The recent publication of the Department for Business, Energy & Industrial Strategy (BEIS) accounts for 2020-21 contained an assessment of the losses expected on the financial provided to businesses through the Bounce Back Loan Scheme (BBLS), the Coronavirus Business Interruption Loan Scheme (CBILS), the Coronavirus Large Business Interruption Loan Scheme (CLBILS) and the Future Fund. This was followed by an updated report from the National Audit Office (NAO) on the administration of the scheme and the potential losses to the taxpayers.
The largest of these schemes was BBLS, with Bounce Back Loans of up to £50,000 provided to eligible businesses to help them weather the first lockdown in the second quarter of 2020, before being extended to the whole of the 2020-21 financial year. In the end, around a quarter of businesses took out a Bounce Back Loan, comprising 1.5m loans for a total of £47bn at an interest rate of 2.5% repayable over six years. The interest in the first year was covered by the government, with no repayments due in that period.
Businesses can extend the loans to ten years through the Pay As Your Grow option, as well as being allowed up to one six month payment holiday and three interest-only payments to provide flexibility without going into default.
The seven main UK banks provided around 90% of the loans by value, with the rest provided by other banks and non-bank lenders, such as peer-to-peer lenders. Each participating financial institution was provided with a 100% guarantee by the government to cover any amounts not repaid. Half a million or nearly 35% of the loans were for the maximum amount of £50,000 (adding up to £27bn) with £18bn lent out between £10,000 and £50,000 and £2bn lent for amounts between £2,000 (the minimum possible) and £10,000.
As the chart illustrates, the geographical distribution of loans was weighted towards the south and centre of England, with £11bn borrowed by businesses in London, £10bn in the South (£6.5bn South East and £3.6bn South West) and £11bn in the Midlands & East (£3.8bn West Midlands, £2.9bn East Midlands and £4.5bn East of England), a total of £32bn. The balance of £15bn was split between £9bn in the North (£3.2bn Yorkshire & the Humber, £4.8bn North West and £1.3bn North East) and £6bn in the other nations of the UK (£2.7bn Scotland, £1.6bn Wales and £1.3bn Northern Ireland).
More than 90% of the loans, amounting to £40bn, went to micro-businesses, ie businesses with turnover below £632,000.
BEIS have estimated in their 2020-21 financial statements that they do not expect 37% of the loans with a value of £17bn to be repaid, comprising £12bn in estimated bad debts and £5bn in estimated losses from fraud, although the NAO says that these numbers are highly uncertain at this stage. With £2bn already repaid, this leaves £28bn believed to be recoverable over the remainder of the six years of the loans (or 10 years for those that are extended).
The fraud estimate, for 11% of the loans with a value of £4.9bn, was based on a sample of 1,067 loans as at 31 March 2021, but a subsequent analysis in October 2021 suggests that the level of fraud may be lower at around 7.5% of loans and so there is some hope that BEIS and the British Business Bank will be able to reduce the amount they will have to reimburse to participating banks under the 100% guarantees.
However, as the NAO reports, these guarantees mean participating banks have no financial incentive to chase repayment and it has raised concerns that insufficient resources are being dedicated by BEIS and the British Business Bank to recovering outstanding amounts.
The challenge for government is that many businesses have not been able to get back to their pre-pandemic level of operation and so there is a need to be sensitive, whilst at the same time seeking to protect public money and tackle those who made fraudulent claims.
The monthly public sector deficit was flat at £18.8bn in October but a last-minute rush by banks to access cheap finance caused public sector net debt to jump by £68.7bn to £2,277.6bn.
The public sector finances for October 2021 released on Friday 18 November reported a monthly deficit of £18.8bn, slightly better than the £19.0bn reported for October 2020 but higher than the £11.6bn deficit in October 2019.
This brings the cumulative deficit for the first seven months of the financial year to £127.3bn compared with £230.7bn last year and £46.9bn for the equivalent period two years ago.
Public sector net debt increased from £2,208.9bn at the end of September to £2,277.6bn or 95.1% of GDP at the end of October. This is £141.8bn higher than at the start of the financial year and an increase of £484.5bn over March 2020.
The increase in public sector net debt of £68.7bn in the month includes £57.3bn to funding lending to banks who rushed to borrow under the ‘Term Funding Scheme with additional incentives for SMEs’ (TFSME) before the extended drawdown period ended on 31 October 2021. A further £26.9bn will be recorded in November for cash movements after the cut-off date, bringing the total amount financed through the TFSME to £193.4bn on 10 November 2021.
As in previous months this financial year, the deficit came in below the forecast for 2021-22 prepared by the Office for Budget Responsibility (OBR) in March 2021 but was in line with the OBR’s revised forecast issued in October 2021 alongside the Autumn Budget and Spending Review 2021.
Cumulative receipts in the first seven months of the 2021-22 financial year amounted to £489.0bn, £65.7bn or 16% higher than a year previously, but only £23.7bn or 5% above the level seen a year before that in 2019-20. At the same time cumulative expenditure excluding interest of £548.2bn was £39.3bn or 7% lower than the first seven months of 2020-21, but £92.5bn or 20% higher than the same period two years ago.
Interest amounted to £39.3bn in the seven months to October 2021, £14.2bn or 57% higher than the same period in 2020-21, principally because of higher inflation affecting index-linked gilts. Despite debt being 24% higher than two years ago, interest costs were only £2.6bn or 7% more than the equivalent seven months ended 31 October 2019.
Cumulative net public sector investment in the seven months to October 2021 was £28.8bn. This was £12.6bn less than the £41.4bn in the first seven months of last year, which included around £17bn on coronavirus lending that is not expected to be recovered. Investment was £9.0bn or 45% more than two years ago, principally reflecting a higher level of capital expenditure.
Debt increased by £141.8bn since the start of the financial year, £14.5bn more than the deficit. This reflects funding to cover outflows on lending to business, including to banks through the Term Funding Scheme, and student loans offset by the receipt of taxes deferred last year and the repayment of coronavirus loans taken out during the course of the pandemic.
Alison Ring, ICAEW Public Sector Director, said: “Today’s public finance numbers show a deficit of £18.8bn in October, which is in line with the revised forecasts published by the Office for Budget Responsibility last month. The deficit has stopped growing now that the furlough and other pandemic support schemes have finished.
“However, a last-minute rush by banks to obtain cheap loans for small and medium enterprises, before the application deadline on 31 October, caused government debt to jump by £68.7bn last month. These loans should help businesses navigate choppy economic waters with rapidly rising inflation, as well as supply chain and staffing challenges. Nonetheless, the Chancellor will need to continue watching events closely to see if he will need to reintroduce any pandemic support schemes.”
Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled.
The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates. These had the effect of increasing the reported fiscal deficit for the six months to September 2021 from £108.1bn to £108.5bn and the deficit for the year ended 31 March 2021 from £319.9bn to £323.1bn.
The Chancellor used tax rises to start repairing the public finances but spending pressures could derail his hopes for a pre-election tax giveaway in 2023 or 2024. Wednesday’s Autumn Budget and Spending Review saw total public spending settle permanently above a trillion pounds a year, as additional spending increases more than offset the end of temporary COVID-19 interventions.
A ‘Boris Budget’ – full of fizz and capital spending announcements
Despite Rishi Sunak’s avowed commitment to a small state and low taxes, the Autumn Budget reality featured both higher taxes and higher spending, and the Spending Review focused on addressing the many pressures bearing down on public services.
The Chancellor benefited from a faster rebound in the economy due to the vaccination programme, as well as being helped by the time lag between inflation benefiting the revenue line and when it starts to feed through into public spending. Combined with the health and social care levy and other tax rises, this provided him with the budgetary capacity to increase spending on health, reverse previously announced cuts in departmental spending, and still reduce borrowing.
This led the Resolution Foundation to label this a ‘Boris Budget’, reflecting the reputedly more generous instincts of Prime Minister Boris Johnson as compared with his Chancellor.
The Office for Budget Responsibility (OBR)’s high-level analysis was that the Chancellor used around half the £50bn net benefit from forecast revisions and tax rises in 2022-23 to increase spending, with the balance reducing the deficit from £107bn to £83bn. However, the Institute for Fiscal Studies (IFS) points out that, apart from health and social care, the additional spending mostly reversed planned cuts made during the November 2020 and March 2021 Budgets that were always going to be difficult to achieve in practice.
The good news from better economic forecasts, including the OBR’s revision of its estimate of the permanent scarring effect on the economy from 3% to 2%, was offset by concerns over the impact of inflation on living standards and the impact of the ending of the temporary uplift in universal credit on those on low incomes.
Higher inflation will also put public sector budgets under pressure as higher wage settlements and supplier costs start to eat into the spending increases awarded as part of the Spending Review. Clearing backlogs built up over the course of the pandemic will absorb further amounts, while there is also a risk that construction worker shortages and rising construction costs will make it difficult to deliver on the capital programmes announced in such a flurry over the weekend before the Budget announcement.
Unemployment – the dog that didn’t bark
One of the key reasons for the better economic situation than was expected at the start of the pandemic is that unemployment has not gone up significantly. The contribution of the furlough schemes and business support has been hugely significant to this outcome, not only by supporting workers and businesses during successive lockdowns but more importantly preserving businesses and the jobs for workers to return to as pandemic restrictions have been lifted.
Unemployment may still increase following the ending of the furlough schemes in September, but any increase is likely to be significantly smaller than the potential more than doubling in unemployment rates that some had anticipated at the start of the first lockdown.
Modest tax reforms overshadowed by higher tax rates, fiscal drag and a major ‘tax’ cut
Perhaps the most radical ‘tax’ change announced in the Autumn Budget was not a formal tax at all. The reduction in the universal credit taper rate from 63% to 55% is in effect a significant tax cut on those on the lowest incomes, even if it still leaves poorer households on higher effective marginal rates than those earning over £150,000 a year. It also does not make up for the removal of the temporary £20 a week boost to universal credit that has already started to hit many of the poorest households this month.
Higher inflation benefits the public finances by increasing fiscal drag as tax allowances reduce in value in real terms, bringing more people into the scope of income tax or onto higher tax bands. This is a hidden tax increase that brings in more for the government without it needing to increase headline rates.
Of course, the government did that as well. The headline rates of employee national insurance, employer national insurance and dividend tax were increased by 1.25% in the coming year, even if in subsequent years the health and social care levy will appear on payslips and PAYE statements as a separate tax in its own right.
Modest reforms to business rates (principally more frequent revaluations), alcohol duties, and air passenger duties were relatively light touch compared with the previously announced health and social care levy and the planned 6% increase in the main corporation tax rate, even if banks saw a reduction of 5% in the bank levy on corporate profits to offset some of that increase.
More money for health and the criminal justice system, but less for the armed forces
The Spending Review saw extra money for health (funded by the new health and social care levy) where demographic pressures continue to drive demand in addition to dealing with the costs of the pandemic and the backlog of treatments that have built up.
The criminal justice system also received a substantial settlement (4.1% on average over three years), but this will not be sufficient to restore spending to the level before austerity. Indeed, the IFS has calculated that with the exception of the Department for Health & Social Care, the Home Office and the Department for Education, all other departments will continue to spend less in real terms than they did in 2009-10.
One surprise in the detail was the flat current spending settlement for the Ministry of Defence over the coming three years, implying a further cut in spending in real terms on the armed forces, which are expected to contract even further than they have done already. While equipment spending is up as part of a ‘more drones, fewer soldiers’ policy, this is one area where additional settlements in the next couple of Budgets appear more likely than not.
Higher levels of capital investment targeted at boosting regional economic growth
A big credit to the Chancellor is that despite the many challenges facing the public finances following the pandemic he has not scaled back the government’s capital investment programme. While it is the case that his two immediate predecessors pencilled in the substantial increases that we are now seeing, it is the current Chancellor who is delivering on them. There are significant boosts in investment in economic infrastructure, housing, research & development and digitising government amongst other areas.
Open questions remain in areas such as transport, where the long-awaited Integrated Rail Plan was not published with the Spending Review as expected. However, the £7bn pre-announced for regional rail upgrades demonstrates how much can be done with a bigger pot of money for investment.
The step-change in the level in capital budgets – from £70bn in 2019-20 to £107bn in 2022-23 is remarkable. The one concern will be whether the relatively flat capital budget allocations in subsequent years will mean investment starts to fall in real terms again, possibly ‘pulling the plug’ on the economic benefits of investment just as the economy recovers from the pandemic.
New fiscal rules: a cautious approach to repairing the public finances
The Chancellor announced two new fiscal rules: a current budget balance target and a declining debt to GDP ratio; although they were accompanied by subsidiary rules, including a 3% of GDP cap on investment spending and a commitment to return overseas development assistance to 0.7% of GDP once budget balance is achieved.
In effect, they provide a fiscally conservative framework of generating sufficient tax revenues to cover day-to-day spending, while allowing a certain amount of borrowing for investment. While debt should still grow – and is expected to reach over £2.5tn during the forecast period, the debt to GDP ratio should start to fall as the economy grows over time.
These changes confirm that George Osborne’s ambition to eliminate the fiscal deficit completely has been abandoned, replaced by a Gordon Brown-style current budget balance target. This is calculated under the statistics-based National Accounts fiscal framework, which for example excludes the long-term cost of public sector pensions; the government is still planning to continue to lose money on an accounting basis under IFRS.
The forward-looking current-budget balance accompanies the Chancellor’s other principal fiscal rule with is to reduce the ratio of public sector net debt to GDP, although again this uses a target based on fiscal measures that do not include other liabilities in the public sector balance sheet.
Even there, the Chancellor adopted a non-GASP (non-Generally Accepted Statistical Practice) measure to target (public sector net debt excluding the Bank of England) that excludes some central bank liabilities, which rather strangely means that money used to finance premiums paid to private investors for gilts purchased by the Bank of England is excluded from the formal fiscal targets.
Irrespective of the precise KPIs used in the fiscal rules, the overall approach is one of repairing the public finances gradually over time. Higher rates of economic growth would enable that to be accelerated, but the government has as yet been unable to identify how to get back onto the pre-financial crisis levels of productivity improvements that would be required to make this possible. In the meantime, the fiscal rules provide a framework in which tax rises to fund public spending are more likely, in particular to fund increases in the health, social care and the state pension costs driven by more people living longer.
There are many risks to the Chancellor keeping to his fiscal rules over the forecast period, especially as there is relatively little headroom within the current forecasts according to the OBR and the IFS. There are also risks from recessions over a longer period.
A weaker but more transparent public balance sheet
The pandemic has seen the liability side of the public balance sheet rise significantly, with £2.2tn rising to £2.5tn in debt adding to similar amounts of liabilities for public sector pensions and other obligations including nuclear decommissioning and clinical negligence.
Higher gearing in a balance sheet already in negative territory increases the exposure of the public finances to changes in interest rates and inflation, providing a higher risk profile for the public finances. For example, the OBR has estimated that a 1% increase in interest rates would add £25bn to interest costs each year – approaching more than twice the amount raised by the health and social care levy.
One positive aspect of the Autumn Budget and Spending Review announcement was a greater amount of balance sheet analysis, providing improved insights into how the government is managing the public balance sheet and into the risks facing the public finances. This includes much more granular detail on contingent liabilities.
Pre-election tax cuts have been promised, but will they happen?
The Chancellor was very clear in telling his backbenchers and the country that he would like to cut taxes before the next election, demonstrating his and the government’s commitment to lowering taxes.
For many commentators, this seemed a contradictory statement to make at the same time as presenting a fiscal event where the government is in the process of raising taxes to their highest level since the 1950s.
In practice, the Chancellor has some capacity to cut taxes based on the current forecasts and he will be hoping that the post-pandemic recovery is better than anticipated, enabling him to be even more generous.
However, as our recent article on the long-term pressures facing the public finances highlighted, the prospects of reversing the entirety of recent tax increases are remote. Long-term fiscal pressures continue to imply higher taxes will be needed absent much stronger economic growth than is anticipated, while there are plenty of economic storm clouds on the horizon including a potential cost-of-living crisis this winter.
More tax, more investment, more spending, less borrowing. ICAEW’s Public Sector experts examine the Spending Review and Autumn Budget 2021 announcements. The centre piece of the Spending Review and Autumn Budget 2021 was the already announced major tax and spending increase from the health and social levy, while a series of pre-announcements of (mostly) capital investment programmes obscured some relatively tough spending settlements for departmental current budgets.
As expected, the Office for Budget Responsibility revised its forecasts for economic growth upwards, reducing its estimate of the permanent scarring effect on the economy from 3% to 2%. The revised forecasts were a big contributor in reducing the forecast deficit for the 2022/23 financial year commencing in April by £24bn from £107bn to £83bn.
The reduction in the expected deficit next year was after absorbing £10bn from the effects of higher inflation on debt interest costs and an extra £27bn allocated to the Spending Review in 2022/23 over and above the £15bn provided by the health and social care levy. However, there is no supplementary pot for COVID-19 measures from April 2022 onwards, leaving departments to absorb any further costs arising from within their budget allocations.
By folding COVID-19 funding into the Spending Review for 2022/23 to 2024/25 in this way, the Chancellor was able to report real-terms increases in resource as well as capital departmental budgets. However, spending pressures remain intense and many departments are likely to need to find cuts in specific areas if they are to meet demands on public services, catch up on backlogs built up during the pandemic as well as cover the cost of what are likely to be higher public sector wage settlements than have been seen for many years.
Total departmental resource expenditure (RDEL) in the Spending Review increased from a March 2021 forecast of £393bn, £410bn and £427bn for 2022/23, 2023/24 and 2024/25 to £435bn, £443bn and £454bn respectively. The changes comprise £15bn, £12bn and £14bn from the health and social care levy announced in September 2021 and a further £27bn, £21bn and £13bn in the Spending Review. The total compares with the £385bn allocated in the current financial year excluding £70bn allocated for COVID-related spending.
Capital investment (CDEL) in the Spending Review has been set at £107bn, £111bn and £112bn in each of the three financial years ending 31 March 2023, 2024, and 2025, pretty much in line with previous announcements from earlier in the year. This still reflects a substantial increase when compared with the £99bn estimate for the current year, the £94bn for last year, and the £70bn recorded in 2019-20.
Welfare spending (outside the Spending Review) is expected to increase from £247bn in 2021-22 to £254bn next year, principally a consequence of inflation more than offsetting a £2bn saving from not continuing with the £20 universal credit uplift, and a £5bn saving from suspending the triple lock.
Total managed expenditure (TME) is expected to fall from £1,115bn in the last financial year to £1,045bn in both the current financial year and next year, before rising to £1,081bn in 2023/24, £1,108bn in 2024/25, £1,148bn in 2025/26 and £1,192bn in 2026/27. At the same time tax and other income is expected to increase from a pandemic-low of £795bn last year, to £862bn this year and £962bn next year, before increasing to £1,020bn, £1,061bn, £1,102bn and £1,148bn in the four following years.
The deficit is expected to fall from £320bn in 2020/21 to £183bn this year to £83bn in 2022/23, before falling to £62bn, £46bn, £46bn and £44bn in 2023-24 through 2026/27. Unlike the Chancellor’s two predecessors, the government is no longer planning to eliminate the deficit completely and instead is aiming to target a current budget surplus by 2023/24 – continuing to borrow to fund capital investment.
Public sector net debt is expected to increase from £1,793bn (84% of GDP) before the pandemic in March 2020 to £2,136bn (97%) in March 2021 to £2,369bn (98%) at the end of this financial year, before gradually rising to £2,561bn (98%) in March 2024, before stabilising in cash terms after that point but falling as a proportion of GDP to 88% by March 2027.
Despite the upbeat nature of the Budget announcement in the House of Commons, the Chancellor made some tough choices, while key announcements such as the Integrated Rail Plan and the Levelling Up White Paper were deferred into the future.
Alison Ring, Director of Public Sector and Taxation for ICAEW, commented: “The statement from the Chancellor was full of fizz, with capital investment across the country and additional funding provided for the five key Spending Review priorities of levelling up; net zero; education, jobs and skills; health; and crime and justice; partially offset by falls in COVID-19 funding.
“The tough decision to raise taxes through the health and social care levy gave the Chancellor more money to address some of the more immediate spending pressures of an ageing population, and the consequences of the pandemic. However, despite improved transparency on the government’s balance sheet, the Budget today left many questions about how he plans to get the public finances back under control over the longer-term.”
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.
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.”
Upward revisions to GDP bring the debt-to-GDP ratio down to 95.5%, but the Chancellor has a difficult Spending Review and Autumn Budget ahead as spending pressures mount.
The public sector finances for September 2021 released on Thursday 21 October reported a monthly deficit of £21.8bn – better than the £28.7bn reported for September 2020 but still much higher than the deficit of £8.1bn reported for September 2019.
This brings the cumulative deficit for the first half of the financial year to £108.1bn compared with £209.3bn last year and £35.3bn two years ago.
Public sector net debt increased from £2,205.4bn at the end of August to £2,218.9bn or 95.5% of GDP at the end of September. This is £83.1bn higher than at the start of the financial year and an increase of £425.8bn over March 2020.
As in previous months this financial year, the deficit came in below the official forecast for 2021-22 prepared by the Office for Budget Responsibility (OBR) in March 2021, when the outlook appeared less positive. The OBR is expected to significantly reduce its projected deficit of £234bn for the full year when it updates its forecasts for the Autumn Budget and Spending Review on 27 October 2021.
Cumulative receipts in the first six months of the 2021-22 financial year amounted to £419.1bn, £57.4bn or 16% higher than a year previously, but only £15.2bn or 4% above the level seen a year before in 2019-20. At the same time cumulative expenditure excluding interest of £468.9bn was £41.2bn or 8% lower than the first six months of 2020-21, but £79.6bn or 20% higher than the same period two years ago.
Interest amounted to £33.5bn in the six months to September 2021, £10.4bn or 45% higher than the same period in 2020-21, principally because of higher inflation affecting index-linked gilts. Despite debt being 24% higher than two years ago, interest costs were only £3.7bn or 12% more than the equivalent six months ended 30 September 2019.
Cumulative net public sector investment in the six months to September 2021 was £24.8bn. This was £13.0bn less than the £37.8bn in the first half last year, which includes over £16bn for bad debts on coronavirus lending that are not expected to be recovered. Investment was £7.1bn or 40% more than two years ago, principally reflecting a higher level of capital expenditure.
Debt increased by £83.1bn since the start of the financial year, £25.0bn less than the deficit. This reflects cash inflows from delayed tax receipts and the repayment of coronavirus loans more than offsetting other borrowing to fund student loans and business lending.
Alison Ring, ICAEW Public Sector Director, said: “Upward revisions by the ONS to GDP brought the ratio of public debt to GDP down to 95.5% at the end of September, which is good news for the Chancellor as he gets ready for a potentially difficult Autumn Budget and Spending Review. September’s numbers continue to track below what now appear to be over-prudent forecasts from the Office for Budget Responsibility back in March, and the OBR will likely improve its projections for the Spending Review period when it reports next week.
“However, at £108.1bn the deficit for the first half of the financial year to September 2021 is almost twice the deficit recorded for the last full financial year before the pandemic, and the Chancellor is a long way from getting the public finances back under control. Difficult decisions await Rishi Sunak in the Spending Review given rising debt-interest costs and existing commitments on health, schools and defence will limit the capacity he has available to address significant spending pressures in many public services.”
Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled.
The ONS made a number of revisions to prior month and prior year fiscal numbers to reflect revisions to estimates. These had the effect of reducing the reported fiscal deficit for the five months to August 2021 from £93.8bn to £86.3bn and the deficit for the year ended 31 March 2021 from £325.1bn to £319.9bn.
