The September UK borrowing figures indicated to the OBR that borrowing was running £19.8 billion below forecast. Just two months later, the November data showed borrowing £6.3 billion above forecast. A £26 billion turnaround in two months is quite a change.

At first sight the financial turnaround suggested a dramatic collapse in public finances. But looking at the small print, the deterioration is less severe. The September figures were compared with the OBR’s March forecast which had predicted £131.6 billion of borrowing for the 2023-24 financial year; the November figures were compared with the OBR’s November forecast for borrowing which had been reduced to £123.9 billion.

But still, it is clear that the underlying fiscal position has suddenly taken quite a turn for the worse. Had the undershoot for September been carried through for the whole year, borrowing in 2023-24 would have been £111.8 billion.  If the overshoot for November is carried through to the end of the year, borrowing for the year will be £18.4 billion higher at £130.2 billion.

Why is this happening?

The biggest single explanation is the economy. For the early part of 2023 the economy significantly outperformed both the OBR’s and Cebr’s forecasts. For 2023 as a whole UK real GDP is now expected to be 0.5% up on 2022; the OBR March forecast predicted a 0.2% decline, so GDP is running 0.7% above the OBR’s forecasts. If you run a 0.7% boost to GDP through the OBR’s ready reckoner to predict its impacts, the model generates about £10 billion per annum additional tax receipts.

Most of us who have been in the forecasting game for a while think the implied fiscal drag elasticity from the ready reckoner of about 1.1 is far too low and would prefer to use a figure of around 1.5. This would bring the additional tax revenue generated from the additional growth to £14 billion.

The other point is the phasing. When the OBR produced its March 2023 forecast, GDP in the first half of 2023 was forecast to be 0.5% lower than a year earlier. The latest data show that GDP has risen over this period by the same amount, though it recorded as having fallen back in the third quarter and we at Cebr estimate that a further fall took place in Q4. This phasing would be expected to bring in more tax than predicted initially and less than predicted latterly. And the effect would be exacerbated if (as appears to have happened) the early prediction was upgraded on the basis of the higher than expected early data.

Looking at the individual taxes, the main component of the £6.1 billion revenue shortfall compared with the forecast in November is a £4.8 billion shortfall in Corporation Tax. This is a surprising change, particularly for months where Corporation Tax payments are traditionally low. We will know more when the December and January figures, which are traditionally months with large corporate tax payments, are published.

When the government announced that the 2023-24 rate of Corporation Tax would rise from 19% to 25% in March 2021, it was expected to raise an additional £11.9 billion in the first year rising to £17.2 billion by its third year.

Obviously with three years of growth and inflation since and some changes in the system of tax allowances the latest numbers are not comparable.

But at the time Cebr argued that the revenue raised might be rather less than predicted because we expected that companies would finance themselves in different ways (more debt, which is tax deductible, and less equity, where the returns are in practice double taxed) and be more aggressive about taking account of tax allowances – many have traditionally not been claimed.

Could the latest data showing a £4.8 billion Corporation Tax shortfall be telling us that the relatively high level of corporate tax that the UK now has is becoming subject to the law of diminishing returns?

It would be a ‘brave’ (in the Sir Humphrey sense) economist who made this claim based on the data to November alone. But all eyes will be on the December borrowing release (due 23 January 2024) and the January release (due 21 February 2024) to see what light they shed on the subject.

And more generally, if tax rises are starting to meet the point where the amount of revenue they raise is diminishing, it puts more pressure on the government to manage the public sector in a way that requires fewer tax increases. Whoever wins the forthcoming election will need to bear this in mind.

For more information contact:

Douglas McWilliams, Deputy Chairman
Email: dmcwilliams@cebr.com, Phone: 07710 083652

Cebr is an independent London-based economic consultancy specialising in economic impact assessment, macroeconomic forecasting and thought leadership. For more information on this report, or if you are interested in commissioning research with Cebr, please contact us using our enquiries page.