FORECASTING EYE

 

Facing a tide of negative press coverage focused on Brexit negotiations and lacklustre economic growth, the Prime Minister has been keen to shift the conversation towards a more positive narrative. This has meant that many of the bold policy announcements which would usually be unveiled during the Budget, have already been revealed. Given the need to build goodwill during these tumultuous times, the announcements have focused on generally popular measures such as supporting the NHS and dialling down spending cuts. Many have jumped to the conclusion that increased spending commitments translate into higher taxes. Below we discuss why this isn’t necessarily true and what else we can expect from the Chancellor.

 

We know that when Philip Hammond gets up to speak on October 29th he will very likely:

• Commit to a continued freeze on fuel duties – this was announced by the Prime Minister at the Conservative Party Conference as a response to higher oil prices.
• Boost NHS spending – earlier this year Theresa May promised to inject an additional £20bn per year by 2023 into the NHS. It remains unclear how the added spending will be funded and the answer to this is certainly something to look out for in the Budget.
• Impose a digital services tax – in his own Conservative Party Conference speech, Philip Hammond announced his intentions to levy a tax on UK profits made by foreign-based tech giants. More details on how and when this will be put in place are expected.
• Scrap the borrowing cap for new council housing – another policy promise to emerge from the Party Conference, the change is meant to enable councils to play their part in addressing the affordable housing shortage.
• Do his best to “end austerity” while balancing the books – ending austerity is a somewhat elusive commitment, but at a minimum would entail boosting (or at least not further lowering) departmental spending limits.

 

Cebr has conducted an analysis of what some of the above policies mean for the fiscal picture. The latest OBR forecasts project that the UK’s deficit will continue to fall gradually from 2.2% of GDP in FY 2017/18 to 0.9% of GDP in FY 2022/23. When factoring in the proposed increase in NHS spending, our analysis finds that the deficit would still continue to decline, falling to 1.3% of GDP by FY 2022/23. Add an “end of austerity” to the mix – which here we assume to mean the cancellation of real term cuts to departmental resource spending limits – and we project that the deficit would fall to 1.5% of GDP by FY 2022/23. Thus, our analysis shows that, while bold, many of the proposed boosts to fiscal spending can be achieved while maintaining the deficit’s downward trajectory – even without increasing taxes. This would set the government two to three years back on its target of achieving a balanced budget by the mid-2020s. However after eight years of austerity, many would forgive the government for applying a dose of fiscal stimulus, given the tempestuous times ahead for the UK economy.

 

It is worth noting that the above projections are based on our central forecasts for the UK economy, which assume very weak but positive growth in the medium term. While this remains the most likely scenario in our view, storm clouds are brewing for the global economy, which have prompted us to raise the risks of a global recession in 2019/20 to one in three. The UK economy faces particularly acute risks related to Brexit, such as the pre-Brexit stockpiling that is beginning to show in official data, which will likely be followed by a drawing down of stocks in 2019. Were the UK to enter a recession in the coming years, this would exert significant pressures on the public finances. However, there would arguably be a stronger case for counter-cyclical borrowing in this scenario, provided that this is temporary and not excessive.

 

Regardless of whether the UK experiences a recession in the coming years, the economic picture looks likely to remain bleak. It is therefore our view that the government can and should delay its target of balancing the books by the mid 2020s. The boost to the NHS and cancellation of real terms cuts to day-to-day departmental spending can be achieved while continuing to bring down the deficit, and these policies would also deliver a fiscal stimulus at a time when the economy is in dire need of a boost. However, we stress that some government departments are in greater need of spending than others, and it is not our recommendation that expenditures in all departmental budgets are treated equally.

 

While the above policy measures have already been hinted at, the Chancellor undoubtedly has other announcements up his sleeve. He may look for a way to attract / keep big businesses, which will be particularly important given the possibility of an extended transition period (i.e. the kick-the-can-down-the-road Brexit scenario) prolonging uncertainty. Cebr expects this will come in the form of liberalised rules for accessing R&D tax reliefs and a more generous annual investment allowance. An incentive for landlords to extend standard lease periods is also possible and tax relief may be used as an incentive. Some early initiatives aimed at replacing EU agriculture funding are also possible. Given the timing of the Budget just months before Brexit, many had assumed that few major policies would be announced. However, it now seems that the Chancellor will need to use this opportunity to achieve a range of goals, from encouraging business investment to ending austerity.

Authors: Nina Skero, Head of Macroeconomics, 020 7324 2876, nskero@cebr.com

Pablo Shah, Economist, 020 7324 2843, pshah@cebr.com