Autumn Statement 2015: the first test for the Chancellor's welfare cap

The July Budget painted a picture of declining borrowing over the next few years, assisted by growth in tax revenues and – in particular – further deep cuts to many areas of public spending. The latest official forecast suggested that borrowing this year would be £69.5 billion, falling to £6.4 billion by 2018–19 and then moving to a surplus of £10.0 billion in 2019–20. If achieved this would be the first overall annual surplus for the UK public finances since 2000–01 and only the ninth since Queen Elizabeth II came to the throne. However, this move into surplus is predicated on significant cuts to some areas of public spending. In preparing his Autumn Statement and Spending Review, Mr Osborne will be facing two particular challenges. The first is how to divide up the diminishing resources available for day-to-day departmental spending. The second is how to remain within his self-imposed welfare cap while also adhering to the recent House of Lords motion that requires him to reconsider the cuts to tax credits that were announced in July.

Short-term economic and fiscal outlook broadly unchanged

The good news for Mr Osborne is that the UK’s economic situation and outlook does not seem to have deteriorated since the last official forecasts were published in July. Average independent forecasts for GDP growth this year and next are identical now to what they were in July.

Despite this, figures released today by the Office for National Statistics suggest the Chancellor may be on course to slightly overshoot his forecast for borrowing this year. Borrowing over the first seven months of 2015–16 has been 10.9% lower than over the same period last year, compared to the Office for Budget Responsibility’s (OBR) forecast from July 2015 that borrowing would fall by 22.9% this year. If this trend were to continue for the rest of the year, government borrowing would overshoot the OBR’s forecast by around £11 billion.

But the picture may not be as bad as it appears at first sight. Some aspects of spending, such as that on investment, are quite lumpy and may well grow less quickly over the remainder of the year than they have done so far. However, total tax receipts do look likely to disappoint slightly this year.

As the table shows, October 2015 was a relatively bad month for receipts, with the main taxes (income tax, National Insurance Contributions, VAT and corporation tax) all performing worse than the full year forecast. Taking the first seven months of the year together, income tax, National Insurance Contributions, VAT and corporation tax have all still grown strongly relative to the full year forecast, but the slowdown in their growth over the last month means they are no longer offsetting weaker growth in other receipts. Total central government current receipts have grown by 3.0% over the last seven months, compared to the OBR’s forecast of 3.6% for the year as a whole.

Table: Growth in receipts, spending and borrowing over the year to date

However, in the context of public borrowing, the size of overshoot suggested by today’s figures is relatively small. Together with the fact that the economic outlook appears little changed since July, this suggests that there are unlikely to be large revisions to the OBR’s economic and fiscal forecasts next week. Despite this, George Osborne still faces a tough challenge in making his overall spending plans add up.

Slicing the departmental cake

The July Budget suggested that George Osborne will be looking to cut departmental day-to-day spending by around 5% in real terms over the next four years. However, some large areas of spending were ‘protected’ from the start – overseas aid, defence and, in England at least, the NHS and schools. As a result, the unprotected areas (after taking account of the Barnett formula, which is usually used to determine grants to the devolved administrations) are set to see real terms cuts to their day-to-day spending averaging 27%, as we described in a recent IFS briefing note. This would bring the total cut to these budgets since 2010–11 up to 50%.

But of course the pain is unlikely to be evenly shared and from the start the Treasury asked departments to propose how they would cut 25% and 40% from their day-to-day budgets. Recent weeks have witnessed a series of announcements about early settlements for certain government departments (although without the actual settlements being published), including the Departments for Transport, Work and Pensions, Environment, Food and Rural Affairs and Energy and Climate Change. However, many of the largest departments have not yet been settled – including Education, the Home Office, Justice, and the Department for Business, Innovation and Skills – meaning that there are still important decisions to be made. Some of these departments have already seen very significant cuts to their budgets over the last five years. For example, the Ministry of Justice has already had its day-to-day budget cut by a third since 2010–11.

Fitting the welfare cap?

Whereas George Osborne always expected to have to make these tough choices about how to divide up the shrinking departmental spending pie, he probably was not expecting to have to revisit difficult decisions on welfare spending. However, the recent vote in the House of Lords (which forced George Osborne to reconsider his planned cuts to tax credits) may have resulted in just that.

At the time of the July Budget, George Osborne announced plans for £12 billion of cuts to working-age welfare spending by 2019–20 (the same total amount, albeit two years later, than committed to in the Conservative Party general election manifesto). At the same time, he lowered his so-called ‘welfare cap’ so that it exactly matched the new, lower forecast for spending on “welfare-in-scope” over the next five years. “Welfare-in-scope” covers, essentially, spending on all social security benefits and tax credits that are set by central government apart from the state pension and the most cyclical benefits.

If the OBR’s forecasts were to remain unchanged but the Chancellor had to unwind (or compensate for) some of his planned cuts to tax credits, then – without commensurate cuts elsewhere – he would breach his cap. Doing so would force him to go to Parliament for a vote to raise the cap.

There are only two ways that Mr Osborne might avoid this scenario next week. The first is for him to find some alternative cuts to other spending within the welfare cap. This comprises mainly working-age benefit spending – such as child benefit, housing benefit and disability benefits – though does also include some benefits paid to pensioners, such as pension credit and the winter fuel allowance. Such cuts would presumably be ones that were considered but rejected in favour of the tax credit cuts in July.

The second way to avoid a Commons vote is for him to hope that the OBR has – for some other reason – reduced their forecast for cash spending on welfare-in-scope. If this happens, it would give Mr Osborne a little more wiggle room under the cap. But the likely unchanged outlook for growth next year – and the fact that spending on social security benefits so far this year has run in line with the OBR’s forecast for the year as a whole (as shown by the “net social benefits” line in the table above) – suggests that any wiggle room is likely to be small. Even the very low inflation in September (which is usually used to uprate many benefits in the following April) will not have made much difference this year as zero inflation was already anticipated in the July Budget, (and the government has announced a cash freeze in working age benefits in any case).

It will be interesting to watch next week how Mr Osborne navigates these treacherous waters and avoids the obstacles he constructed for himself. As he said when he introduced the welfare cap in November 2013: “The government has a responsibility to taxpayers to control their spending on welfare; and Parliament has a responsibility to the country to hold the government to account for it.” Might this be the first time we see this principle in practice?