If the pattern observed in the first ten months of the financial year continues for the next two, government borrowing will be £44 billion this year. This would be £3.5 billion lower than implied by the OBR’s restated March 2019 forecast. But it is worth recalling that just four years ago, in March 2016, a surplus of £10.4 billion was forecast for this financial year: i.e. we have seen a deterioration of around £55 billion in four years.
£18 billion of the deterioration results from accounting changes. The remainder is more than explained by a £36 billion increase in spending and £2 billion net tax cut – i.e. a significant discretionary fiscal loosening compared with previous plans. While the fiscal target back in 2016 was to eliminate the deficit this year, this has now been superseded twice by new sets of targets. We will analyse how much headroom the new Chancellor, Rishi Sunak, has against
the targets set out alongside the Conservative manifesto at our pre-budget briefing on February 26th.
Today, the Office for National Statistics published its latest Public Sector Finances release, covering data on government revenues and spending up to January of this year.
Since reaching a peak in the aftermath of the financial crisis, borrowing has returned to long-run averages (see Figure 1). In fact, the current budget – that is, borrowing excluding investment spending – was in surplus for the first time in seventeen years in 2018–19. This means government revenues were sufficient to cover day-to-day spending. This year, we are on course to see another modest current budget surplus.
1. Deficit and current budget deficit over time
But looking back a few years, there has been a marked increase in the forecast for borrowing in 2019–20 since March 2016. At the time, the government was committed to eliminating the overall deficit by this year (see Figure 2). Then, the Government was forecasting an overall budget surplus of £10 billion in 2019–20, whereas we are now on course for borrowing to run at around £44 billion: an increase of almost £55 billion.
2. Deficit in 2019–20, successive March forecast and extrapolation from most recent data
Large revisions to deficit forecasts are not uncommon. The average spring forecast error for borrowing in four years’ time has, over the last 26 years, been 2% of national income or around £45 billion in today’s terms. While the OBR’s average absolute errors have been smaller (at 1.7% of national income, or £37 billion) so far in five out of six cases they have been in the direction of borrowing turning out to be more than forecast. The £55 billion increase in headline borrowing in 2019–20, compared to what was forecast in March 2016, is decomposed in Figure 3.
First, changes to accounting methodology – most importantly, welcome improvements to how student loans are accounted for in the public finances – have pushed up the headline measure of borrowing by £18 billion in 2019–20, according to the OBR’s estimate. In this sense, the ‘real’ change has ‘only’ been around £36 billion.
This £36 billion increase matches changes to spending announced since March 2016, which have added an estimated £36 billion to borrowing in 2019–20. Top-ups to spending plans include additional day-to-day spending on public services such as the 2018 ‘birthday present’ for the NHS, alongside increases in planned investment spending announced in autumn 2016, the cancellation of cuts to the Personal Independence Payment in the autumn of 2016 and some increases in the generosity of Universal Credit. On the revenues side, there has a small net tax cut of about £2 billion, with successive freezes to rates of fuel duties and increases to the income tax personal allowance and the higher rate threshold being the most fiscally significant.
On the other hand, the cost of servicing the UK’s debt has been lightened by enduring record-low interest rates. As a consequence, debt interest spending is on course to be over £4 billion lower than what the OBR forecast in March 2016. And this is despite higher than forecast borrowing in the intervening period.
3. Revisions to the deficit forecast since March 2016
These changes account for almost all of the deviation in the latest pattern for borrowing from what was forecast four years ago. But there is another part to the story: back in March 2016, the OBR was assuming that growth would by now have returned to the robust real growth rates of about 2% annually that were considered normal before the crisis. Instead, sluggish post-crisis productivity growth has proven very persistent, business investment has suffered after the UK’s EU referendum, and growth has remained subdued.
According to the latest data, between the beginning of 2016 and last quarter, the economy had grown by 2.4% less in real terms than forecast in the March 2015 Budget. The cash size of the economy, which is particularly important for government revenues, has grown by 2.7% less than forecast. In the face of such a large downward revision to growth, we would normally have expected another twenty billion or more to be added to the deficit. Instead, revenues have held up remarkably well in the face of low growth since the 2016 referendum. The OBR discussed this apparent contradiction in its Forecast Evaluation Report last December. They highlight that household spending has proved more robust than expected, boosting VAT revenues, and capital allowances have been used less, increasing corporation tax revenues. The latter is very much consistent with the finding in our 2019 Green Budget that the shortfall in growth since the referendum has been driven by weak business investment. While this has actually worked to boost tax revenues in the short run, it will disguise a negative long-run effect as depressed investment now gradually feeds into lower growth and therefore reduced tax revenues in the future.
The commitment to eliminate the deficit by 2019–20 was short-lived, being replaced by Mr Hammond’s new target of reducing structural borrowing to less than 2% of national sincome in 2020–21. Sajid Javid then swiftly abandoned this target, and replaced it with one to balance the current budget on a three-year rolling basis, which was included alongside the Conservative Party’s 2019 general election manifesto. The Budget will be the first opportunity to see whether Mr Sunak remains committed to this latest target. We will present our take on how constraining this might be at our pre-budget briefing on Wednesday, February 26th.