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Spending Review 2020: IFS analysis

Presentation

IFS researchers presented their initial analysis of the Chancellor's announcements at an online briefing the day after the 2020 Spending Review. You can download the slides used, watch the full event, or read IFS Director Paul Johnson's comments below.

Download the slides used here:

Opening remarks 

Paul Johnson

A lot of today’s headlines focus on the scale of this year’s loss of economic output and elevated government borrowing. They are record breaking.  We’ve never seen anything like it. The UK government has increased spending and borrowing this year by more than any other advanced economy bar Canada. The economy is likely to have shrunk by more than a tenth. The amounts being spent on job and business support schemes and on public services are breathtaking. A deficit approaching £400 billion is astounding. I’m already running out of superlatives.

It’s a shame actually that it took until yesterday for us to discover the full extent of the government’s Covid spending. We have had far too many announcements without costings attached either from Treasury or from the OBR. Nearly all of the £80 billion of spending in addition to the £200 billion acknowledged in the Summer economic statement was committed well before yesterday but only now do we have an estimate of the cost. That’s not good enough.

Of greater importance is the longer-term effect on the economy and the longer-term response. We got the OBR’s take on the former and the first sense of the Chancellor’s take on the latter.

Arguably there is some reassurance here. On the OBR’s central scenario there is “only” a 3% long term hit to the size of the real economy. That will be painful, especially after such a long period of poor income growth, but it is way less than the impact of the financial crisis. And on central scenarios borrowing will be ”only” £100 billion or so in 2024-25, not a million miles away from either current budget balance or at least stabilising debt as a fraction of national income. Though even then we would need a fiscal tightening of at least 1% of national income to achieve some sort of balance.

Those central scenarios are not great. But they are not terrifying. We have had much bigger economic shocks and fiscal tightenings before. See the last decade.

I’m not so sure this is really a central scenario though. There are clearly downside risks to the economy from Covid and our ability to respond to it and, as the OBR make clear, from a no deal Brexit. Of course, history need not repeat itself but remember that the long term economic, and hence fiscal, hit from the financial crisis was far greater than predicted at the time. Don’t forget those economic risks, but I’m not going to focus on them. I’m going to focus on the fiscal risks.

First, this was a pretty austere spending review. It cut non Covid related public service spending by more than £10 billion next year, and in subsequent years, relative to plans. It is not obvious that either the need or the appetite for public spending has diminished since March. There has been no top up to NHS spending plans after next year. Frankly I would be most surprised if these plans were adhered to.

Second, while the Chancellor has sprayed enormous amounts of money at dealing with Covid this year and has allocated a whopping £55 billion for next year, he has allocated precisely zero for subsequent years. I hope he is right that we will no longer need to spend anything at all on test and trace, PPE and the rest, but I wouldn’t bet on it.

Third, these plans involve ending the temporary increase in Universal Credit from April next year. It was intended as a temporary policy and it is government policy to end it. Experience suggests, though, that pressure will build for it to be kept and the government may change course in response.

Put these pressures together and my central scenario would have borrowing at least another 1% of national income higher in 2024-25 and subsequently, even given the perhaps relatively benign central economic scenario outlined by the OBR. In that case if the chancellor did want to aim for current budget balance he’d eventually need a 2% of national income fiscal tightening – about £40 billion in today’s terms.

There is an additional risk lurking here. The government is benefiting hugely from interest rates at record low levels. Because such a huge fraction of government debt is held by the Bank of England interest rate rises translate immediately into higher government spending. As the OBR made clear, a 1 percentage point increase in interest rates will now lead to double the increase in debt interest spending as would have been the case back in March.

The key core spending review decision was to reduce public service spending, other than the £55 billion allocated for Covid, relative to March plans. It may seem odd to ignore that £55 billion, but none of that is planned to continue beyond next year so it is right to focus on the rest. That core spending will still be 4% higher next year than last. But it will mean a tougher time for some public services than expected, especially after next year. This may not quite be a return to austerity, but for some public services it may not feel much different.

Once you account for the government’s various commitments on health, defence and so on, things look extremely tight for everything that remains. Remember that outside of Health, real-terms public service spending was cut by 20% (25% per person) over the decade to 2019−20. Some of those areas could well be facing another bout of austerity – if the Chancellor does in fact stick to his spending plans.

As for the other specifics.

First, it is disappointing that we didn’t have an announcement on Universal Credit. If the government is not going to maintain it at its current level it should say so explicitly and give people time to prepare; £20 a week is a lot for those dependent on benefits. If government is going to keep the increase introduced in April then it should have recognised that in its plans. If it does delay announcing the increase until March and is once again unable as a result to increase legacy benefits and contributory benefits at the same time then that would be simply inexcusable

Second, while it looks like this crisis might not end up making the pension triple lock more expensive than expected it remains the case that the state pension is set to rise by 6% in real terms between now and 2025, raising its cost by £6 billion. Again, pensions will rise much faster than earnings, let alone working age benefits.

Third, this was actually a tax raising spending review. The chancellor has chosen to reduce support to local authorities and has given them the ability to raise council tax by 5% instead. If they do, and they’ll mostly probably need to, that will increase annual tax bills by an average of around £70 per household. It is perhaps worth remembering that on April Fools day next year council tax valuations will become 30 years out of date.

Fourth, the decision to freeze public sector pay for some will probably save only between £1 and £2 billion next year. The chancellor has perhaps picked a big fight over not very much money. And as ever in the public sector the decisions look driven by politics not by economics or the need to spend money either equitably or efficiently. It is graduate public sector workers in London and the South East who are least well paid relative to the private sector and local living costs yet they will be targeted by the freeze. Two teachers working half time on £20,000 each will each get a £250 pay rise. A full-time teacher doing the same job for £40,000 will get nothing. This is no way either to spend public money or to treat public sector workers.

Find out more

External publication
Article for Public Finance magazine on the implications of the 2020 Spending Review