We have had 13 major fiscal announcements since the last Budget on March 11th last year. Those announcements have involved more than £250 billion of additional spending, largely focussed on supporting public services, jobs, businesses and incomes through the pandemic.
We can expect Rishi Sunak’s second Budget on March 3rd to do more of the same. But it should also focus on supporting the recovery as restrictions are eased.
In an online event, researchers from the Institute for Fiscal Studies, joined by an analyst from Citi Research, will set out some of the challenges and options confronting the Chancellor as he prepares for what is only his second Budget.
Researchers will say that:
- The Budget needs to announce well-targeted extensions in emergency support to households and employers over coming months. It also needs to set out a plan for phasing them out. The economy cannot adjust and recover until most of this support has been removed.
- The Chancellor also needs to set out plans for how to help the economy recover and adjust to a new normal. The economy needs to adjust to the triple challenges of Brexit, recovery from Covid, and the move towards Net Zero.
- The public finances are not on a sustainable footing. Sizeable net tax rises – to help meet likely demands for additional public spending and make-up for any enduring weakness in revenues, while keeping inflation low – will be needed at some point. But substantial tax rises should not be part of the coming Budget. Mr Sunak should only commit to permanent spending rises (or for that matter tax cuts) if he is sure of an appetite for larger subsequent tax rises.
Paul Johnson, IFS Director said:
"This will be just Rishi Sunak’s second Budget, but his 15th major fiscal announcement. In it he needs to strike a balance between continuing support for jobs and businesses harmed by lockdowns, and weaning the economy off blanket support which will impede necessary economic adjustment. Any significant continuation of the furlough scheme must be limited and carefully targeted.
"In the recovery phase he needs to support jobs and investment, but also crucially needs to recognise and address the multiple inequalities exacerbated by the crisis. Fiscal policy should lean against the effects of looser monetary policy which has again benefited the older and wealthier at the expense of the younger and poorer. And he will need to allocate substantial sums to help the health, education, justice and local government systems deal with ongoing consequences from the pandemic.
"In all this he is facing huge economic uncertainties as the economy adjusts to the triple challenges of Brexit, recovery from Covid and the move to Net Zero. It is possible that that growth will be fast enough that big fiscal deficits will largely dissipate of their own accord. But that is not a central expectation: more likely we are on track for ongoing unsustainable deficits. For now, Mr Sunak needs to focus on support and recovery. A reckoning in the form of big future tax rises is highly likely, but not as yet inevitable."
The economic uncertainties remain unprecedented (Citi)
The outlook for the economy over the coming years remains hugely uncertain. Despite positive news on both the (albeit thin) UK-EU trade arrangement and progress to date on the rollout of effective vaccines the strength of the recovery will hinge on the extent to which the lockdown can be eased and how, in particular, consumer spending responds. Citi’s view is that the vaccine will underpin a rapid but ultimately incomplete recovery, with substantial reconfiguration still likely necessary over the coming years.
- Under Citi’s central scenario at the end of this year the economy would still be 3% below its pre-Covid level. This assumes virus fears dissipate only gradually over 2021, while some social distancing remains in place until the end of Q3. Under a plausible benign scenario where the vaccine offers a more complete exit from the pandemic and household savings are unwound, the economy could reach 1% above its pre-Covid level by Q1 2022. Conversely under an equally plausible adverse scenario, where tight restrictions need to be re-imposed next winter, the economy could begin 2022 still 8% below its pre-Covid level.
- Households have accumulated around £125 billion of savings so far during the pandemic. This saving has been driven by higher income households and a large portion appears to be flowing into housing. In contrast lower-income households have, on average, dissaved. These groups are likely to face a higher risk of unemployment in 2021 which looks set to rise sharply as ‘deferred’ firm failures accumulate and the furlough scheme is wound down.
Support for households and employers needs to be extended and better targeted. It is important for recovery that the furlough scheme is phased out as soon as conditions allow. There is no such need to phase out the £20 a week increase to Universal Credit
Many of the support measures introduced in response to the pandemic are set to expire shortly. They should be extended in some form, and phased out gradually rather than coming to an abrupt halt. But the economy will not be able to adjust properly so long as the furlough scheme remains in place. Budget decisions that need to be made include:
- £20 per week boost to Universal Credit and Working Tax Credit (due to end on 31 March). Given that basic support for the (childless) unemployed has not risen in 50 years as earnings have more than doubled, and is much less generous than in many comparable countries, there is a case for maintaining this increase. It would however come at a long-term cost of £6½ billion. If it is not to be made permanent it should be phased out over several months. Not doing this would see 6 million low income families see their benefit income fall by £80 or more between March and April 2021. The lowest income single, childless, adults aged over 25 receiving Universal Credit would see their income fall by a fifth.
- Suspension of the Minimum Income Floor (MIF) affecting many of the self-employed who receive Universal Credit (30 April). For most self-employed claimants the MIF limits the support they can get by assuming their income is equal to at least 35 hours a week at the minimum wage. The MIF, or something like it, should be reintroduced. But it should be done gradually, with advance notice, to give those affected more time to adjust.
- Employee Job Retention Scheme (JRS, 30 April). This furlough scheme should be phased out as restrictions ease. It should not be cut completely in one go. Nor should it be extended much beyond the point at which most restrictions are eased, otherwise it will actually choke off recovery. A much more tightly targeted version may be needed where activity is more restricted for longer: perhaps the aviation and airport industry for example.
- Self-Employment Income Support Scheme (SEISS, 30 April). If the JRS is extended then this would justify another tranche of SEISS payments. As the JRS is tapered away, additional SEISS payments should be at a reduced level. The Chancellor could straightforwardly and relatively cheaply provide support to those excluded so far because their previous profits were above £50,000 or did not represent the majority of their total income, or, for any new support, because they had only recently become self-employed.
The chancellor needs to allocate substantial sums to health, education, local government and justice
Mr Sunak has set aside a sizeable – £55 billion – pot to be made available to public services as necessary if Covid related pressures emerge in 2021–22. The Budget is an obvious moment for some of this to be allocated. As well as continued need for spending on test and trace, Personal Protective Equipment, and vaccinations, other public services will need supporting. Obvious areas include:
- The NHS where there is now a huge backlog in non-Covid care. Between April and December 2020, there were 5.3 million fewer referrals for hospital care in England than over the same period in 2019. At least some of these people will need treatment eventually, which will only add to the 4.5 million already on a waiting list for NHS care. Waiting times are already lengthening: in December 2020, more than 224,000 people had been waiting for more than a year for hospital care, compared to just 1,500 at the same point in 2019. The Government’s official figures suggest – rather optimistically – that after March 2022, the NHS in England will revert to its pre-Covid spending plans. Instead, clearing the backlog created by a year of cancelled and delayed procedures will require billions of additional NHS funding in the years to come.
- Education where the long-run costs of lost schooling could be enormous. Pupils have fallen well behind expected progress, with the poor faring worst. School children have lost up to half a year of in-person teaching on which the state would normally have devoted £30 billion. It is likely we will need to devote many billions to offset the consequences of school closures.
- The court system where huge backlogs have also emerged. The Institute for Government estimate that dealing with these would require £300 million over the next two years.
- Local government where we project increasing cost pressures will total over £2 billion a year by 2025.
Medium-term spending pressures have surely increased further due to the pandemic. But in the Autumn the Chancellor decided to shave £12 billion off his medium-term spending plans, despite at the same time announcing a much greater increase in defence spending than committed to in the Conservative Party election manifesto. The idea that we will now spend less in the medium-term than we would have done had the pandemic not hit looks implausible. A clear risk to the public finances is that spending will turn out higher, and potentially considerably higher, than is currently assumed.
The budget should set out plans for supporting the recovery and offsetting the impacts of Covid on inequalities
As the lockdown is eased the government will need to turn its attention to measures that can support the economic recovery. The Chancellor will need to take account of the fact that lower income and younger people have been hit especially hard. One impact of even lower interest rates and more Quantitative Easing will be to again push up asset prices to the benefit of the older and wealthier and to the detriment of the younger and less wealthy. The recovery plan should recognise this.
We need a plan for measures that increase the productive capacity of the economy and help steer and ease the transition to a new normal. This should include:
- Measures to prevent long-term unemployment. For example, extending the kickstart scheme beyond December 2021 and other schemes for groups particularly vulnerable to long-term unemployment;
- Making investments in physical and digital infrastructure, training, and science to boost the productive capacity of the economy and to achieve goals such as reaching Net Zero by 2050;
- Encouraging private sector investment by ensuring that businesses don’t face regulatory uncertainty and by removing disincentives to investment in the tax system.
There are no silver bullets here. We will need clear strategies and detailed policies in a number of areas. Many of the specific policy options will be ones that would be good at any point in time, but that are particularly valuable now in aiding economic recovery. Many such tax policies could be implemented as part of broader reforms that also raised revenue in the medium run. For example:
- Stamp duty land tax is a particularly damaging tax. Its abolition would stimulate the economy and could be introduced alongside a commitment to replace the forgone revenues with a reformed and revalued – and therefore fairer – and increased council tax.
- Changes to the tax base that improve investment incentives could be introduced alongside increases in tax rates on business owners’ incomes and/or an increase in the corporation tax rate.
- A cut to Employer’s NICs could boost job creation in the short run, while a subsequent increase in employee and self-employed NICs could raise revenue and be designed to reduce the current tax penalty on standard forms of employment.
The public finances are likely on an unsustainable path. That will need to be addressed, but not in this Budget
Borrowing and debt have jumped up and there is a great deal of uncertainty over how they will evolve:
- Borrowing will come in at around £400 billion in 2020–21 – a remarkable increase on the £55 billion forecast in the last Budget, and easily its highest ever level as a fraction of national income outside of the two World Wars.
- Under Citi’s central scenario for the UK economy we forecast that borrowing in four years’ time (2024–25) would still be running at around £130 billion. This is more than twice the £58 billion forecast in the March 2020 Budget, and 30% above the Office for Budget Responsibility’s November forecast for borrowing of £100 billon. But there is tremendous uncertainty around this figure: borrowing would fall to pre-pandemic levels of around £50 billion under Citi’s much more optimistic scenario and would remain at around £190 billion under their more pessimistic scenario.
- We forecast that, under Citi’s central scenario for the economy, underlying public sector net debt would climb to over 100% of national income in 2024–25. This compares to below 75% of national income in 2018–19 and 35% of national income in 2007–08, prior to the financial crisis.
Government is benefitting from being able to borrow at extremely low rates of interest. Despite high debt levels debt servicing costs are at historically low levels. But the expansion of quantitative easing means the interest on a much larger share of government debt is effectively the contemporaneous Bank Rate (currently 0.1%), such that increases in Bank Rate will add considerably – and immediately – to the government’s debt interest bill. To reduce this risk there is a strong case for the government tilting its gilt issuance further towards long-dated index-linked gilts, to lock in the currently extraordinarily low real cost of borrowing.
On central forecasts debt would continue to rise as a fraction of national income over time. Even modest rises in the cost of borrowing would see debt rising considerably faster. And increases in public spending, which we judge likely, would put yet more pressure on the public finances.
The Chancellor has said that he wants to “balance the books”, but the Government has also highlighted the “end to austerity” for public spending. This suggests sizeable net tax rises will, at some point, be needed.
Under the central Citi scenario for the economy and assuming that the £12 billion cut to spending plans is not delivered – but before accommodating any of the other spending pressures set out above –, we estimate that tax rises of around £60 billion could plausibly be required to ensure that government revenues cover day-to-day spending. But again there is a huge amount of uncertainty around this figure: while under the optimistic scenario tax rises might only be needed to meet new spending pressures, under the pessimistic scenario they would be considerably larger. This uncertainty is one of several reasons why tax rises should not be implemented any time soon. But the Chancellor should be preparing for them, and certainly should not be engaging in any permanent spending increases (or for that matter tax cuts) unless he is sure of an appetite for larger subsequent tax rises.