ICAEW.com works better with JavaScript enabled.

Options for easing the squeeze

On 30 October, the Institute for Fiscal Studies presented its latest assessment of the UK’s current fiscal position

At an event hosted by ICAEW's Chief Executive Michael Izza, Paul Johnson, Director of the Institute for Fiscal Studies, outlined the findings of its latest report, which concludes that Chancellor is "trapped between his own fiscal targets, deteriorating economic outlook and growing pressures on spending".

In its report, Autumn 2017 Budget: options for easing the squeeze, which was part by ICAEW and the Economic and Social Research Council, the IFS concludes that Philip Hammond faces a choice between maintaining his commitment to a public finance surplus or respond to growing demands for increased public spending. 

“The first Budget of a new parliament is often the best chance a Chancellor has to set out his stall. Mr Hammond, though, has been dealt a very tricky hand indeed," concludes Thomas Pope, a research economist at IFS and an author of the report.

"The political arithmetic makes any significant tax increase look very hard to deliver. It looks like he will face a substantial deterioration in the projected state of the public finances: were the Office for Budget Responsibility to downgrade productivity growth halfway towards the terrible experience of the last seven years, this could add £20bn to borrowing five years out. And, in the known unknowns surrounding both the shape and impact of Brexit, he faces even greater than usual levels of economic uncertainty.”

Key findings, in terms of the outlook for the public finances, include:

  • Borrowing last year lower than forecast in the March Budget. As a result, despite weak economic growth, the deficit could come in at around £51bn - £7bn lower than forecast. 
  • Giveaways announced since March will only add modestly to borrowing over the next few years.
  • Were the OBR only to downgrade its growth forecasts, then the lower borrowing this year could still mean borrowing being forecast to be around £5bn lower in 2021–22, at around £11bn, rather than the £17bn the OBR forecast in March. 

The public finances forecasts for the next five years are hugely sensitive to the productivity assumptions the OBR chooses to make. 

  • Were the OBR to assume productivity growth of 1% a year – i.e. a downgrade halfway towards the terrible growth experienced over the last seven years – borrowing would be forecast to be around £33bn in 2020–21 rather than the £21bn forecast in March. In this case, the Chancellor could still expect to meet his fiscal targets for this parliament, but with only a 60% probability. The target to eliminate the deficit by the mid 2020s would look even more difficult than it did in March.
  • Were the OBR instead to decide that the terrible productivity growth of the last seven years is now the new normal, borrowing could rise to almost £70bn in 2021–22. In this case, the Chancellor could not expect to meet his fiscal targets for the current parliament and the ambition to eliminate the deficit entirely by the mid 2020s would seem almost sure to be abandoned.

Key findings, with respect to some specific policy options, include:

  • Higher inflation means that manifesto commitments to raise income tax thresholds are now less expensive than expected (just £1.1bn a year to deliver a personal allowance of £12,500 and a higher-rate threshold of £50,000 in 2019–20). This would be on top of the £12bn a year spent on raising the personal allowance since 2010.
  • Another freeze in fuel duties would cost £¾ billion a year on top of the £5.4bn cost of having frozen them since 2010.
  • The largest cut to benefits to come over the next couple of years is the continued freeze to the rates of most working-age benefits. Cancelling this entirely would cost £4bn in 2019–20.
  • Fully-funding inflation increases in public sector pay would cost £6 billion more in 2019–20 than retaining the 1% cap.