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Economic implications

Ross Campbell, ICAEW's director of public sector, examines whether Philip Hammond was able to balance the demands of ending austerity while also continuing deficit reduction, concluding that the Chancellor's flurry of small announcements diverted the eye away from an underlying financial position that remains extremely challenging.

IFS Green Budget

Read ICAEW's contribution to the Institute of Fiscal Studies' Green Budget 2018 which was published on 16 October.

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The Chancellor went into this budget with the seemingly impossible task of tackling the contradictions of today’s politics, says Ross Campbell, ICAEW's director of public sector. On the one hand, Theresa May, had committed him to ending austerity and increasing public spending, on the other he was expected to continue the government’s programme of deficit and (eventual) debt reduction. 

All of these promises have been made while still implementing a series of pledged tax cuts and also finding money for much needed investment in infrastructure against the backdrop of a flagging economy. With various commentators estimating the amount of additional public spending needed to ‘end austerity’ as between £19bn and £31bn, it looked like some political sleight of hand would be needed to make it look like all these demands were being satisfied.

In another era the prospect of a booming economy or even inflation might have come riding to the rescue. It’s easy to pretend more borrowing for spending is prudent when debt is falling as a share of a rapidly rising economy. We won’t dwell on the fact that, as Gordon Brown well understood, an often used chancellor’s conjuring trick is increasing public spending to make the economy look bigger. As statisticians know, public spending is part of the formula for GDP.

In fact the public sector finances have performed better than the Office for Budget Responsibility (OBR) expected this year. This is in part because last year’s forecasts were even gloomier. Increases in tax receipts above forecasts have meant that the Chancellor has had to borrow less than expected.

Consequently he went into this budget with perhaps as much as £13bn more fiscal headroom than expected. While it is a mistake to think of this as a windfall: rates of growth forecast for the next five years are still low by historical measures, it does mean he can borrow and spend more and still hit his self-imposed fiscal target.

So has the Chancellor pulled off his conjuring trick?

At first sight he has tried to address a range of significant demands on the public purse. He has allocated the first £2bn of the pledge to increase NHS funding by £20bn by the end of the Parliament.

He has announced more money for improvements to motorways and trunk roads plus an additional £420m for potholes, though this is most likely an allocation of money already in the National Infrastructure Plan.

The Armed forces will receive an additional £1bn for this year and next, with £160m for counter terrorism police, £800m for Adult Social Care, and £60m to plan more trees in town and country. Added to this he plans to temporarily cut his revenues by cutting business rates for business premises with a rateable value of less than £51,000 by a third.

However, this was not quite a spending spree… most of the big decisions about future public spending have been pushed off until next year’s spending review. The other conjurer’s trick has been to talk less and less about returning the public finances to surplus and push out a little further the date by which the deficit will turn to surplus, if indeed it ever does.

With insufficient political leeway to raise the headline rates of income tax or VAT, corporation tax held low to encourage industry wary of the consequences of Brexit, and commitments to keep fuel duty and some alcohol duties frozen, the Chancellor has mostly chosen to live within his means than engage in significant tax-raising measures. More will be done to tackle tax avoidance and a new UK digital services business tax will apply from 2020. However, both are forecast to raise only relatively modest amounts.

The most eye-catching and significant use of his fiscal headroom was to announce the increase of income thresholds of £12,500 for the basic rate and £50,000 for the higher rate a year earlier than planned in 2019 rather than 2020. He has however, been careful to build himself some wriggle room by insisting that this budget is contingent on a Brexit deal. All deals are most likely to be off if the UK leave the EU next March without an agreement. 

What the Chancellor has managed in his flurry of small announcements is the conjurer’s trick of diverting the eye away from an underlying financial position that remains extremely challenging. The National Debt is now approximately £1.8 trillion or 84% of GDP.

The most recent and more comprehensive Whole of Government Accounts (WGA) shows that total public liabilities have reached £4.3tn or 214% of GDP. The £2.4bn net liabilities of government are now roughly three times the government’s annual income and economic growth the government relies on to pay them has still not returned to pre-financial crisis levels.

In reality any headroom the Chancellor might have or any Brexit "dividend" is likely to be more than swallowed up by the demands on public spending. This was a budget from a government with insufficient political capital to significantly increase taxation and having to limit its spending accordingly. Austerity might be due to ‘end’ in next year’s spending review, but the reality is the need for continued efficiency and belt tightening in government is not going to go away anytime soon.