A loan not a gift
There’s a lot of focus on whether the government is really cutting taxes after the Chancellor’s Autumn Statement today. Overall, they’re not, and if anything the tax burden is set to rise even higher as a proportion of GDP than expected back in March on a comparable basis.
But that’s not the main take-home from this fiscal event. The real story is that the government has effectively raided the budgets of public services to fund an equally large tax cut. And since the previous departmental spending plans were widely believed to be undeliverable, there’s no question that the new ones are implausible.
The upshot is that whoever wins the next election is going to have to walk back today’s £21bn of tax cuts, and probably more besides. The Autumn Statement wasn’t so much a giveaway as a loan with repayment due after the election.
Here are five things I found interesting from the Chancellor’s Statement and the OBR’s report.
1. Unexpected inflation means that, despite today’s giveaway, the tax burden is set to rise by even more than expected in March
The story from the economic forecast is stubborn inflation combining with frozen tax thresholds to rake in billions more for the exchequer than the OBR anticipated back in March.
On a like-for-like basis (i.e. ignoring the effect of revisions to historical GDP figures), that would have left the tax burden over a percentage point of GDP higher than expected in March. Today’s tax cuts still leave the tax burden up, if only by a bit. That’s a whopping 4.5 percentage points of GDP higher than before the pandemic.
A debate about the tax burden is a sideshow compared to the real action in the Autumn Statement though, which is about the viability of public services.
2. Departmental budgets are facing further cuts to the tune of £19bn per year
The tax giveaways were directly carved out of the budgets for public services in future years. The net tax giveaway by 2028–29 is around £21bn in cash terms, while departmental spending is expected to absorb the effects of higher inflation, resulting in a real terms cut of £19bn.
As the Resolution Foundation and the IFS have previously shown, the old plans were set to involve a vicious squeeze on public services. They were almost certainly undeliverable, especially given that some departments and areas of spending — most significantly the NHS — are protected.
After today we can be fairly certain that today’s real terms budget cuts will have to be unwound. That will mean reinstating tax rises of the same scale as today’s cuts. But obviously that good news will be left to whoever is chancellor after the election.
3. Raising Local Housing Allowance is welcome but, since levels will again be frozen, it’s only a temporary reprieve
On benefits there was welcome news that they will be adjusted in line with inflation, and good news that the Local Housing Allowance will be increased to the 30th percentile of local rents. This was desperately needed to help stem rising homelessness and destitution among private renters, boosting support for 1.6 million families by an average of £800 per year.
But unfortunately it’s not a permanent fix. In years gone by LHA was linked to the 30th (and, under Labour, the 50th) percentile of local rents. Its generosity therefore tracked the changing cost of renting. But today’s increase will see rates refrozen from April next year.
This is unsustainable. Rent rises tend to lag wage growth by one to two years, so recent rapid nominal wage growth means that there are some big rent increases already in the post. In two years’ time then, it’s very likely that affordability will be quickly eroded despite today’s help. The only permanent fix is to relink LHA to the 30th percentile of rents. But it looks like it will fall to the next chancellor to figure that out.
4. There’s also a significant risk the OBR is being over-optimistic
On top of the problems above, there’a risk that the OBR is being too optimistic — yes, really! — about medium term growth. That has huge implications for taxes and public spending. Indeed the OBR presents a fascinating scenario analysis on this point.
On their central forecast, productivity grows at about twice the rate we’ve seen over the past 15 years (blue line). So what happens if that turns out to be wrong and we end up with continued sluggish productivity growth (purple line)?
Well then the outlook is fairly dire. The OBR suggests that unless something changes the government would miss its ‘debt falling’ target by over £40bn in 2028–29. That would be a huge and very painful problem to add to all the other ones outlined above — but one that will, yet again, weigh on the shoulders of the next chancellor by the time we find out.
5. The political gamble could go wrong if inflation falls too quickly, wiping out fiscal headroom
There is one thing that might come back to bite the current occupant of №11 though. Much of the forecast growth in tax revenues is coming from the combined effect of frozen tax thresholds and inflation that is now expected to be much more stubborn than the OBR expected in March. Look at the gap between the yellow and blue lines here!
But what inflation giveth, inflation can take away. If it was to fall more rapidly towards the Bank of England’s 2% target in the coming months, that would put a dent in projected tax revenues. That, in turn, would eat into and potentially wipe out the remaining £13bn of headroom the chancellor has against his target to get debt falling by the fifth year of the forecast.
That would create a major political headache for him in a pre-election budget next spring. Maxing out the budgetary headroom looks like clever politics today but it might not look that way in a few months’ time.
