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UK budget: Back to orthodoxy

In his Autumn Statement Chancellor Jeremy Hunt stated his priorities as stability, growth and public services. He gets full marks for stability with the deficit reduced and government debt ratio now projected to come down from 2024-5. Meanwhile he has provided more protection for public services, pensions and benefits than some feared. But there is little support for long-term economic growth here. And the burden of tax is heading up, making the UK look more like a continental European economy than before. His other priority seems to have been to raise taxes in a way that would have the least visible impact on the majority of voters.

Tax rises and spending restraint

Thursday’s Autumn Statement was widely trailed as a major budget tightening exercise and it lived up to that. In place of the tax cuts and dash for growth of the Kwasi Kwarteng mini-budget, Chancellor Jeremy Hunt outlined a programme of tax rises and spending restraint aimed at bringing down the budget deficit and the ratio of debt to GDP. It was broadly welcomed by markets, unlike the aftermath of the September mini-budget.


The back-drop is a painful recession which has already started and will last well into 2023. Unemployment is expected to rise modestly from 3.5% to 4.9% but, due mainly to the energy price shock which has boosted inflation, average living standards are expected to fall back by about 8% from pre-Covid levels, though much of this has already happened with inflation well ahead of wage growth this year. Inflation is forecast to decline from the middle of 2023.


Why tightening now makes sense

Does it make sense to tighten the budget in the face of a recession? Critics of ‘austerity’ will say no. Unfortunately, we need a recession now to help slow wage growth and bring down the inflation rate. Economic reality can be harsh. By tightening fiscal policy the government ensures that the Bank of England does not have to raise interest rates so much. The flaw in Kwasi Kwarteng’s approach was that his stimulatory fiscal policy had the effect of raising interest rates sharply which raised questions over the long-term sustainability of government debt and triggered chaos in the financial markets.


Further, the situation is different now from the period after the 2008 recession when former Chancellor George Osborne cut the deficit. Then, interest rates were already near zero and there was no room for the Bank of England to ease policy if the economy flagged, as it did when the euro crisis came along in 2010. Over the next couple of years the Bank of England can cut rates when and if necessary.


With GDP depressed but spending still rising, the ratio of government spending to GDP will rise to about 44% of GDP by 2025/26, up from about 40% pre-Covid. The Autumn Statement confirmed that spending on pensions, benefits, the NHS, education, defence and infrastructure will be protected, rising with inflation. But, even with this increase, there will be pressure on other public spending over the next 2 years, especially with public sector wage settlements likely to rise. There will be even more pressure in later years, on the projections for spending here.


All this has to be paid for and there are five main sources. First, the existing 5-year freeze on tax thresholds (basic and higher rate income tax, national insurance contributions and inheritance tax) has been extended for 2 more years to 2028, steadily raising the tax take over time. Secondly the threshold for the additional rate of tax of 45%, previously at £150,000 will be reduced to about £125,000. Thirdly, the allowance for capital gains is being slashed, from £12,300 to £6000 and later to £3000. Fourthly, the tax-free dividend allowance is being cut from £2000 (not long ago it was £5000) to £1000 in 2023-4 and then £500 in 2024-5. Finally, the windfall tax on energy producers has been increased and extended to a wider set of energy companies. Many small-business owners will pay more in tax. On the plus side, there was some relief on business rates.


Limited help for long-term growth

What of the impact on economic growth potential? Kwasi Kwarteng and Liz Truss emphasized economic growth as a priority and Jeremy Hunt professed that he agrees with this. He outlined a series of micro-measures designed to boost growth. The Office for Budget Responsibility did not seem impressed with this and maintained its view that long-term potential growth is about 1.7% pa. The protection of the infrastructure spending budget and Research and Development spending, at least for the next couple of years is a positive. But higher taxes on capital gains, dividends and on higher income people will not help growth. Nor will the decline in tax thresholds at the lower end help, as people judge whether to seek work or rely on benefits.


Overall, the Chancellor faced difficult choices with the economy performing so poorly. The UK is particularly hard-hit by higher natural gas prices because of its dependence on gas. There is a huge hit to households and business as a result. Another big issue for the UK, where it seems to be suffering more than other countries, is the high number of ‘missing workers’. If we had projected forward the steady upward trend in employment from the late 2010’s, pre-Covid, there would be about a million more people working today, boosting GDP. Some of these missing workers are doubtless Europeans, driven away by a combination of Brexit and Covid. Some seem to be people retiring early and some are ill with long Covid.


The political choice being made is to maintain public services and benefits with the help of higher taxes. The UK’s share of government spending and taxes is still well below most countries in Europe but is much higher than the US. The near-term economic outlook is grim with GDP expected to fall 1.4% in 2023, reverse that with a 1.3% rise in 2024 and then see a couple of years with growth of about 2.6% before subsiding to the long-term trend rate.


Keywords: Fiscal policy, UK economy, UK budget

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