Light at the end of the tunnel

Aided by the biggest upgrade to the OBR’s fiscal forecast in five years, the Chancellor held out the promise of a brighter future in his third Budget.  Far from a Halloween horror show, Mr Hammond heralded the end of austerity by confirming a huge injection of funding into the health service and other tax and spending giveaways lining the pockets of Britain’s consumers.

Tax rich.  Following a £5bn reduction to public borrowing in 2017-18 and stronger than expected growth in receipts from a broad range of taxes over the first six months of this year, the Office for Budget Responsibility (OBR) revised down their forecast for the deficit substantially. Taking into account all Budget policy measures, the deficit this year is now forecast to fall to just £25bn (1.2% of GDP), a decrease of £11.6bn compared to last March

Big call.  Concluding that their past forecasts have been overly-pessimistic, the OBR now assume the recent increase in tax receipts is structural and will be sustained in future years.  This benefitted the underlying public finances to the tune of 0.6% of GDP on average over each of the next five years.

More potential.  Economic growth in 2018 was revised down from 1.5% to 1.3% due to frosty growth in the first quarter and GDP growth is forecast to remain historically muted at just 1.5% per year on average.  The OBR have, however, taken a more optimistic view of the UK’s growth potential.  The fiscal arithmetic assumes that the economy is able to sustain slightly higher growth over the next few years due to a rise in labour market participation and a fall in the sustainable rate of unemployment to just 4% (from 4.5%).  As a consequence, employment from 2020 onwards is now expected to be 400,000 higher than forecast in March.  Basing a forecast on unobservable variables like the ‘natural rate of unemployment’ and ‘output gap’ is always risky.  Let’s hope that subsequent events don’t prove the OBR wrong.

Elephant in the room.  The other major uncertainty around the economic forecasts stems from the fact that – in the absence of any reliable information on the form of future trading and migration regimes – the entire forecast is conditioned on a smooth exit from the EU, including a two year transition period.  The OBR note pointedly that a disorderly Brexit would have severe short-term impacts on economic activity.

Borrowed money.  The unexpected windfall meant that the Chancellor could have chosen to eliminate the deficit and achieve his goal of balancing the budget by the mid 2020s.  But he instead chose to loosen the fiscal stance by £100bn over 5 years (about 1% of GDP).  This turned a small potential surplus of £3.5bn in 2023-24 into a £19.8bn deficit.  As a result of additional spending, devolved administrations will see their budgets increase by £950m (Scotland), £550m (Wales) and £320m (Northern Ireland) through to 2021.

Balanced approach. This was no spendthrift Budget though.  Against a backdrop of a potentially disruptive Brexit, the Chancellor chose to retain £15bn headroom (0.7% of GDP) against his self-imposed fiscal rule that the structural budget deficit must be below 2% of GDP in 2020-21.  This is the same margin as in March.  Keeping this fiscal firepower in reserve will allow government to dispense some fiscal medicine should the economy require a stimulus in the future – which could be as soon as the Spring Statement if Brexit negotiations turn sour.

Double deal dividend.  The chancellor told MPs that reaching a good deal with the EU would enable government to use his rainy day fund to lift public expenditure further, while also reaping the benefits of an upgraded economy forecast as less uncertainty released pent up demand.

A brighter tomorrow.  After eight years, we were told that austerity is coming to an end.  Government will raise NHS spending by a whopping £28bn by 2023-24, so much that the additional government consumption raises GDP, and provide an average of £3.6bn p.a.to ensure that real day-to-day spending by other government departments rises by 1.2% per year from 2019-20 to 2023-24, rather than falling as planned.

Bonus time.  Disposable incomes will be boosted by the decision to raise the Personal Allowance to £12,500 and the Higher Rate Threshold to £50,000 from April 2019, a year earlier than promised.  (Scottish taxpayers will only benefit from the rise in the Personal Allowance unless the devolved government decides to follow suit by adjusting other income tax thresholds in December.)  An outsize rise in the National Living Wage – set to rise 4.9% (38p) to £8.21 per hour – and more money to ease the transition to Universal Credit and make it more generous will both act to put more money in the pockets of people most likely to spend it.