After relatively mild autumn weather, there was a wintry chill in the fiscal air yesterday as the newly installed Chancellor, the Rt Hon Jeremy Hunt MP, set out a range of measures to help restore the UK’s economic and fiscal credibility. This comes almost eight weeks to the day from the so called “mini-budget” which triggered a period of well publicised economic turbulence and market instability.
The result of that market instability is that the UK Government has gone, in the space of two months, from proposing the biggest tax cuts in 50 years to proposing measures which will reduce the deficit by £60 billion by 2026-27, relative to previous plans. Having said that, the fiscal tightening was not as large in the short term as had perhaps been feared.
In some ways, recent fiscal pronouncements from the UK Government have been directed more at “the markets” than the electorate. They have been about providing markets with “reassurance” that the UK government had restored economic credibility. Market confidence is important as it directly impacts on the premium charged for UK government debt, and influences things like currency exchanges which in turn impact on the price of every-day goods – for example, if the pound falls against other currencies, the cost of buying imported goods increases. Borrowing costs also impact on households through higher mortgage payment costs.
At the time of writing, the markets appear to have held up and the pound has retained its pre-Statement value against the US dollar and the Euro.
Grim OBR forecasts point to challenges ahead
Following much criticism about the lack of official forecasts accompanying the “mini budget”, the Office for Budget Responsibility (OBR) published its Economic and Fiscal Outlook alongside the Autumn Statement. They forecast inflation to hit a 40 year high of 11% later this year, driven by higher energy and food prices. The resulting inflationary squeeze on households and business is forecast to push the UK into a recession. The OBR expects the recession to last for just over a year, and see the economy fall by 2%, not returning to pre-pandemic levels until the end of 2024.
The inflationary impacts on people’s living standards were striking, with the OBR forecasting a 7% fall in living standards over the next two years, the largest fall in generations according to the IFS.
Inflation has been a driver of higher debt interest payments on UK government debt. This means that the amounts which have to be paid on debt interest have increased markedly in recent months. This is central to the fiscal problem the UK is facing. High inflation, higher interest rates, high borrowing and high levels of debt translates into a high fiscal cost for the Treasury.
Table 3 of the OBR Economic and Fiscal Outlook lays out the implications in £ billion. In March 2022, the OBR was forecasting the UK to be spending £83 billion in debt interest this year (2022-23) and £50.6 billion in 2023-24. Those figures now stand at £120 billion and £109 billion respectively, a difference over these two years on the March forecast of over £95 billion. Paul Johnson, Director of the Institute for Fiscal Studies, noted that total debt interest payments of over £100 billion this year and next is more than we spend on any public service in the UK other than the NHS. Rising interest rates since the last OBR forecasts in March 2022 mean that the cost of servicing UK debt will rise from below 5% of government revenue pre-pandemic to 8.5% in 2027-28.
The Chancellor also introduced two new fiscal rules to be assessed by the OBR: that underlying debt must fall as a percentage of GDP by the fifth year of a rolling five-year period and that public sector borrowing, over the same period, must be below 3% of GDP.
Back-loading the fiscal consolidation
In some ways, this could be described as a tale of two budgets, with fiscal policy supporting the economy in the next couple of years, before Budgets are consolidated in the period beyond 2024-25, once economic growth is forecast to return.
As mentioned above, in the near term the level of fiscal consolidation was not as high as some may have thought. Public spending will continue to grow over the next couple of years (albeit at a time when high inflation will squeeze how far that money goes). Over that period, increased tax revenues for the UK government will largely come from the freezing of tax thresholds resulting in “fiscal drag” and wage inflation bringing more people into higher tax brackets. This freeze was already factored in until 2025-26, but the Autumn Statement extended it for another two years. Further income tax revenue will be generated by the reduction in the additional rate threshold from £150,000 to £125,140. The freezing of the personal allowance affects Scottish taxpayers, but other changes to income tax do not directly affect taxpayers in Scotland (see below).
Beyond the next two years (which, to note, broadly corresponds with the period after the next UK election) the Chancellor has pencilled in some more significant squeezes in public spending as well as a continuation of tax threshold freezes. His judgement is that with the economy forecast to be growing by then, it will be more able to withstand a fiscal consolidation than currently, when we stand on the precipice of a recession.
By “back-loading” spending cuts, the Chancellor will also be hoping that an improving economic picture might mean that these later cuts might not be required.
As is often the case with fiscal statements, many of the announcements made today were heavily trailed in advance.
On taxation, as expected, the thresholds for the income tax personal allowance and the higher rate thresholds will be frozen for another two years, until April 2028. The threshold at which the highest earners in the rest of the UK pay the “additional” rate of tax will be reduced from £150,000 to £125,140 from April 2023.
With non-savings non-dividend income tax being devolved to the Scottish Parliament, it will be up to the Scottish Government to come forward with its proposals for Scottish income taxpayers when it sets out its Budget next month.
On reserved taxes, which apply UK-wide, the main national insurance and inheritance tax thresholds will be frozen for another two years until April 2028. There were cuts announced to the tax-free allowances for dividend and capital gains tax.
The Chancellor also announced that the National living wage will be increased from £9.50 an hour for over-23s to £10.42 from next April.
There had been much discussion in advance as to whether Pensions and Benefits would rise in line with inflation, and the Chancellor confirmed that they would, translating to a 10.1% increase.
The Energy Price Guarantee has been extended for one year beyond April 2023, but is less generous than previously with average bills being capped at £3,000 a year instead of £2,500.
The Windfall tax on the profits of oil and gas firms was increased from 25% to 35% from January 2023 and will last until March 2028. The levy applies to profits made from extracting UK oil and gas, but not from other activities such as refining oil and selling petrol and diesel on forecourts.
What was announced on public spending?
In some ways, and as mentioned above, public spending plans in the Autumn Statement were less painful than had been trailed in advance. Previously scheduled public spending will be maintained until 2024-25, before being squeezed in subsequent years. Over and above this, there will be additional spending on Health and Schools, and resultant Barnett consequentials for Scotland as discussed below.
By deferring painful cuts for a couple more years, the Chancellor will be pinning hopes on future OBR forecasts providing him with a bit more fiscal wiggle room.
By pencilling in future cuts, he is possibly practicing an element of expectation management, whilst signalling to the markets that he has the plan to reduce UK debt.
Implications for Scotland and the Scottish Budget
The extent to which the Scottish spending envelope is influenced by UK fiscal events depends on the degree to which a spending area is either devolved or reserved. If an area like Health receives additional resource in England, this translates to a population-based Barnett consequential for the Scottish budget. If the area of increasing UK government spending is fully reserved, like Defence, the Scottish Budget receives no additional resource.
There were two key areas of budget priority identified by the Chancellor which resulted in additional Barnett consequentials for Scotland. The Chancellor announced that the NHS budget will increase in each of the next two years by an extra £3 billion and he also announced that Schools in England will receive an extra £2.3 billion in each of the next two years. There will also be extra money for social care.
As these areas of policy are devolved to the Scottish budget, it will receive additional Barnett consequentials on the back of these choices. HM Treasury state that this translates to an additional £1.5 billion over the next two financial years for Scotland (2023-24 and 2024-25). The Scottish Government is free to spend these additional monies on any area of devolved competence, and does not need to replicate the UK Government’s choices.
There are no changes to the financial settlement for the current financial year (2022-23), meaning that the Scottish Government will have no additional flexibility from this fiscal event to fund more generous public sector pay deals as part of the ongoing negotiations.
This was a disappointment to the Deputy First Minister, who in a press release responding to the Chancellor’s statement said:
“Inflation is eating away at the Scottish budget, and due to the lack of additional funding in 2022-23 and the financial restrictions of devolution, we have had no choice but to make savings of more than £1 billion…
The constant U-turns on tax by the UK Government have made planning for the Scottish Budget more challenging this year. We will take time to consider the implications for Scotland before setting out our own plans as part of the normal budget process…
“This leaves me with the difficult task of setting Scotland’s Budget for 2023-24 with no hope of financial flexibility to make a real difference in the lives of those who need it most.”
The reduction to the additional rate threshold in the rest of the UK also has implications for Scotland. As this change will increase rest of UK income tax revenues, this will mean a larger “block grant adjustment” to the Scottish budget. The Scottish Government must decide whether to follow this move (and so increase its own income tax revenues) and/or introduce other changes to its income tax policy.
The next big date in the fiscal calendar is 15 December 2022, when the Scottish Government sets out its tax and spending plans for next year. These will be accompanied by the Scottish Fiscal Commission’s (SFC) economic and fiscal forecasts. SPICe will provide quick reaction blog articles like this, as well as detailed briefings on the Scottish Budget, to support the parliamentary budget process.
Ross Burnside, Senior Researcher, Financial Scrutiny Unit (FSU)