The writer is director of the Institute for Fiscal Studies
As the dust begins to settle on this week’s Budget, one thing is clear: being chancellor is becoming increasingly difficult.
This was perhaps the most telling sentence in the OBR’s 166-page Economic and Fiscal Outlook. “It is now harder for this chancellor to deliver a falling path for the debt-to-GDP ratio in the medium term than it has been for any of his predecessors since the OBR was established in 2010”. That is despite the tax take heading up very fast, by about £100bn. And despite the OBR suggesting we are heading for a primary budget surplus — borrowing only to pay debt interest — for the first time in more than 20 years.
Jeremy Hunt is caught in this cleft stick for four main reasons. First, debt interest payments are at historically high levels and will remain at levels above those seen on a sustained basis since the early 1960s for some time to come. Second, debt itself is high. Third, nominal growth is subdued. Lastly, there are some additions to debt — associated with the way in which student loans are financed, for example — which do not add to borrowing. The result is that even historically quite low levels of borrowing can lead to the debt ratio rising. For any given level of borrowing, more has to be spent on debt interest, which is now projected to settle at nearly twice the level the OBR predicted a year ago.
Meanwhile short- and medium-term demands for extra spending remain acute. The announcement of £4bn more for childcare was sold as a measure to increase labour supply, but it is largely a response to intense pressure to extend the scope of the welfare state to help working parents. More money was announced for defence — a budget that, having been cut over the decades, has traditionally provided the wherewithal to finance the ever-expanding welfare state. All that is before we start worrying about the costs of ageing. And the political pressure to mitigate the fast-rising tax burden, rather than raise it further, is likely to prove increasingly hard to resist — not least in the face of ongoing stagnation in household incomes.
You could see the effects of all this in the Budget. The chancellor could not have got closer to breaking his own fiscal rule — that debt should be falling in the last year of the forecast period — without actually breaking it. This is despite some fairly vigorous massaging of the figures. Some is tried and tested massaging: pretending that fuel duties will rise with inflation when they have not done so in 13 years, and pencilling in spending plans for after the next election (which will involve unspecified cuts for some public services). But some of that massaging could prove considerably more damaging.
On the spending side, there is the lack of any money for even partially restoring pay for restive public sector workers like teachers, nurses and, yes, civil servants. The current settlement, whereby many have seen real pay cuts of more than 10 per cent since 2010, and are falling further and further behind private sector comparators, cannot be sustainable. Being held constant in cash terms, capital spending is on its way down — which is not a good sign for the future.
On the tax side we had the curious spectacle of Hunt introducing full expensing in the corporation tax system, saying he wanted it to be permanent, but that he was announcing it as a temporary measure. Being temporary, it is set to cost £11bn in 2024-25 but raise £2bn in 2027-28 because, by distorting the timing of investments, it is expected to reduce investment in that final year. That may look good in the fiscal forecasts but it is a policy which adds, yet again, to uncertainty for businesses.
Continuing to muddle through, massage the figures, and implement poorly designed policies will only make the problems worse. There is no simple answer. Facing up to the scale of the challenge would be a good start though.