Hammond holds back from fiscal gymnastics

Posted on November 23, 2016

It was extensively trailed that the Autumn Statement would be peppered with bad news. Facing weak economic forecasts, the chancellor refrained from indulging in his predecessor’s penchant for fiscal gymnastics.

Instead he set out a simple plan: the government will borrow £122bn more during this parliament and push deficit reduction beyond the next election. It would give out some extra cash, mainly to invest in infrastructure.

1 How bad were the economic forecasts?

Pretty bad. There has been a lot of bad news for the public finances since March. Tax receipts have failed to come in as strongly as expected, despite reasonable economic growth. Local authorities, after five years of spending cuts, are now spending all the money they can, rather than topping up their reserves as the Office for Budget Responsibility (OBR) thought they might.

The largest hit has come from the UK’s vote to leave the EU, which is expected to dampen growth prospects over the next few years. Higher inflation, as a result of the weaker currency, will also push up some elements of public spending, like public service pensions.

The OBR is less gloomy than the Bank of England about the economic outlook post-referendum. But nonetheless it revised up its forecast for borrowing over the next five years by £96bn (not including the government’s extra spending commitments), with £58bn coming directly as a result of the Brexit vote. This is the biggest deterioration in the forecasts since December 2012.

2 Won’t we have extra cash once we leave the EU?

Possibly. But the OBR did not include this in their forecast. Without knowing what deal the government is likely to strike with the EU or what they would do with any money no longer going to the EU, the OBR made what they describe as a “fiscally neutral” assumption — that any money saved once the UK leaves the EU would be ploughed back into other public spending.

3 Why are tax receipts below expectations?

One area where the OBR forecasts look particularly gloomy is the projections for revenues from income tax and National Insurance contributions. The OBR now expects them to be much lower than they thought in March, while corporation tax revenues are expected to be somewhat higher.

The OBR has noticed in recent years that the government is raising more than they expected from corporation tax but much less from income tax and NI contributions. One factor they think is contributing to this is many more people classifying themselves as businesses rather than ordinary workers. Changes to the labour market — like the rise of the gig economy and other non-traditional work arrangements — mean there are growing numbers of people with flexibility about how to classify their income for tax purposes. Overall this shift is expected to reduce government revenues.

4 Was it all bad news for the Chancellor?

No. Not everything has gone against the chancellor recently. Equity and oil prices are both now higher than the OBR was expecting in March. This boosts tax revenues.

5 Did Mr Hammond try to offset the damage?

No. The chancellor decided the government would simply borrow more over the next five years as the economy faces particular uncertainty. To give himself the room to do this, Mr Hammond abandoned the previous fiscal rules and adopted three new rather looser ones.

Mr Osborne set himself a very stringent target for government borrowing. But it meant he had to adjust his plans many times when bad news arrived. Mr Hammond is less willing to give a hostage to fortune.

6 How generous was he able to be?

Not very. The biggest giveaways were on infrastructure spending: £23bn more over the next five years. But even this is a relatively modest package, amounting to only around 0.25 per cent of national income on average each year.

Other giveaways — including cancelling the fuel duty increase due next April, making universal credit a little more generous and a new market-leading savings bond — were matched by takeaways elsewhere. The tax on insurance premiums will go up next summer, National Insurance contributions will also rise and the government plans to limit the range of benefits that employers can provide to their workers tax-free.

7 Did he pull any rabbits out of his hat?

Only one really. Mr Hammond announced that this would be his last Autumn Statement. Not because he is about to resign but because he is going to have just one major fiscal event each year: an Autumn Budget from next year onwards. In the Spring he will — he says — simply issue a statement responding to the OBR’s updated economic forecasts. Mr Hammond cannot ditch the second statement altogether because the government is required by law to publish two economic and fiscal forecasts each year.

8 So he is very different from Mr Osborne, then

Not entirely. There were at least two announcements in the Autumn Statement that were reminiscent of his predecessor.

First, Mr Hammond said the income tax personal allowance and higher rate threshold will increase more quickly than previously expected between now and 2020, but reduced growth thereafter. Second, he pencilled in another year’s freeze to public service spending in 2021-22.

Mr Osborne was also fond of announcing measures that sound generous in the short term but raise money in the long term and of extending the squeeze on public services to help cut the deficit in an apparently painless way. But public services are already in their sixth year of spending cuts and face another five years before they can expect to see budget rise faster than inflation, meanwhile the population will keep growing and ageing, putting ever greater pressure on services.

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