Sunday, November 22, 2020
In a deep fiscal hole - and the government is still digging
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

November can be a cruel month for chancellors. The last thing Rishi Sunak wanted was a second national lockdown and on Wednesday we will all find out what the additional measures he has been forced to put in place, including the extension of the furlough scheme until March, will cost.

On Wednesday the chancellor will announce the results of his one-year public spending review, covering 2021-22, the fiscal year starting next April. Shortly after that the Officer for Budget Responsibility (OBR) will unveil its latest fiscal assessment and economic forecast.

There is plenty to consider on both fronts. On the face of it, the spending review will process has been a gain for the often wasteful defence budget and a loss for overseas aid and for public sector workers, who face a one-year pay freeze. The chancellor could yet surprise us and not cut overseas aid from the 0.7% of gross national income the government delivered even during the austerity years, or not freeze public sector pay, but both have been briefed. So the Ministry of Defence has been celebrating what Sunak himself has described as the biggest defence boost in nearly 30 years. I shall come back to that.

More attention, I suspect, will be devoted to the latest assessment from the OBR. Its last assessment, in its fiscal sustainability report in July, set out three scenarios. Even in the most optimistic it expected gross domestic product (GDP) to drop by more than 10% this year, which would mean the biggest annual fall since 1709, which as you will know, was the year of the Great Frost. This month’s national lockdown will have tilted the balance towards a bigger rather than smaller hit to GDP.

I read a headline the other day saying that the chancellor faces the worst hit to the public finances since the war. That was hardly news. In August, the OBR updated its central scenario to take into account Sunak’s July economic measures, to predict a budget deficit of £372bn this year.

Nothing like that has ever been seen before in peacetime, either in comparison with its cash level – the previous peak was £158bn during the financial crisis – or as a percentage of GDP, which is the high teens.

This week’s OBR exercise will take into account the chancellor’s many variations in his winter economic plan, originally announced in September with a new and less generous job support scheme but later modified to include the extension of the furlough scheme, initially for this month and subsequently until the end of March.

It is not all one-way traffic. While the monthly public borrowing figures have broken records this year, they have come in below what the OBR feared. Figures released on Friday showed that public sector net borrowing was £22bn last month, for a cumulative total of £215bn so far this fiscal year. That is lower than the cumulative figure of £291bn for the first seven months of the fiscal year consistent with the OBR’s projections. This week’s figures will be horrible but they might not be as horrible as they could have been.

Dealing with the deficit will not be easy. On the face of it, we have a typical 10 and 11 Downing Street relationship, in which a chancellor tries and mainly fails to restrain a spendthrift prime minister. But the relationship between these two is hard to work out. I would like to bet that cutting overseas aid, which saves a few billion for the loss of a large amount of international reputation at a time when poor countries need help, has proved popular with focus groups.

Sunak, despite being opposed to a review of defence spending lasting more than a year, was quick to make the best of a bad job, sending out a signed tweet with the message: “We’re providing a record £24bn for the defence budget over the next four years.” More defence spending tends to be popular with Tory voters.

What should be unpopular, with all voters, is the terrible waste of public money during this crisis. The Treasury has provided a blank cheque and plenty of people have been cashing it, including friends, and friends of friends, of the government. Comparisons have been made between this crisis and wartime. In one respect, the emergence of an army of spivs and profiteers, it has been like the war.

How do we get down from all this? Most of the emergency support the chancellor has offered will come to an end by the start of the next fiscal year in April, though there many have to be a gradual winding down of the furlough scheme and government losses on bounce back and business interruption loans could be a feature of the public finances for many years to come.

The Centre for Policy Studies, a right-of-centre think tank, says that public sector workers have done well relative to their private sector counterparts during the crisis (public sector employment has also increased). A three-year freeze on public sector pay from now, and not just the planned one-year freeze, could save a cumulative £23bn, it suggests, with spending in year three down by nearly £12bn. The chancellor hinted after the most recent public sector pay settlement that he would be seeking to restore the balance between public and private sector workers.

I doubt, however, that he would want to go as far as a three-year freeze. This is a government with a huge fiscal hole to fill but which is also committed to avoiding a return to austerity. It does not take much for a Tory government to be accused of a return to austerity. A public sector pay freeze would certainly do so.

Then there is tax. The Office for Tax Simplification, at the chancellor’s request, has suggested that a shake-up of capital gains tax, unifying it with income tax and reducing allowances, could bring in an extra £14bn a year, though it might also lead to big behavioural changes. Other tax increases being considered by the Treasury include an increase in corporation tax from 19% to 24% and cutting higher rate pension relief.

The Resolution Foundation, in a report Unhealthy Finances, agreed that capital gains tax and corporation tax should be increased but also proposed a 4% health and social care levy “to raise significant revenue, improve our tax system and deliver badly-needed resources for social care”.

It would apply to incomes above £12,500, be combined with National Insurance changes to ensure that anybody earning under £19,500 would be net gainers, and make a big contribution to the £40bn a year in extra taxes the group deems to be needed.

None of this is for now. The Resolution Foundation suggested that tax increases should not come before 2023. This week will give us a better idea of the size of the fiscal hole. How to fill it remains mainly a question for the future.