Sunday, May 30, 2021
We mustn't begin to think yet of scrapping tax hikes and more public spending
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. Not to be reproduced without permission.

We are past the peak in the pandemic, if that is not too many hostages to fortune, and we are past the hump in public borrowing, the budget deficit. This time last year, we reeled from monthly government borrowing figures that were off the scale in terms of previous experience. Now we are in a run of numbers that are just very large indeed.

When I talk about the hump in public borrowing, I am aware that this does not really do justice to a budget deficit that jumped from £57 billion in 2019-20 to more than £300 billion in 2020-21. That is not so much a hump as a high and jagged mountain peak, which you would need the help of a team of sherpas to think about climbing.

And when I talk about still very large monthly figures, April’s borrowing of £31.7 billion was not much below the annual total just over two years ago in 2018-19. Then, public borrowing was 1.8 per cent of gross domestic product. In 2020-21, the fiscal year just ended, it was 14.3 per cent, with more to come from write-offs on pandemic loan schemes, officially estimated to be about £27 billion, which will take it up towards 16 per cent.

It is right to talk about the pandemic and public borrowing peaks in the same sentence, as it is for other economic variables. While some people are getting very excited about another “roaring twenties” as the recovery gathers strength, there is nothing more remarkable happening than an economy that was turned off being turned on again, just as happens to the computer on which I am writing this.

As far as the budget deficit is concerned, its fall is a product of the economy firing up and returning to growth. Compared with April 2020, the month of maximum lockdown, tax receipts last month were sharply higher, with income and capital gains tax revenues up by 31 per cent and VAT by nearly 9 per cent, even though non-essential shops were not open for the full month. The government’s day-to-day expenditure, in contrast, was down by an annual 15.6 per cent.

The pandemic analogy is also appropriate in another sense. Just as the government and public health professionals cannot afford to drop their guard because of the risk from known and potential future Covid-19 variants, so the chancellor cannot afford to drop his guard on the public finances.

Last month’s borrowing, while large, was only two-thirds of the April 2020 figure. That and the fact that it undershot the Office for Budget Responsibility (OBR) budget forecast has led to a bit of an outbreak of deficit optimism.

Some say if things go on like this Rishi Sunak might be able to cancel the tax increases that he announced two months ago, the two main ones being a freeze on personal income tax allowances and thresholds, starting in April next year, and a hike in corporation tax from 19 to 25 per cent a year later.

Others are looking towards the chancellor’s second budget of the year, which is expected in November, and advocating some chunky increases in public spending, made possible by an undershoot in government borrowing.

To both of these suggestions I say, hold your horses. The public finances have been through an enormous shock, from which they will take years to recover.

The OBR, which a year ago was faced with the enormous task of trying to assess the public finance implications of a public health crisis which had met with an unprecedented economic response, initially suggested (in April 2020) that the budget deficit for 2020-21 would be a jaw-dropping – at the time - £273 billion.

It went even higher three months later, with a forecast of £322 billion. This, allowing for the losses on pandemic loans still to come through in the figures, looks like being close to the outturn. Its worst forecast, made during the November lockdown, was for a deficit of £394 billion. That and its March budget forecast, £354 billion, were conditioned on the effects of the second and third lockdowns on the economy being bigger than turned out be the case.

The point is that these are all very large numbers, and playing the game of “undershooting the forecast” in this context is a bit like debating whether the gale that just blew your roof off was a force 9 or 10. The black hole is still a very dark grey.

As it is, the excitement about a borrowing undershoot last month was overdone. While a superficial reading suggested that the deficit had come in £7.3 billion below the OBR’s March forecast, some of this reflected a change in the official treatment in, of all things, the timing of payments under the Brexit divorce bill. The actual undershoot was £1.8 billion, big to you and me, but small change in public finance terms.

The OBR predicts that this year’s budget deficit will be £234 billion, which would be the second biggest on record after 2020-21, and still significantly larger than borrowing in the worst year of the global financial crisis, £158 billion in 2009-10.

Independent economists surveyed by the Treasury this month think it will come in a but lower than that, but that it will nevertheless be very large at £217 billion. They also fear it will come down more slowly subsequently than the official forecaster expects.

We should remember too, that borrowing from now is likely to be in an environment in which there is rather less aid from the Treasury’s helpful friends at the Bank of England. The Bank’s quantitative easing (QE) over the past 14 months has been of enormous assistance to the government in getting the debt away. But that process is coming to an end and, in the light of rising inflation, the Bank may be looking to reverse some of the QE that it undertook during the pandemic.

As it is, even if the economy gets back to pre-pandemic levels quite soon, which it should, the public finances will not. The OBR expects public sector borrowing in 2025-26 to be 2.8 per cent of GDP; higher than in 2018-19 and, for that matter, part-pandemic affected 2019-20.

The central point is a straightforward one. There has been a massive shock to the public finances. We will be lucky if the tax increases already announced provide enough of a repair to the public finances and if the chancellor can restrain other ministers and the prime minister and stick to the relatively tight public spending plans sketched out in his March budget. Talk of relaxation is misplaced.

Finally, and it is a little early for a curtain raiser, the OBR will publish its fiscal risks report in early July. That will set out some of the longer-term challenges for the public finances, including from an ageing population. It may not make for comfortable reading.