Sunday, October 24, 2021
Sunak prays that the pandemic's economic scars are healing
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.

The budget, which will be unveiled by Rishi Sunak on Wednesday, alongside the government’s comprehensive spending review, is usually one of the biggest occasions of the year for people like me. Wednesday’s announcements will, it should be said, be important.

We have, however, been rather spoiled this year. There was a big tax-raising budget in March, with the announcement of an increase in corporation tax from 19 to 25 per cent and a freezing of income tax allowances and thresholds. Both are delayed but that does not make them any less real for that.

Then last month, we had the manifesto-busting announcement of a 1.25 percentage point increase in both employee and employer National Insurance (NI) contributions, together with some other tweaks. All these hikes added up to a big increase in taxes, equivalent to between £35 billion and £40 billion extra when fully implemented by the end of the parliament.

So, this is the second budget this year, breaking what previous chancellors had hoped would be the convention of one big fiscal event a year. The NI increase announced in September, supposedly to pay for both a National Health Service catch-up and fixing social care, continued the pandemic pattern of big fiscal announcements being made outside budgets. The September increases were thought to be worth around £13 billion a year out of this year’s tax-raising total, though the costings have been left to the Office for Budget Responsibility (OBR).

The broad shape of the spending review looks to be set in as much stone as is possible with this government. The NHS will be getting more, partly thanks to the new levy, and the chancellor will recommit to a big increase in infrastructure spending as part of the government’s levelling-up agenda. For much of the rest of government, and for local government, it looks like thin gruel. The challenge for Sunak is to try to ensure that this thin gruel does not get labelled Austerity II – the sequel.

Inevitably, budgets get noticed for the small stuff, not the big numbers. George Osborne still has the scars on his back from the 2012 “omnishambles” budget, which included the ill-fated pasty (as In Cornish) and caravan taxes, as well as some other horrors. None would have raised much money, but they came to be seen as symbolic of a government struggling to get things right.

Talking of scars, if that is not too clumsy a link, one of the big questions for the budget and spending review, the answer to which has been keenly awaited by the Treasury. This is the extent to which the OBR, the official but independent forecaster, believes that the economy will be permanently damaged by the pandemic.

The extent of such scarring is far more important for the outlook for the public finances than individual tax changes. The smaller the extent of it, the better the prospect, though this has to be put in context. After the huge shock of the pandemic on the public finances, the outlook for government debt and deficits is worse than it was to be expected to be before the coronavirus struck.

The latest public finance figures, published a few days ago, showed that public sector net borrowing last month was £21.8 billion, £7 billion less than a year earlier but the second highest on record. Borrowing in the first six months, £108.1 billion, was huge, but £101.2 billion lower than in the corresponding period of 2020-21.

A significant undershoot is in prospect compared with the OBR’s deficit forecast for 2021-22 of £234 billion, made in March. The average of new independent forecasts is a shade over £200 billion but the Institute for Fiscal Studies, in collaboration with Citi, the investment bank, estimated £180 billion in its “green” budget, published earlier this month.

This should be the last of the really big budget deficits, assuming that the current high number of Covid-19 cases in the UK does not necessitate further significant restrictions. Borrowing should fall quite sharply in coming years, though government debt, currently more than £2.2 trillion, will remain permanently higher.

There are two measures of debt. One includes the Bank of England and is 95.5 per cent of gross domestic product, compared with just over 80 per cent before the pandemic. The difference is equivalent to around £400 billion. The Bank’s contribution is not, by the way, the full cost of its quantitative easing (QE) programme but the notional losses on it, plus its term funding scheme.

The other debt measure, excluding the Bank, is currently £1.98 trillion, 85.2 per cent of GDP, compared with 74 per cent before the pandemic.

Now back to scarring. In March, the OBR, while stressing the uncertainties, estimated that the long-term damage to the economy from the pandemic would be 3 per cent of GDP. That’s about £70 billion using this year’s GDP as a basis.
The chancellor has not made life easy for the OBR in the run-up to this week’s budget, requiring it to cut off its economic forecasts on September 24 and its fiscal forecast on October 1, so it has not been able to take account of the latest news, including some upward revisions to GDP, announced by the official statisticians on September 30.

Even so, it is expected to revise down its scarring forecast, and this matters. Every percentage point reduction in the amount of scarring means a £10 billion or more reduction in the annual budget deficit in the medium term.

There are good reasons for the OBR to revise scarring lower. The furlough scheme has worked even better than the Treasury hoped, and the risks of a surge in unemployment – assuming Covid remains under control – are low. Others have revised down their scarring estimates. The Bank, in its August monetary policy report, said that “longer-lasting scarring effects” would be only 1 per cent of GDP.

The OBR may not go that far. The Resolution Foundation, in a pre-budget report, suggested a new scarring assumption for the OBR of 2 per cent of GDP. The IFS and Citi, in the green budget, suggested 2.5 per cent, though that also included some additional Brexit damage.

The chancellor is, then, set for some good news; a borrowing undershoot for this year and a drop in the extent of scarring. It would be a mistake though, I think, to conclude that all this is about getting the government into a position in which it can deliver tax cuts before the next election.

Sunak’s focus is on repairing the public finances, and the pressures have not gone away. The IFS estimates that, in order to properly fix social care, the health and social care levy will have to rise from 1.25 per cent (on both employee and employer NI) to 3.15 per cent over the source of this decade to “fix” social care. Debt is high, and the government is still borrowing a lot, neither of which is comfortable for any chancellor.