Sunday, February 26, 2023
Things are looking up, but the deficit isn't yet fixed
Posted by David Smith at 09:00 AM

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

The mood is lifting. In the space of a few weeks the outlook for this year has gone from gloom to cautious optimism. Measures of business activity like the purchasing managers’ surveys have jumped this month, and not just in the UK. From January’s surprise rise in retail sales onwards, hard data is coming out stronger than expected.

Consumer confidence in recent months has been at its weakest in the 50 years since GfK has been surveying it, a reflection of the fact that the pandemic quickly gave way to the cost-of-living crisis and the biggest fall in real incomes on record.

It, too, is also on the up. The latest GfK reading, for this month, showed a jump of seven points, on figures released on Friday. Confidence is still at historically low levels, with an index reading of -38, but as GfK’s Joe Staton points out, “consumers have suddenly shown more optimism about the state of their personal finances and the general economic situation, especially for the coming year”.

This is good news, and what looks like a collective sign of relief that we are coming to the end of what could have been a terrible winter. It is also an encouraging backdrop to Jeremy Hunt’s budget, his first – though he has already had a couple of bites at the cherry – due on March 15.

Here again, there has been good news. It is not unusual for official figures to show a budget surplus in January, when the self-assessment income tax receipts roll in. This year, however, the fear was that this would be swamped by the cost of supporting households and businesses through the energy crisis.

Strong tax receipts, however, and a smaller than expected cost of energy support led to a £5.4 billion budget surplus last month. Not only that, but in the first 10 months of the current fiscal year, cumulative borrowing of £116.9 billion is, after adjustments, about £30 billion lower than the Office for Budget Responsibility (OBR) expected as recently as last November. The OBR could not assume last autumn that the cost of energy support would be a lot lower than industry experts and energy markets were indicating at the time, though that has been the case. Tax receipts, particularly income tax, national insurance and capita gains tax, also outperformed expectations.

When the figures were published, you could almost see the pound signs flick up in the eyes of Tory MPs desperate for the chancellor to announce tax cuts in the budget, and among business groups which would love him to scrap April’s rise in corporation tax from 19 to 25 per cent. Simon Lowth, BT’s chief financial officer, described the coming increase as sending the UK in a “drastically anti-investment direction”.

Hunt has thus found himself in the far from unusual pre-budget position of furiously trying to dampen down expectations. You can understand this, If you are planning to pull a few rabbits out of the hat, you do not want them hopping around the fields for everybody to see first.

But, while we wait to hear what he has up his sleeve, the chancellor had a point. This year, as far as the budget is concerned, is the past, and what matters is the future. It may not feel like a tax cut but reports suggest that the chancellor, to avoid open revolt on his own backbenches, is planning one.

By convention, it is assumed for official projections of the public finances, that petrol and diesel duties rise in line with inflation, a convention that was criticised recently by the Commons Treasury committee. On that assumption, the duty would go up by 12p a litre next month, a combination of inflation and the reversal of the 5p a litre cut in duty announced last year by Rishi Sunak when he was chancellor.

That is not going to happen. All the signs are that last year’s cut will remain in place and a freeze on uprating the duty in line with inflation will continue, as it has done since 2011. That comes at a cost of £5.7 billion in the coming fiscal year, 2023-24.

The government is also under pressure to settle the public sector pay disputes, particularly those affecting the NHS, and that will cost more than is currently allowed for in the plans. Though it would be better if the chancellor could avoid the corporation tax increase or do it in a way that was originally talked about in the Treasury – phasing the increase in over years – the optics of conceding help to business while holding out against “unaffordable” pay rises for nurses would look terrible.

The bigger point is that what matters for the chancellor is whether he can claim to meet his fiscal rules in the future. The OBR’s last projections, in November, stood out for two reasons. One was that, in contrast to the previous March (essentially a projection done before the Russian invasion), the medium-term outlook for the public finances was worse.

Fiscal rules that were due to be met in three years with a margin to spare were, instead, only likely to be met by a whisker, and after five years. The new fiscal targets, to have public sector debt falling as a percentage of gross domestic product, would not be achieved until 2027-28, which is also when the budget deficit, projected to be nearly £70 billion even then, would be below 3 per cent of GDP, the other target.

The other striking feature was that this only occurred because of significant tax increases – the corporation tax increase and a prolonged freezing of income tax allowances and thresholds – and stronger growth. The OBR projected growth rates of 2.7 per cent in 2025 and 2.7 per cent in 2026, after a brief recession this year.

Those punchy medium-term projections, it seems, are now under threat. Reports emerged a little while ago that the OBR would now be taking a more downbeat medium-term view.

This, according to Samuel Tombs, an economist with Pantheon Macroeconomics, will be “the sting in the tail” of the OBR’s new forecasts.

“The OBR will lower its forecast for borrowing in 2022/23 and in 2023/24 by about £37 billion and £32 billion, respectively,” he says. “But it will revise up its medium-term forecast for RPI inflation and reduce its estimate of trend GDP growth... ...potentially leaving the deficit on track to top the 3% limit in 2027/28; no wonder Mr. Hunt is still sounding cautious.”

There are some Tory MPs and right-of-centre think tanks, looking at Labour’s big poll lead, who think the government’s hands should not be tied by the OBR. The former prime minister Liz Truss is one, though ignoring the OBR got her into all sorts of trouble last autumn. There are plenty of others who would say that fiscal rules are made to be broken, certainly those that refer to uncharted waters five years away.

But this was a system set up by the Conservatives in 2010 and it has become central to the UK’s institutional structure. Does the OBR always get things right? No, very frequently it does not. Does it act as a constraint on politicians? Yes, and given that the public finances are still far from healthy, that is a good thing.