Key points:
On 27 October, Rishi Sunak will deliver a Budget alongside a Spending Review which will set departmental budgets for 3 years.
With the crisis phase of Covid over, this will be a significant moment: Sunak’s first Budget not overshadowed by emergency spending programmes, and the first full spending review since George Osborne’s in 2015.
A strong initial post-lockdown recovery has been stifled by the Delta variant. Significant supply bottlenecks, consumer nerves and absent workers led to the economy flatlining in July. More recently, surging gas prices and petrol shortages are adding to a sense of a faltering recovery. By the time the Chancellor delivers his Budget, both the furlough scheme and benefit uplift will have been withdrawn, putting more pressure on consumers.
Nevertheless, economic activity remains well above the March forecast from the Office for Budget Responsibility (OBR). This feeds into the fiscal numbers, with borrowing for the current financial year already £31bn less than expected in March. The medium-term picture on the public finances is also less daunting than the Treasury would like the rest of Whitehall to believe, for two reasons.
First, at 3% of GDP the OBR’s March assumption about the permanent damage from the pandemic is far more pessimistic than other independent forecasters. Should it move towards the Bank of England’s position of 1% – which is likely, on past form – this would entail a significant upgrade for the public finances.
Second, unlike other major economies, the UK is ahead of the game in planning for a further cut in borrowing. Having committed in March to raise tax by almost £30 billion a year medium-term, the Treasury recently confirmed it will suspend the ‘triple lock’ on pensions and raise a further £12 billion a year in tax for healthcare backlogs and the underfunded social care system.
Taken together, this may leave the Chancellor with something in the region of £10-25 billion a year to play with while still being able to balance day-to-day spending and put the UK’s debt burden onto a downward path – the likely centrepiece of the new fiscal framework expected at the Budget.
Prudent Chancellors like to keep room for manoeuvre. Sunak will probably want headroom of around £10 billion against his fiscal rules to allow for future adverse shifts in the forecasts, or unanticipated shocks. Some of this headroom may be called on soon if the recent softening of the economy and emerging supply-side problems from Brexit persist. If not, he will be left with an election war-chest available to be deployed in a couple of years’ time.
The short-term politics will make holding that prudent line difficult. While many of the issues on the supply side should resolve themselves over the coming months, there is a risk that in the interim the cost of living turns into a political crisis as households are hit by a triple-whammy of rising inflation (particularly in energy) and the end of both furlough and the universal credit uplift. If the problems persist over the coming weeks, the Chancellor will come under huge pressure to fund a package to ease the strain on households.
On the departmental spending side, although overall spending totals appear generous there will be pressure for more, particularly from departments who were unshielded from the cuts of the past decade. The politics has also changed since 2010, when Conservative ministers competed to show who could bear down hardest on spending. Now newly appointed Secretaries of State will see wresting cash out of the Treasury as a badge of honour, particularly given the view that higher spending is a key part of holding on to Red Wall voters. An increase in the overall envelope for day-to-day spending is therefore likely.
Senior voices within the Treasury will also be telling the Chancellor he needs to mend fences with business following raids on corporation tax and employer NICs. Of particular interest is the long-awaited conclusion of the business rates review, where Labour has thrown down the gauntlet by promising to abolish business rates.
None of these problems are cheap to fix.
Amidst these demands, the capital budget is relatively free of pressure, as existing plans are already at half-century highs. With much of this currently unallocated, the Spending Review will provide a clearer idea of how it will be spent, with the focus on the Prime Ministerial priorities of levelling up and net zero.
Expectations for the much-vaunted levelling up agenda are high, stoked by the recent appointments of Michael Gove and Neil O’Brien to key ministerial roles, with former Bank of England chief economist Andy Haldane now leading a “Levelling Up Taskforce”. A White Paper was expected shortly before the Spending Review, though may be delayed. With support from No10, Gove will feel emboldened to push for a generous Spending Review settlement but will face a Treasury highly sceptical of the plans that have emerged so far, which are seen as focussed more on politically driven prizes than solid economic evidence. Expect an escalation of Whitehall tensions.
The Spending Review also comes just days before COP26, making some sort of net zero package inevitable. Rising wholesale energy costs will however dampen the urge for carbon taxes or new costs to bills to fund clean technologies. Recent delivery challenges with key taxpayer funded schemes, such as the Green Homes Grant, will also reduce the pressure for further taxpayer funds.
All in all, faced with this array of spending pressures and some better news on the fiscal and economic forecasts, the Chancellor is likely to put more money into the spending envelope for public services. But any increase will feel pretty small compared to the largesse we have grown used to over the course of the pandemic.
Tim Pit, Partner joined Flint from the Treasury where he was a senior adviser to Chancellors Philip Hammond and Sajid Javid. Before entering politics, Tim was a corporate lawyer at the City firm Slaughter and May.
