Chancellor Rishi Sunak on Wednesday delivered a “tax, spend and save” Budget in which improved official forecasts gave him a £35bn annual windfall of additional revenue on top of the £36bn a year of tax rises he had already imposed.
He chose to split this bounty between improving the underlying UK public finances and spending more on public services to offset rising inflation.
As he sought to set out the government’s priorities after devoting much of his time as chancellor to firefighting the coronavirus crisis, Sunak said his third Budget “does begin the work of preparing for a new economy post Covid”.
He said this would be a UK economy of “higher wages, higher skills and rising productivity”, adding there would also be “strong public services”.
Sunak’s House of Commons speech was complicated for analysts due to how he had already announced many changes in tax and public spending outside of normal Budgets.
Further complexity was added by the way the UK fiscal watchdog used out-of date information on the economy in its assessment, which potentially changes the picture substantially compared with the Office for Budget Responsibility’s documents issued on Wednesday.
Understanding Sunak’s Budget starts with the underlying outlook for the economy and the public finances, which the OBR now expects to be much brighter compared to its assessment at the March Budget.
In the near term, the OBR has upgraded its economic growth forecasts for 2021 significantly to reflect the improved recovery made possible in every advanced economy by the widespread availability of Covid-19 vaccines.
Instead of an increase in gross domestic product of 4 per cent in 2021, the OBR now expects growth of 6.5 per cent, the fastest for 50 years. But because the UK vaccine programme got into full swing in early 2021, the growth forecast for 2022 has been revised down from 7.3 per cent to 6 per cent.
This growth will allow the economy to get back to its pre-pandemic level in the first quarter of 2022, earlier than previously thought, and some of these gains will last into the medium term.
One of the most important assumptions made by OBR is that the persistent economic scars from the Covid-19 pandemic will leave UK output on a path that is 2 per cent lower than anticipated before the crisis. In March it expected the pandemic would leave scars worth 3 per cent of GDP.
Although real growth rates are normally the most important forecasts at the Budget, this time they were secondary to the inflation predictions, which dominated the outlook for the public finances.
Over the winter, the OBR expects inflation will peak at 4.4 per cent, saying this “mainly reflects higher utility prices”. It will hit living standards, with real household disposable income per person reaching pre-pandemic levels only in the second half of 2023.
But the OBR thinks higher inflation will be good for the Treasury because it will raise wages and the tax base much more than it increases the costs of servicing the government’s £2tn of debt or spending by Whitehall departments.
The OBR expects the cash size of the economy to be 5 per cent larger in 2025 than it forecast in March, mostly reflecting increased spending by households as they contend with inflation, and this is the crucial forecast that underpins the medium-term tax revenue assumption.
With buoyant revenue, the OBR expects public borrowing in 2021-22 to be £183bn, well below the £234bn figure at the March Budget. By 2024-25, the improvements are smaller, but the net borrowing prediction of £46.3bn is still well below the £74.4bn estimated in March and less than the watchdog thought in March 2020, in the last forecast reflecting the pre-pandemic world.
The improved revenue forecasts allowed Sunak to boast that he was meeting his two newly announced core fiscal rules: first, balancing the budget excluding net investment, with £25bn room to spare; and second, getting the burden of underlying public sector net debt on a downward trajectory by 2024-25.
Sunak’s previous rhetoric — that he would stick to the spending totals outlined in the March Budget — appeared to be just a negotiating tactic with government departments as he finalised three-year budgets with them. He increased total departmental day-to-day spending each year from 2022-23 by at least £24bn, although most of the additional cash will simply cover higher inflation.
As the forecasts stand in the OBR documents, the conclusion is that Sunak has been given a huge windfall from higher nominal GDP and chosen not to roll back his plans to increase corporation tax and national insurance contributions, and freeze income tax allowances.
“He’s used that windfall to spend significantly more, especially in the next few years,” said Torsten Bell, chief executive of the Resolution Foundation, a think-tank.
This is not the end of the story, however. The OBR’s willingness to close its forecast early, on September 24, has left the predictions badly out of date. Revisions to official data show the economy is only 0.8 per cent below its pre-pandemic level, not the 2.8 per cent in the OBR’s latest forecast, and suggest the watchdog’s prediction is still too pessimistic.
The OBR said the developments since it closed its forecasts were broadly neutral and “shed no meaningful additional light in either direction on our medium-term scarring judgment”.
This view should be taken with a degree of scepticism because the OBR would face questions if it said the new information was important for the economic outlook.
This Budget is therefore unfinished business, even if Sunak has built resilience into the public finances and used higher growth and taxes to increase public spending.
Likely future upward revisions to OBR forecasts should give him a good chance of delivering tax cuts before the next general election, and the chancellor made it clear at the end of the Commons speech that he was already planning to do just that.