UK Autumn Financial Statement

Jeremy Hunt’s Autumn Statement will be judged in terms of its perceived ability to lift the UK economic growth rate. The signs are not propitious, most economic commentators, taking account of the lack of growth over the past two quarters, are expecting relatively limited growth during the 2024.

It is as well to note that despite what governments, politicians, and the public appear to believe, governments are only able to exert a limited influence on. how the economy will behave. Obviously in modern economies the size of the public sector and its funding via taxation does provide a strong element of aggregate demand that can influence the rest of the economy, though economic growth will essentially be determined by the “animal spirits” of entrepreneurs and workers reactions to the structure of businesses and their employment of technology in determining levels of productivity.

Statements that the growth rate under the last Labour government from 1997 was 2% as against the 1.5% growth of the Conservative government from 2010 are meaningless if they are used to suggest that Labour governments are better at managing the economy there are too many variables involved to make such a categorical statement.

The Autumn Statement and its assessment should be viewed in this context together with a circumspect referencing of the OBR economic forecasts, themselves hedged with uncertainty.

Current Overall Economic Position

The UK economy, notwithstanding falling inflation is not in a healthy state. Growth currently is anaemic and is not expected to be other than modest at best in 2024; public services are in need of investment, and child poverty is still a scourge. The suggestion that inflation may have boosted tax revenues and permitted tax reductions is misleading as it does not account for the need to adjust public expenditure budgets to account for the cost rises of significant public sector wage settlements. Moreover, the increase in interest rates as the principal mechanism for reducing inflation puts upward pressure on the  budget deficit. Finally, upward adjustments of benefits and especially state pensions will necessitate increasing public spending.

The fiscal policy stance in relation to the period of high inflation has remained neutral. The policy action to reduce the second-round wage impacts of the energy and food commodity price rises – engendered by the Russia-Ukrainian conflict, amplified by the US-led economic sanctions – has been entirely reliant on monetary policy and the Bank of England sharply increasing the Bank rate throughout 2022 and most of 2023. The reduction in the inflation rate in 2023 appears to be principally associated .with reversals in the earlier energy and food price hikes. The rise in interest rates has impacted most severely on business investment and the housing market, leading to the current very low economic growth rate. In common with the US Federal Reserve and the ECB – and unlike many emerging market economies – the Bank should have moved earlier and more gradually to increase interest rates, this enabling commercial banks more time to adjust their lending (Petersen Institute Working Paper October 2023).[1]

Ironically, notwithstanding the fall in the core inflation rate, private sector wage growth has remained resilient and is probably the reason for the UK having, so far, avoided a recession, though this positive factor has been mitigated by the freezing of the personal tax allowance and the fiscal drag involved.

A further problem inhibiting any major new fiscal stimulus relates to the substantial increase in payments on government debt. The severity of the problem was described by the OBR (Spring statement report, OBR 2022):

The overall maturity of the debt stock has shortened over time (largely as a result of the quantitative easing operations of the Bank of England that in effect swap long-dated gilts for floating rate reserves). This reduced the median maturity of public sector debt from seven years before quantitative easing began in 2008 to less than two years today. That means nearly half the effect of a rise in interest rates is felt within a year today, rather than only a quarter if the maturity structure of debt in 2000-01 still prevailed. And the combination of the higher debt stock and shorter maturity means that every percentage point increase in short-term interest rates adds £13 billion to spending over the following year, rather than just £2 billion if the stock of debt sensitive to such rates were still at its 2000-01 share of GDP.

The debt stock that is inflation-linked has risen in step – also almost quadrupling from 6 per cent of GDP in 2000-01 to 22 per cent today. This means that every percentage point increase in RPI inflation raises spending by £6 billion, rather than £2 billion if index-linked debt were still at its 2000-01 share of GDP.

A far larger overall debt stock, which has almost quadrupled from 28 per cent of GDP in 2000-01 to 102 per cent in 2022-23. That means a 1 percentage point rise in the effective interest rate paid across all debt adds £26 billion to spending, whereas it would add only £7 billion if debt were still at its 2000-01 share of GDP.

The OBR Assessment of the Economy and the Impact of the Statement

In fact, prior to the launching of QE as a means of redressing deflationary pressures, the average maturity of UK public debt was 14 years, that is higher than the 2008 figure provided in the OBR report quoted above. The reduction of the current stock of bonds via quantitative-tightening by the BoE, needs to be accompanied by conversion of short-term bonds to longer-dated securities.

In its report accompanying the Autumn Statement, the OBR has indicated that the overall impact of the tax measures introduced by Hunt will not exacerbate inflation.  The growth rate in terms of real GDP increase is expected to be raised on average over the next 5 years of 0.28%, through a combination of demand impacts and supply impacts. The demand impacts are strongest in 2925/2026 and decline to zero in the final 2028/2029 year. The main supply-side measure is the decrease in national insurance payments which if it continues throughout the five-year period will contribute slightly more than half of the total 0.28 growth. The welfare reforms contribute a small increment of 0.04% to growth over the period. The full-expensing investment tax relief contributes a rising amount, after an initial negative contribution (because it is permanently extended) to contribute 0.07% ln the final year.

The overall economic growth rate for 2023 is estimated to be 0.6% and for 2024 0.7%. Both these estimates are lower than those estimated in March 2023. These estimates are hardly the launch of a sustained, significant growth path.

Hunt has chosen to hold public services investment constant and to use part of the tax dividend to reduce the net/debt/GDP ratio to around 92% on average over the next 5 years.

Hunt has been unable to reduce rising tax-take as a proportion of GDP, now 37% rising in each of the next 5 years to 38%. Of itself this is not necessarily a problem, many advanced economies have a higher percentage, driven by demographic changes affecting pensions  and increased health and social care provision. However, both main political parties appear to be concerned about the level and both Hunt and Reeves are stressing the need for public sector reform and increased public sector productivity. In some of the media commentary this issue has been a key discussion.

The OBR points out that though the fiscal cost of the tax reductions made by Hunt is around £27 billion, this is outweighed by a wide margin by the tax revenue derived from the freezing of the personal allowance.

The Key Measures in Summary

Hunt has introduced a wide-range of tax reductions, to provide business tax relief, including to the self-employed. The problem with these business taxation measures is that they may make investment more profitable when undertaken, but it is only via increased consumer demand that will render the investment likely to happen. With virtually stagnant economic growth the impact of business tax reductions is likely to be insufficient to lift the growth rate more than marginally, as indicated in the OBR assessment in the above section. This is also  the  case with any supply-side measures, however desirable they may be, especially given that such policies generally take time to have any significant impact. The measure of the task is reflected in the dire UK productivity performance.

The substantial decline is reflected in a productivity growth rate between 2008 and 2020 of only 0.5%, The productivity growth rate in 2021 was 0.21%. (Figures taken from the first report of the UK Productivity Commission, 2022). The OBR comments that:

Productivity growth where annual growth is ½ a percentage point above or below our central estimate of around 1 per cent over the next five years. Productivity growth of 1½ per cent, i.e., a return toward its pre-financial crisis rates, would reduce borrowing by £46.0 billion in 2028-29 while growth falling back to its post-financial crisis average of ½ per cent would increase borrowing by £40.5 billion.

The task of raising productivity remains on the agenda, though without any clear indication of how it will be raised to earlier growth rates.

The raising of the minimum wage will be welcome in lifting a proportion of the working poor out of poverty and in impacting positively on aggregate demand.

The reduction in business rates will help small businesses. The abolition of class 2 and Class 4 contributions for the self-employed will be a useful benefit for those earning over £10,000/year.

The most significant measure introduced as far as most people in work are concerned will be the reduction in the national insurance contribution reducing from 12% to 10%. This will save the worker on the average wage some £440 per year, and this appears to be the measure which has the most significant impact on growth in overall real GDP over the next 5 years, though not in real GDP per person.

There is a plethora of detailed, minor supply-side measures which are not discussed here.

Conclusions

Concern about the persistence of inflation is one reason for the caution of the Chancellor towards substantial reductions in taxation. However, concentration on supply-side measures, including corporation tax relief, will not achieve the sort of economic growth required to generate the stimulus that is essential to increasing both real incomes per capita.

Missing from the Autumn Statement is the substantial tax revenue required to fund the public services required to cope with the demographic and other changes that are driving the need to raise taxes as a proportion of GDP. The apparent view that, at 37%/38% of GDP is either sufficient or too high, a view shared by both the Conservatives and Labour, is a serious mistake. In common with similarly-placed countries a significantly higher tax percentage is required just to support the current level of public service provision, let alone generate the provision required. Reform of public services may be a necessary condition for improvement, it is by no means sufficient.

The Chancellor’s decision to maintain a net/debt GDP ratio at 94%, supports another canard, namely that keeping the level below 100% is a crucial metric. Providing the economy is growing at a reasonable rate, say 2%, this ration is irrelevant, it will gradually reduce and reduce the government interest payments on the debt. Labour seems to share the concern over the metric, despite promising borrowing for major infrastructure investment. How it will square the circle is not clear.

As other commentators have also observed, the continued freeze on the personal allowance means that effectively the tax take will actually increase, especially as te government has pushed tax increases on to local government with 5% rises in council tac almost inevitable.

Overall. The Autumn Statement will: a) not significantly increase the UK economic growth rate over the next five years, b) will leave a substantially under-resourced set of public services massively under-funded, c) repeats the Conservatives’ myth that all that is required for economic growth is low taxes, rather than substantial increases in key public provision, via regional educational, bousing, and other public service provision, in collaboration with the private sector (though probably not via narrow investment zones and freeports, that displace rather than create development), and d), does nothing to reduce the maldistribution of income and wealth across the UK .

Endnotes

[1] Tatiana Evdokimova  et al ‘Central banks and policy communication: How emerging markets have outperformed the Fed and ECB’, PIIE Working Papers, https://www.piie.com/publications/working-papers/central-banks-and-policy-communication-how-emerging-markets-have

About the GPI

The Global Policy Institute is a research institute on international affairs. It is based in the City of London, and draws on both a rich pool of international thinkers, academics as well as policy and business professionals. The Institute gives non-partisan guidance to policymakers and decision takers in business, government, and NGOs.

Categories