What didn’t the chancellor tell you in his spring statement?
The government has taken action to support families worth over £22 billion. But is this enough? The Chancellor used his Spring Statement to deliver rebates and tax cuts. He pledged to cut the basic rate of income tax by one percentage point to 19% in 2024. The first time any Chancellor has ever promised a tax cut two years ahead of time. The public finances might have emerged from the pandemic in better shape than expected, with public borrowing 52% lower than the 2020/21 peak, however rising interest rates mean that the debt servicing costs are 53% higher than a year ago
Russia’s invasion of Ukraine has helped to push inflation to a 40-year high of almost 9%, and living standards are set for a historic fall over the next 12 months.
Long-term economic scarring
The uncertainty over subsequent international sanctions brings the prospect that energy prices could rise further than any forecasts currently assume; driving inflation close to double digits and leading to GDP being 0.8% lower in the near term. This century has already seen the UK economy subjected to an extraordinary array of shocks. The financial crisis, Brexit and the pandemic are all expected to have long-term consequences for potential output.
Growth forecasts have now been slashed to 3.8%, down from 6% predicted in October. The Office of Budgetary Reform forecasts a further 1.8% dip next year. GDP won’t get back to the expected trajectory set out in the October budget forecast until 2025. A sustained increase in input costs of energy could do lasting damage to potential output in net energy importing economy like the UK, compounding the long-term economic legacy of past shocks.
So far the pandemic has led to economic scarring of 2% of GDP. However, Covid cases are on the rise around the world and the emergence of a vaccine-escaping variant could lead to a further sharp contraction in GDP.
Have taxes really been cut?
The Chancellor’s claims that this is his ‘largest-ever tax cut’. The truth is the tax cuts will undo one-sixth of the total tax rises Sunak has previously announced. In other words, we are getting back £1 for every £6 the chancellor has already taken from us. Tax will account for more than 36% of GDP, up from 33% before Covid. This is the biggest leap earners’ contribution to the economy at any point since the late 40s.
The Resolution Foundation found that Mr Sunak’s measures were not particularly progressive. The top 50% of earners will benefit more than any other sector of society. The analysis showed average gain across the top half of the income distribution is £475, compared to a gain of just £136 for the poorest fifth of households.
Fiscal drag race
The freezing of the income tax personal allowance and higher rate threshold turns out to be much bigger than tax rises because of ‘fiscal drag’. Fiscal drag occurs when workers who receive a pay rise as a result of inflation are forced into a higher tax bracket. Each extra pound they earn is subject to the higher rate as tax thresholds are not rising with inflation. The cuts to income tax and national insurance are effectively paid for by increasing revenues as a result of fiscal drag. This will leave the Treasury with an extra £30bn from these higher tax receipts.
As well as moving into a higher tax bracket, rising inflation outpaces nominal earnings growth which, combined with net tax increases starting in April, will weigh heavily on living standards in the coming 12 months. Real household disposable incomes per person is expected to fall by 2.2% in 2022-23, the largest fall in a single financial year since records began in 1956-57.
Taking account of all pressures on household incomes, the policy measures announced offset a third of the overall fall in living standards that would otherwise have occurred in the coming 12 months.
Spring statement – Austerity by stealth
Rishi Sunak delivered a cost-neutral statement, thanks to inflation being twice the prediction just in October. By saying nothing about public spending, the Chancellor effectively delivered real-term cuts for public services. You could call this public sector austerity by stealth for defence, education, health, and policing.
The 5p cut to fuel duty is useful in the short term but does not affect the tax burden in the medium term because it is to be reversed after 12 months. The price is indexed to inflation so could imply an 8p increase next year.
The weak outlook for households’ real incomes means we can lower consumption but this will be highly dependent on what happens with the saving rate, which is at an all time high. Rising interest rates also mean household income spent on monthly mortgage payments will start to rise, further squeezing real incomes.
