Six things we learned from the spring budget 2023
What the chancellor's announcement revealed about the government's plans for tax and spending policy.
On 15 March 2023, chancellor Jeremy Hunt presented his first budget. This set out the government’s plans for tax and spending policy. Alongside it, the Office for Budget Responsibility (OBR) published updated economic and fiscal forecasts for the next five years – running up to and beyond the next election. Here are six things we at the Institute for Government learnt from the chancellor’s announcement.
1. How will lower energy prices affect growth and household incomes this year?
The new forecast from the Office for Budget Responsibility (OBR) was conditioned on much lower forecasts for both interest rates and energy prices than its previous forecast in November. The drop in energy prices is particularly stark: wholesale prices are now expected to average £1.50 per therm in 2023, less than half the £3.40 assumed in November.
This good news means that the OBR expects the economy to shrink by less in 2023 than previously: the contraction is now expected to be 0.2%, which is very shallow relative to historical recessions and markedly lower than the 1.4% predicted in November. This improved economic outlook means that the government has more fiscal space over the next year than thought.
As anticipated, the chancellor used some of this fiscal space in the near term to keep the energy price guarantee limit at £2,500 per year for the average household, rather than rising to £3,000 as previously planned. This will stay in place until June. From then, energy prices are expected to fall below the guarantee threshold anyway, reflecting a steep fall in wholesale energy prices since the start of the year. Hunt also announced that the charges for those on prepayment meters will be brought in line with those paid by direct debit customers, bringing a welcome end to the premium that those (typically vulnerable) customers currently pay for their energy.
But it is not all good news. Even with lower energy prices and more government support, real household disposable income is still expected to fall by 6% between 2021/22 and 2023/24, only slightly better than the 7% fall expected in November. UK households are still facing the largest fall in living standards since records began in the 1950s – and they won’t return to their pre-pandemic level until at least 2028, reflecting the impact of the trade shock suffered by the UK since the energy crisis began, on top of structural weaknesses in the economy.
2. Is the OBR more optimistic or pessimistic about the economy’s medium-term prospects?
According to the OBR’s new forecast, the UK’s GDP will be higher than previously expected at the end of the forecast. This is partly a result of lower energy prices, assumed to feed through to the potential growth rate of the economy. Another factor is the forecast for inward migration, which the OBR has revised up to match the most recent statistics. More immigration leads to a larger economy, due to an increase in population size.
These positive effects however have been partly offset by a weaker path for the amount of capital per worker because the projected increase in population size is not being matched by cumulative investment (an increase in the capital stock), which is forecast to be broadly the same as in the last forecast. The other factor pushing down on GDP in the medium term is the OBR’s downwards revision to its forecast for labour force participation because they judge that the recent fall will be more persistent than previously expected.
Tackling falls in labour force participation was a key focus in Hunt’s speech, and he announced several policies in these areas as a way to boost growth. The OBR judges that five of those policies will have a material and positive impact on the productive capacity of the economy:
- Expanding free childcare for working parents of nine-month to two-year-olds is expected to mean an additional 60,000 people enter the workforce and to increase the hours worked of others.
- Increasing the requirement for more parents and carers claiming Universal Credit to seek work and increase their hours is assumed to increase employment by 10,000.
- Increases in the generosity of tax treatment for pension contributions, through raising the lifetime and annual allowances, are forecast to increase employment by 15,000
- A new disability employment programme will increase employment by a further 10,000.
Hunt billed this as a "budget for growth”. The OBR agreed, saying the chancellor had used his “fiscal windfall to address persistent supply-side challenges”. The OBR judged that Hunt’s new policies had resulted in “the largest upward revision we have made to potential output within our five-year forecast as a result of fiscal policy decisions taken by a government in any of our forecasts since 2010”. But even then the overall effect on economic output was modest – increasing output by just 0.2% in 2027/28.
3. Does the government have more or less headroom against its fiscal rules?
Despite being more pessimistic about the UK’s medium-term growth prospects than it was last November, the overall effect of the OBR’s updated forecasts was to reduce projections for public borrowing and debt. Stronger than expected tax revenues are projected to continue, lower energy prices will save the government some money on energy support in the short-term, and lower borrowing costs and less debt issuance is expected to reduce future spending on debt interest. Taken together, the improvements to the economic and fiscal forecasts reduce forecast borrowing in 2027/28 by around £28bn.
Jeremy Hunt has used some of that good news for spending increases and tax cuts. These measures focused on trying to boost UK economic growth, with a major expansion in support for childcare costs, more generous tax treatment of business investment, changes to pension tax allowances to try to reduce incentives for early retirement, and more support and encouragement for benefit claimants to move into work. But there were also two other major permanent giveaways: cutting fuel duty and increasing defence spending.
This has left the chancellor with just £6.5bn of headroom against his main fiscal rule – to ensure that debt is falling as a share of national income between 2026/27 and 2027/28. This is slightly less than he had in the autumn and is, historically, a very small amount of room for manoeuvre.
It appears to have led to the chancellor making some suboptimal choices. The change to allow full expensing for investment will only apply for the next three years, a timeframe which means the chancellor meeting meets his fiscal rule but which also creates uncertainty for businesses about the UK government’s longer-term approach to taxation. This diminishes the benefits that might have been achieved by giving a clearer signal that the UK government was committed to a globally competitive corporate tax regime, and follows the pre-budget announcement that the northern leg of the HS2 train line was to be delayed – a decision also apparently motivated in part by a desire to help meet the fiscal rules.
4. Will the government address pressures on public service workforce and performance?
Despite speaking for over an hour the chancellor managed to avoid talking much about public services at all. Given the large number of public sector strikes this week, including on budget day itself, and the bad state of many public services highlighted by the Institute for Government and CIPFA’s Performance Tracker 2023, this was a notable omission.
He left departments’ spending totals mostly unchanged, though he did find extra money for defence and his new childcare commitments. That means most services will see only small budget increases over the next two years, with even tighter plans still pencilled in beyond the current spending review period, from April 2025 onwards – that is, after the next election.
These tight budgets could undermine Hunt’s ambitions to promote growth: the OBR rightly cautions that “additional resources” will be needed to deliver the chancellor’s growth-enhancing measures like the new disability employment programme. 9 https://obr.uk/docs/dlm_uploads/OBR-EFO-March-2023_Web_Accessible.pdf , p23
A major cause of the current problems in public services is that many – most notably the NHS – are operating less productively than before the pandemic: even where budgets are increasing, they are not translating into better results. Yet there was nothing in this budget to address that, and the eagerly awaited NHS workforce plan – which Hunt announced in November – was not released either.
Hunt did not address strikes during his speech. But his decision to maintain departments’ existing budgets will also make it very hard for departments to offer pay increases large enough to match those in the private sector – which could cost £11 billion, according the OBR – and so bring an end to ongoing industrial action.
10
https://obr.uk/docs/dlm_uploads/OBR-EFO-March-2023_Web_Accessible.pdf, p99
However, the chancellor has retained a larger-than-usual reserve (unallocated departmental spending) of over £13 billion in each of the next two years. This is ‘dry powder’ Hunt could deploy to make more generous pay offers later. That he increased the overall spending envelope to pay for his new defence commitments, rather than taking it from this reserve, suggests that he wanted to retain that flexibility.
5. Will the government top up capital budgets to address cost pressures?
Despite tax measures designed to boost growth by increasing private investment, the chancellor was silent on public sector capital spending plans. These remain unchanged in cash terms since the spending review in October 2021, despite sharp increases in construction costs as a result of labour force shortages and high energy and materials prices that mean building infrastructure is now much more expensive than originally anticipated. There are already widespread reports of capital projects being delayed in the face of rising costs – contributing to a £3.6 billion underspend of capital budgets this year. 12 https://obr.uk/docs/dlm_uploads/OBR-EFO-March-2023_Web_Accessible.pdf, p99
By keeping budgets fixed in cash terms, the chancellor is implicitly accepting that less will be built than originally intended. This is especially true because the OBR also expects investment budgets will be underspent by a considerable margin over the next few years as disruptions to the construction supply chain affect the pipeline. Beyond the high-profile announcement of HS2 delays in the days leading up to the budget, it is unclear exactly which projects will be cancelled, scaled back or delayed. However, early signs are that local government projects – including those awarded through the Levelling Up Fund – are at high risk of delays because local government budgets are limited.
Beyond the spending review period, the chancellor kept to his tight capital spending plans which imply net investment spending would be barely more than 2% of GDP by 2027/28. That represents a marked change from plans set out just a few years ago that suggested investment would be closer to 3%.
6. Will any tax measures announced demonstrate a coherent strategy?
Jeremy Hunt announced a series of big tax giveaways in the budget, including a permanent increase in the generosity of pensions tax allowance, a permanent reduction in fuel duties and a temporary increase in the generosity of tax treatment for business investment. This amounts to a peak giveaway of nearly £14bn a year in 2024/25, but this large tax cut does not appear to be matched by a long-term strategy.
There are several ways in which tax changes over the last couple of years have reversed the direction of travel for tax policies since the Conservatives first came to power in 2010. George Osborne’s chancellorship saw a multi-year programme of cutting the rate but broadening the base for corporation tax, raising the levels of the income tax personal allowance and higher rate threshold, and reducing the generosity of pensions tax treatment by cutting the annual and lifetime allowances. First Rishi Sunak and now Jeremy Hunt have started to reverse Osborne’s measures. The headline rate of corporation tax has gone back up while the base has been narrowed by extending investment allowances. The income tax personal allowance is being frozen in cash terms until 2027/28, meaning it will fall back to its 2013/14 level in real terms. And now Hunt has announced plans to ease previous limits on pensions tax relief. The one consistent thread of tax policy has been repeated decisions to delay and abandon planned inflationary increases in fuel duties.
While a desire to boost growth provides some coherence to recent tax changes, there are also areas that lack clarity. The fuel duty freezes sit awkwardly with the government’s wider net zero objectives and its need to sustain long-term revenue raising, while announcing higher capital allowances in corporation tax for just three years undermines the positive effect on longer-term business decisions.
Jeremy Hunt would benefit from having a clear tax strategy, as it would help him to prioritise new measures and assess which are best value for money. A long-term tax strategy would also make it easier for private sector actors to make long-term decisions. It would also improve policies, with a clear strategy allowing parliament and outsiders to hold the government to account on the choices it makes. So far, however, Jeremy Hunt’s announcements on tax falls short on all counts.
- Topic
- Public finances
- Keywords
- Budget Tax Public spending Economy Public sector
- Position
- Chancellor of the exchequer
- Administration
- Sunak government
- Department
- HM Treasury
- Public figures
- Jeremy Hunt Rishi Sunak
- Publisher
- Institute for Government