Six things we learnt from budget 2020 | Institute for Government

The first budget of a new government often takes on additional significance. In the run-up to the budget, Dr Gemma Tetlow laid out six things she was looking out for and has since assessed what we learnt.

No chancellor since Dennis Healey in 1974 has had less time in post before presenting a budget than Rishi Sunak had when he stood up in the House of Commons on 11 March. In the end, Sunak’s first budget was dominated by coronavirus – its impact on the economy and how the government was responding. But beneath that near-term issue, the budget statement also gave an indication of the Johnson government’s longer-term priorities. These were very much in line with what had been promised in the Conservative’s election manifesto. There was more money for investment and also for day-to-day spending – with only a modest tax rise, most of this largesse was funded through extra borrowing.

1. Fiscal rules

Will Rishi Sunak stick to Sajid Javid’s fiscal rules?

The fiscal rules were the dog that did not bark in Rishi Sunak’s first budget. The past few weeks were riddled with speculation that weaker-than-expected growth and the Johnson government’s desire to increase support for public services would lead Sunak to water down the fiscal commitments made in the Conservative’s 2019 election manifesto. The rules allow plenty of scope for extra investment spending – but sticking by the pledge to balance the current budget within three years appeared to leave him somewhat hamstrung on day-to-day spending.

But in the end, Sunak managed to adhere to his predecessor’s rules while being fiscally generous – not least by adding £31bn a year to day-to-day spending for public services by 2022/23. The spending increase is, in reality, a bit less dramatic than it first appears: around £13bn a year of that figure had already been announced in last year’s spending review, and some of the extra money (perhaps around £4bn a year) will be needed to replace spending programmes that the EU used to fund. But it still amounts to a big spending uplift. How was that possible?

In part, because the economic and fiscal forecasts from the Office for Budget Responsibility (OBR) have not been downgraded as much as some had predicted. This reflects a number of offsetting factors. The OBR now takes a dimmer view of prospects for productivity growth in the UK than it did in its last forecast a year ago, and assumes that the government’s new stricter regime for EU migration will also constrain growth. But the government’s increase in spending and higher forecast labour-force participation both boost economic growth, while the higher national living wage and lower debt interest costs boost the public finances.

A £7bn-a-year net tax increase from the cancellation of plans to cut the rate of corporation tax from 19% to 17% has also helped. As has the government keeping hold of money that would once have been paid to the EU.

But the question of what fiscal rules this government should adhere to has not gone away. The chancellor announced a wide-ranging review of the fiscal framework ahead of this year’s autumn budget. The remit of that review is broad – covering not only the detail of the fiscal rules but also the role of fiscal institutions, such as the OBR, Office for National Statistics and National Infrastructure Commission – and could lead to a more radically different approach to fiscal management than much of what was rumoured over the past few weeks.

It is welcome that the chancellor has chosen to conduct a thorough review of the fiscal framework, rather rushing to adopt a new set of rules. It is also welcome that, in setting out the review’s terms of reference, he has acknowledged the strength of the UK’s existing independent institutions, like the OBR. As the Institute has noted before, the OBR’s work has improved the quality of public debate on the UK’s public finances and helped ensure that difficult fiscal questions are faced by providing a comprehensive picture of the health of the UK’s public finances.

Changes to public sector net borrowing in 2022/23, £bn

Further reading

2. A 'Brexit dividend'?

Is there a 'Brexit dividend'?

The chancellor announced a large increase in spending on public services in the budget – even if the details of how the money will get divided up will not be set out until the spending review in the autumn. But the headline increase in the money that will be available is large.

Part of this has been made possible by using money what would previously have been ear-marked for the EU. Sunak did not quite call this a ‘Brexit dividend’, but he did say “for the first time ever, today’s OBR [Office for Budget Responsibility] forecast shows that the billions of pounds we would have sent to the EU, we can now spend on our priorities”.

But that was only half the story of what Brexit means for the UK’s public finances. As the OBR has stated, in its Economic and Fiscal Outlook on Wednesday, “an average of external estimates of the effect of a typical free trade agreement [of the sort the UK is seeking with the EU]... implies around a 4 per cent loss of potential GDP over 15 years, relative to what would have happened [had the UK remained a member of the EU]”.

The impact of this Brexit-induced reduction in productivity growth on the UK’s public finances is less obvious – but larger – than the money freed up from its no longer having to make contributions to the EU. If two thirds of the impact on growth materialises by 2024/25, a rough rule of thumb suggests borrowing could increase by around £30bn a year.

The peculiarities of the OBR’s approach to accounting for EU contributions meant that, on 11 March, the chancellor was able to announce a large increase in public service spending apparently from nowhere. But the bigger picture is that Brexit is expected to dampen UK economic growth and so – overall – constrain the UK government’s ability to spend.

3. UK–EU trade and the economy

What does the government’s desired future trade deal with Europe mean for the economy?

For most of the period since the referendum in 2016, it has not been clear what the UK’s future trading relationship with the EU would be, not least because any final trading arrangements are not exclusively within the government’s gift. Therefore, the OBR has until now based its forecasts on “a few broad-brush assumptions about the medium-to-long-term impact of Brexit that would be consistent with a variety of possible outcomes”. These range from a very hard Brexit – trading with the EU on World Trade Organization (WTO) terms – through to a much closer relationship as a member of the European Economic Area (EEA).

The OBR had always said it would adjust its assumptions “when concrete agreement is reached”. On 27 February, the government published its negotiating mandate. That made clear that the government is not seeking the sort of very close trading relationship that EEA members have. As a result, in its forecasts published alongside the budget, the OBR has adjusted its modelling assumptions, stating: “An average of external estimates of the effect of a typical free trade agreement [of the sort the UK is seeking with the EU]... implies around a 4 per cent loss of potential GDP over 15 years, relative to what would have happened [had the UK remained a member of the EU]”.

The OBR’s report added that it believes about a third of this hit has already happened, another third will manifest over the next five years and the rest will crystallise after 2024/25.

This is a more explicit statement than the OBR has previously made about the impact it thinks Brexit will have on the UK’s long-term growth prospects.

4. Spending review

What can the budget tell us about government’s plans for this year’s spending review?

The big (medium-term) story of the budget is a substantial increase in spending, the majority of which is for day-to-day spending. This gives the upcoming comprehensive spending review, expected in the autumn, a very different complexion – especially when compared with the government’s plans as of a year ago.

In March 2019, the plan was for day-to-day departmental spending to increase by £18bn (6%) in real terms between 2019/20 and 2023/24. However, after taking into account commitments made to the NHS and schools, and ongoing commitments on defence and aid spending, this implied that day-to-day spending on all other services would fall – adding to big cuts that had already been sustained since 2010.

The government’s spending round in September changed this picture quite a bit. An additional £12bn was put into public services in 2020/21, meaning that unprotected spending was no longer on course to fall. But it still implied tight settlements for this year’s spending review (which is expected to cover the years 2021/22 to 2023/24), as the chart shows.

But in today’s budget, the chancellor announced another chunk of money for public services. An extra £14bn in real terms has been added to annual day-to-day spending on public services by 2023/24 (after accounting for money needed to replace EU spending that will no longer take place in the UK, which comes to around £4bn a year). This additional leeway means the government could maintain – and even increase – its commitments to the NHS and schools while still providing real-terms increases to other departments. This will be welcome for many public services that are showing signs of strain after a decade of cuts.

The spending envelope – which will be the subject of negotiations between departments and the Treasury over the summer – suggests that this year’s spending review could truly be one that ‘ends austerity’. But turning on the taps is not without its risks, especially as Whitehall will need to get out of a cost-cutting mindset to ensure that they don’t waste the additional spending.

5. Tax announcements

What tax announcements will be made?

The budget was relatively quiet on tax, albeit enacting a net tax rise (as often happens after elections), mainly through the cancellation of a cut to corporation tax trailed in the manifesto. What we didn’t see was an overarching vision for the tax system. If Rishi Sunak is to be a tax-reforming chancellor, and enact much needed changes to the tax system, he should start laying the groundwork for change as soon as possible and articulate a longer-term plan for tax at the autumn budget.

We will provide further analysis on making changes to the tax system, through upcoming reports and further comment, in due course.

6. A green chancellor?

This was not the green budget many were hoping for from a government preparing to host the COP26 climate talks in November.

After reportedly giving thought to ending the freeze on fuel duty that has been in place since 2011, the chancellor decided against it (following vocal opposition from Conservative MPs in the Midlands and the north of England). Fuel duty is by far the country’s largest green tax: freezing it again has cost the government half a billion a year. Combined with a further £27bn committed to building new roads, this was a missed opportunity to signal a shift towards low-carbon transport.

Tax relief on red diesel (fuel used by non-road vehicles) will be abolished, raising some £1.6bn in 2023/24, though areas including agriculture and fishing will be exempt. There was also a significant change in the climate change levy, a tax paid by energy companies: this will be raised on gas but frozen on electricity, to better reflect the differences in carbon emissions from each energy source.

The chancellor announced a range of other smaller measures, including new funding for energy innovation and ‘green heat’ networks; a new levy to support biomethane; and a plastic packaging tax. But there was little detail on other key areas, such as improving the energy efficiency of the existing housing stock.

Sunak promised further funding for green initiatives in the spending review later this year, after the National Infrastructure Strategy has been published. He also stated that the Treasury’s own review of the costs and opportunities of reaching net-zero carbon emissions by 2050, due in the autumn, would set out the government’s “strategic choices”.

The chancellor said before the budget that it would “lay the foundations” for a transition to net zero. On that aim, along with other climate issues that were similarly overshadowed, it fell short.