Rishi Sunak delivered his spring statement against a difficult backdrop given rising prices and the war in Ukraine. He took measures to further support households in the short term, and cut some taxes in the medium term, although overall improved fiscal forecasts allowed him to increase headroom against his fiscal rule.
Before the statement, we set out six things that the Institute for Government was looking out for in the chancellor’s announcement. Here is our reaction to each of those.
1. How has the economic and fiscal outlook changed in the short and medium term?
Despite big changes in the outlook for household finances, the changes to headline economic growth in the Office for Budget Responsibility’s (OBR) forecast were modest. It still expects real GDP to be at around the same level in the mid-2020s, as anticipated in October, albeit with somewhat slower growth this year and next. This means that the OBR remains much more optimistic about the prospects for the economy than the Bank of England, the other UK public sector forecaster.
The public finances are in a stronger position. In the current fiscal year, borrowing is now expected to be a remarkable £55bn lower, mainly because tax revenues have been much stronger than anticipated. The OBR expects some of that strength in tax revenues to be permanent and so benefit the exchequer in future years too. The main offsetting factor will be high debt interest spending, expected to hit over £80bn next year – £40bn higher than anticipated in October – although it then falls back thereafter.
The forecast presented by the OBR therefore gave the chancellor room for manoeuvre. Before accounting for any measures, borrowing was forecast to be £8bn higher next year but £14bn lower in 2024/25, when the chancellor’s fiscal rules apply. Overall, the measures announced by Rishi Sunak in February and today to support household incomes add £20bn to the deficit in 2022/23 (offset to an extent by the reforms to student loans announced last month). By 2024/25, the tax cuts announced today cost around £10 bn (student loan changes saving around half of that)
Overall, the chancellor has acted in the short term but kept some of his powder dry beyond next year. He now has more headroom against his fiscal targets in 2024/25 than he started with, spending around half of the good fiscal news in giveaways and banking the rest. But – as he hinted in his speech – he may need that headroom. The economic situation remains highly uncertain and could easily deteriorate, eating up any ‘war chest’. And he can expect pressure for more giveaways in the coming years. For example, if the ‘temporary’ fuel duty cut this year becomes permanent, as seems more likely than not, that would cost £2.5bn a year. And increasing budgets for public services beyond what was announced in the October spending review, to protect them from higher inflation, would cost a further £8bn a year by 2024/25.
2. How bad does the OBR expect the cost of living crisis to be?
Several factors are set to culminate this year in the biggest single-year fall in real disposable household income per person – the amount households have to spend after taxes and after accounting for inflation – since records began in 1956/57.
The Office for Budget Responsibility (OBR) has forecast inflation to reach a 40-year high of 8.7% at the end of the year. And while wages are now expected to grow more quickly than the OBR predicted last October – in response to higher inflation and a tight labour market – those rises will not keep pace with inflation. Take-home pay will also be hit by tax rises scheduled for April, including the National Insurance increase and the freeze in the income tax personal allowance and higher rate thresholds, which are only partially offset by the rise in the National Insurance threshold Sunak announced today. And the value of benefits for pensioners and low-income households is expected to fall by 5% in real terms (after adjusting for inflation).
This means that average real household disposable income per person is predicted to fall by 2.2% in the 2022/23 financial year, with two thirds of this coming from inflation exceeding income growth and a third from tax rises. This decline would have been around half as big again if the government had not stepped in with the measures it has announced to prop up household incomes, such as the council tax rebate and the fuel duty cut.
But the cost of living hit will not be evenly felt across households. There are several reasons to think the squeeze will be felt more sharply by lower-income households. First, they tend to spend a greater fraction of their budgets on goods whose price is expected to increase most rapidly – such as energy and food. Second, the OBR predicts that some of the cost of living hit will be cushioned by a drawdown in household savings – but these are concentrated among middle and higher income households. Third, the real-terms fall in benefit income (at 5%) is expected to be larger than the real terms fall in wages (at 2.7%), albeit wage earners will also be hit more by tax increases.
3. How (if at all) will the chancellor cushion the blow for households and businesses?
The main measures to help address the cost of living crisis had been well trailed before the chancellor stood up on Wednesday.
The first was a temporary one-year cut to fuel duty of 5p, delivering a net benefit to consumers of £2.4bn over the next year. This measure is targeted in that the greatest benefits will go to those that spend the most on fuel. But because higher-income households tend to consume more fuel, this measure is overall regressive – that is, it benefits people on higher incomes most.
Sunak also announced that the income threshold for National Insurance contributions (NICs) will rise to £12,570, bringing it in line with the threshold for income tax, a tax cut worth around £6bn a year. The benefit of this policy is greatest for middle-income households, and more than half of the saving will go to the highest-income half of the population. This move is still more progressive, however, than the cancellation of his previously announced NIC rises would have been (something Labour had called for).
But one possible set of measures that had been speculated about in advance was absent from Sunak’s announcements: targeted support for lower-income households through the benefits system. Instead, the only new help focused on this group is to be delivered through an extension to the Household Support Fund, raised from £500m to £1 bn. This money will be distributed by local authorities and is intended to help households with the cost of essentials such as food, clothing and utilities. This measure is targeted at lower income households, but its overall size is small when compared with the other, more broad-based measures.
As a result, the overall package of measures is not well-targeted on those who are likely to be most vulnerable to rising energy and food prices. The chancellor has chosen to prioritise wide coverage of policies over targeting support at those on lower incomes. If household energy bills rise again in October by as much as some fear, the Treasury is likely to come under pressure to do even more for the poorest in society before next winter.
- Adam Corlett and Torsten Bell, Softening the blow, Resolution Foundation, 21 March 2022, www.resolutionfoundation.org/publications/softening-the-blow
4. Beyond the immediate ‘crisis response’, will the chancellor use the war in Ukraine to set out measures to incentivise the net zero transition?
The spring statement was mixed from a net zero perspective – though the full picture will only emerge when we see the government’s proposed new energy strategy, due next week.
The chancellor made a welcome decision to remove all VAT on energy-saving installations, including heat pumps and solar panels. This will make a difference for some, reducing the cost of a typical heat pump by around £500-£2,000. He also brought forward green relief on business rates, which will similarly help businesses wanting to invest in green technology. But beyond that, Sunak did not take any steps to boost the funding available to support household energy-efficiency upgrades such as for replacing roof insulation, and he has still not brought forward the full £9.2bn promised for this in the 2019 manifesto.
While the VAT cut makes sense as a long-term signal, most people will not be in a position to install a heat pump or solar panels before next winter. And there was only limited extra support for energy costs beyond the energy bill loan announced in February.
The decision to cut fuel duty was sold as a measure to support households with the cost of living. But it is poorly targeted for that purpose (since it benefits most those on the highest incomes who drive further in less fuel efficient cars). Furthermore, although the chancellor is assuming the cut will be reversed in a year’s time, experience suggests that may well not happen. In the long-run he needs to find a way to replace fuel duties and to further incentivise the take-up of electric cars. Nothing in the spring statement announcements made headway on those priorities.
The impact on the long-term net zero transition will be clearer once we see the energy supply strategy next week. But with petrol now cheaper and little progress on scaling up energy-efficiency measures the statement arguably leaves the UK farther away, not closer, to reaching net zero carbon emissions.
- Sissons A, Wiley K and Williamson C, How to reduce the cost of heat pumps, Nesta, 2 March 2022, www.nesta.org.uk/report/reduce-the-cost-of-heat-pumps
5. How will the war in Ukraine and higher inflation affect the chancellor’s spending plans?
Despite higher inflation, the chancellor chose to maintain the departmental spending allocations he set in the spending review last October. Taking into account higher inflation, departmental day-to-day budgets are now only set to increase 2.9% in real-terms over the Spending Review, compared to the 3.3% planned rise in October 2021. This will mean that departments budgets will not go as far as planned when they were set.
Allowing departmental budgets to rise less quickly in real-terms improves the government’s fiscal position – but risks the government not beingable to deliver the same scope and quality of services as planned, and makes public sector recruitment and retention harder.
Half of day-to-day spending is public sector pay, and the OBR now forecasts that nominal wages will grow on average by 5.3% in 2022, up from their forecast of 3.9% in October. If departments also face pressure to increase public sector pay more quickly than they had been planning when budgets were set in October, that would reduce spending available for services. But if they do not, they risk exacerbating recruitment and retention problems at a time when recruitment and retention pressures are already apparent. Departments’ own evidence to the public sector pay bodies in February 2022 – just a month ago – acknowledged pressures such as increasing proportions of staff leaving the and difficulties recruiting and retaining prison officers. And these pressures may intensify if private sector wages increase as fast as the OBR now forecasts.
Despite the specific calls to increase the UK’s defence budget in the wake of the invasion of Ukraine, there was also no new defence spending in the spring statement.
Instead the chancellor chose to sidestep these upcoming pressures, not mentioning reprioritisation or public sector pay directly. He instead emphasised several ‘efficiency programmes’ to get the best value from public spending. There is some scope to increase efficiency by expanding some of the innovations adopted during the pandemic, but the government should avoid the shortcomings of previous efficiency drives – which focused on cutting costs rather than transforming how services work – if they are to be successful.
6. Will the government maintain the momentum behind its ‘levelling up’ agenda with new commitments?
Levelling up was relegated to only a cursory and vague mention in the chancellor’s closing remarks. Given that the levelling up white paper was published only a month ago, this lack of attention will only add to concerns that the Treasury is not fully committed to this ambitious plan to reshape the UK’s economic geography.
The spring statement did confirm that the government will be launching the second round of the Levelling Up Fund, but this will only allocate money that has already been announced. These competitive funds have also been criticised for sucking up time and resources as local authorities prepare bids, whilst they also place constraints on how local areas can direct funding. The white paper promised to reduce this kind of ring-fencing to give local areas more freedom over how they spend their money but the spring statement showed no signs of starting this process.
Even though levelling up was not an explicit focus of the chancellor’s statement, choices around whether and how the government will intervene to support people through the cost of living crisis will have implications for regional disparities. Andy Haldane, one of the lead authors of the recent white paper, has cautioned that rising inflation will make the levelling up agenda harder to achieve by hitting the living standards of those in ‘left-behind’ areas.
So while the Treasury might argue that the best way to reduce regional disparities is to find the right measures to ease cost of living pressures and support economic growth, this would be in stark contrast to the levelling up white paper’s ambition to ‘hardwire’ spatial considerations into all government decision making.
The spring statement was an opportunity to build on the white paper’s momentum and show that all of government is united behind the project to reshape the economic geography of the UK. But instead, unless you were listening very carefully, you might have thought that the government’s supposed flagship agenda had in fact been abandoned altogether.
- Payne S, ‘Levelling up chief warns inflation will make tackling UK inequalities harder’, Financial Times, 23 March 2022, retrieved 23 March 2022, www.ft.com/content/6f47aae1-d853-4cd9-b53e-87b44c2f7d30?shareType=nongift