Boris’ Budget Boost

Last week Boris Johnson conducted his first cabinet reshuffle as Prime Minister. Cabinet reshuffles always attract the attention of the press, but they are rarely dramatic with most senior ministers staying in their posts. The recent reshuffle broke with that tradition with the resignation of Sajid Javid as Chancellor (ostensibly due to Number 10’s desire to sack the Chancellor’s special advisors) and the promotion of his deputy, Chief Secretary to the Treasury Rishi Sunak.

With mere weeks until the Budget, Mr Sunak faces a daunting task to form and articulate the Government’s fiscal policy for the next year.  But he also has an opportunity to reset priorities and pivot expenditure to meet the government’s policy agenda.

Implications for the Budget

We cannot claim to know the exact contents of the Budget, but it is evident that Javid’s removal and Sunak’s elevation will have implications for the UK’s fiscal landscape. Sunak’s appointment has coincided with the establishment of a joint Treasury policy unit, overseen directly by Number 10. This should produce a cohesive relationship between the Chancellor and his boss, preventing the hostiles which have dominated previous PM-Chancellor relationships, arguably leading to better governance

Resultingly, imminent changes to the Treasury’s Fiscal Rules are expected. The rules, first announced during Gordon Brown’s tenure as Chancellor, have been repeatedly changed to reflect each respective governments’ spending priorities. The present iteration of the rules originated during Javid’s occupancy of Number 11. They limit public sector net investment below 3% of Gross Domestic Product (GDP), prevent the government from borrowing to fund day-to-day spending and commit the government to reducing the UK’s national debt.

The spending promises made by the Conservatives during the election do not conflict with these requirements if extra revenue is raised to offset a potential expansion in overall expenditure, or spending reallocated from other commitments. However, whether the government is willing to exhibit the same fiscal discipline that has characterised the policies of its immediate predecessors remains to be seen. In that context it is sensible to examine some of the possible spending pledges that could be announced on the 11^th of March.

Potential Budget Features:

• National Insurance Cut – One of the flagship pledges in the Conservative manifesto was to raise the threshold for paying National Insurance at first to £9,500, with the ultimate ambition of increasing it to £12,500. This would effectively grant a tax cut for most of the UK’s working population. The current threshold is around £8632.
• Social Care Costs – Reflecting a commitment made in the Queen’s Speech it is likely £1 billion will be allocated to councils to alleviate pressures on local social care schemes.
• Health Spending – An increase in the NHS budget is expected to be announced.
• Pension Changes – A change to the system of pension tax relief has been mooted as likely, with those earning over £50,000 per year seeing their tax relief rate halved to 20%. The reduction would raise around £10 billion in revenue.
• Infrastructure Spending – With the High-Speed Rail 2 finally receiving approval, it is almost certain that the Budget will provide for at least part of its £100 billion budget. Likewise, having committed closing the productivity gap between the North and South, it is possible there will expenditure committed to upgrading Northern Rail lines too.
• Increased expenditure for the NHS

Our Perspective

Previous Chancellors have traditionally kept their exact budgetary proposals under lock and key, occasionally surprising observers by producing proverbial rabbits from hats. Nevertheless, taking manifesto commitments and public statements from ministers into account, we will probably see spending above last year’s expenditure of £842 billion. Unless the government raises more revenue through higher taxes, this will likely require further borrowing.

Increased public spending can produce advantageous economic outcomes. A school of economics known as Keynesianism states increased fiscal spending can increase demand over the short run and produce higher economic growth. However, not all public spending is alike and there is a qualitative difference between borrowing to invest in areas such as infrastructure and borrowing to cover general government spending. Likewise, the original theory envisioned debt-fuelled spending should only occur in periods of recession not at the top of an economic cycle.

Advocates of debt funded investments in public services could quite reasonably point to the fact that we are in a period of exceptionally low interest rates, with yields on 10-year UK gilts currently hovering around 0.60%. This means governments can potentially borrow to invest at low rates.

Nevertheless, it is important to remember the value of the UK’s total public debt amounted to around 85% of GDP at the time of the last budget; £1.8 trillion in monetary terms. The chart below depicts the level of the UK’s national debt as a percentage of GDP.  Prior to the financial crash in 2008-2009, the level of national debt never exceeded 40% of GDP.  As the size of the economy fell and public spending rose during the Great Recession, this increased to 65%, reaching a peak of at 87% in 2017 and declining more recently.

Graph: Total Value of UK General Government Debt 1994 – 2019

Source: Office for National Statistics, data as of March 2019

Like all debts, interest must be paid to investors and the monetary value of the UK’s debt interest payments amounted to £41.6 billion according to the Office for Budget Responsibility. Putting this figure into context, the entire UK defence budget amounted to £40.2 billion for 2019.

Some loosening of the fiscal strings could produce benefits to UK economy. Infrastructure spending should provide a much-needed boost to the overall productivity of the economy and an increase in broader expenditure could alleviate some pressures on public services. But, given the overall level of debt a vast expansion in expenditure is unwise.

We are unlikely to see a significant jump in overall levels of spending. The fiscal rules will not be scrapped. Rather, they will be reformed to allow a marginal rise in expenditure and bring forward some investments, while delaying the requirement to balance the books for a few years. Additionally, the present low yield environment allows the government to deploy fiscal stimulus at low cost, potentially providing an overall boon to economic growth.