The Chancellor and Shadow Chancellor have both outlined the fiscal targets that they would seek to adhere to. Mr Javid has chosen to adopt a forward-looking rolling target aimed at current budget balance. In other words, day-to-day spending could not exceed total revenues. This is very similar in nature to Mr McDonnell’s longstanding current budget target.
In March the OBR forecasts a current budget surplus of £37 billion in 2022–23 potentially suggesting plenty of room for spending increases or tax cuts. But our analysis suggests that a combination of accounting changes and spending increases already announced means that that headroom has now gone. Adhering to these targets would leave next to no room for significant increases in day-to-day spending unless taxes rise to pay for it.
Yesterday saw the Conservative Party commit to a large (£20 billion per year), and the Labour Party commit to an even larger (£55 billion per year), increase in investment spending. Both Chancellor Sajid Javid and Shadow Chancellor John McDonnell have also announced a new set of fiscal targets. A key part of these now has much in common. Since 2016 Mr McDonnell has said he would have a forward-looking rolling target for total receipts to exceed day-to-day spending five years out. Today Mr Javid has said he would have similar target, albeit one that operates on a three year horizon. For both compliance will be a challenge.
Back in March the Office for Budget Responsibility forecast that in three years’ time (in 2022–23) total receipts would exceed day-to-day spending by £37 billion: i.e. there would be a current budget surplus of that magnitude. This might suggest that both the Conservatives and Labour would have plenty of headroom against their current budget targets and that perhaps we could look forward to net giveaways on the current budget in their forthcoming manifestos. But the outlook has deteriorated since March:
- Significant classification and methodological changes have reduced this surplus by around £18 billion. These include an increase in estimated depreciation (£10 billion), a fall in recorded interest on student loans (£4 billion), correcting for an error in corporation tax receipts (£2 billion) and a change to the accounting of some public service pension schemes (£2 billion).
- The September Spending Round boost to spending, with no increase in tax, reduces the surplus by around £15 billion. (This assumes that departmental spending continues to rise in real terms by enough to cover commitments the government has made for spending on schools and the NHS in England.)
These two changes alone are almost enough to wipe out what looked like a healthy surplus back in March. But in addition replacing EU spending in the UK could, over and above the payments negotiated under the new Withdrawal Agreement, require additional funding of around £2 billion.
The overall effect of these changes would, on our estimates, be sufficient to wipe out the forecast current budget surplus in 2022–23. There is a reasonable amount of uncertainty around the exact numbers not least because some of the methodological changes are very technical in nature.
Greater investment spending would, at least in the near term, boost demand in the economy and therefore revenues and – to the extent to which it was spent well and managed to increase potential growth – could also have an enduring positive impact on the economy. But higher investment spending would also increase depreciation and, since it is financed through higher borrowing, increase debt interest spending.
Overall the broad message is that to be able to comply with a target for not running a deficit on the current budget, significant tax cuts or increases in day-to-day spending need to be paid for not by further increases in borrowing but instead by tax rises or spending cuts elsewhere. This was the intent – but not, at least in our judgment, the reality – of Labour’s 2017 general election manifesto. And we wait to see whether commitments to cut tax, or to increase spending on areas such as social care, are in the Conservative Party manifesto and if so whether they identify credible ways to finance these that do not involve higher borrowing.
Green Budget forecasts - update
We have also taken this opportunity to update our October 2019 Green Budget forecasts for the public finances, in particular taking into account the slightly weaker near-term path for growth in the forecasts published today by the Bank of England. We have also included a forecast for the current budget surplus. Note due to the technical nature of some of the methodological changes there is a reasonable amount of uncertainty around the exact numbers. These updated forecasts are available here.