Fiscal illusions? the Autumn Statement unpacked

Good morning from New Economy Brief.

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The Chancellor delivered his Autumn Statement yesterday, claiming that the government’s economic plan is working and the UK economy has turned the corner. However, with growth forecasts revised down, inflation revised up, and public services facing swinging cuts in coming years, critics have accused the government of gaming their fiscal rules with implausible plans.

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The Statement’s centrepiece was a package of personal and business tax cuts, which the government claim will reward work and improve investment. What Chancellor Hunt didn’t mention is that these will ultimately mean public spending cuts of a similar pace to those seen in the Cameron/Osborne years, all pencilled in until after the general election and widely thought to be politically undeliverable. 

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This week’s New Economy Brief unpacks the big stories from the Autumn Statement.

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‘Headroom’ and political choices. 

Media coverage in the week before the Statement was dominated by speculation about how the government might choose to spend their ‘headroom’. This is a measure of how much leeway the government has to cut taxes or increase spending without breaching its chosen fiscal rules. (Reminder: the government’s fiscal rule is to have national debt as a percentage of GDP fall at the end of a rolling five-year period.) Where this headroom comes from, and how the government has used it, is in many ways the central story of the fiscal event.

Explaining the source of ‘headroom’. The Office for Budgetary Responsibility (OBR), the official, independent forecaster for the government’s spending plans, explain that an extra £27bn of ‘headroom’ has opened up as higher-than-expected inflation has increased the nominal value of tax receipts. (This happens through a concept known as ‘fiscal drag’ – as nominal incomes rise while tax band thresholds stay the same, the result is big increases in the tax take.) At the same time it has eroded the real value of departmental spending - this is forecast to be £19bn lower by 2027/28 than it was in March. 

What did the government choose to ‘spend’ this ‘headroom’ on? Mostly on two big tax cuts – a 2p reduction in National Insurance Contributions and making ‘full expensing’ (a tax break for businesses that invest in certain types of capital) permanent. This left them with £13bn of headroom remaining against the fiscal rule at the end of the forecast period - slightly up from the £6.5bn in March, but still lower than average. 

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‘Austerity by stealth’ to pay for tax cuts.

But is this really a case of the government cashing in on economic good news? Buried in the OBR’s Economic and Fiscal Outlook is what may be the defining story of the upcoming general election: the scale of predicted cuts to public services, and how these cuts are paying for pre-election giveaways. (For an explainer on the effects of inflation on public spending, read NEF’s Austerity by stealth.)

‘Fiscal illusions’. The Resolution Foundation warn that any forecast of the amount of ‘headroom’ assumes “implausibly low departmental spending”, meaning that “any extra policy space will be a ‘fiscal illusion’”. Inflation is now expected to remain higher in the UK, and for longer, than previously forecast. This is eroding the real spending power of government departments and putting more pressure on public services as costs rise because of higher-than-anticipated pay awards. Consequently, the government’s planned spending cuts, baked in for after the election, are coming under fire for being even more politically undeliverable. Even the OBR note that “the outlook for departmental spending is therefore a significant and growing risk” to the accuracy of their forecasts…which is about as they come to saying that they don’t believe these cuts will happen. 

Cuts on a similar scale to Osborne-era Austerity. The Resolution Foundation note that the spending power of unprotected departments will take a 16% cut over the next five years, “which would mean austerity-level cuts being implemented at a similar pace to those overseen by George Osborne in the early 2010s.” (Reminder: 335,000 excess deaths were attributable to austerity between 2012-19.) The Institute for Government warn that “after a decade of budgetary constraint, there is no more meaningful fat to trim in public services”, and argues that the Chancellor "has abdicated his responsibility for public service performance." Alongside day-to-day spending, the Chancellor also announced a new long-term cash freeze on public sector investment, which the Institute for Fiscal Studies’ (IFS) Paul Johnson explains “is not good for growth…We already have public sector investment well below that in most comparable countries.”

These cuts have consequences. The Centre for Progressive Policy calculated that public services will need an additional £142bn in spending by 2030 just to maintain services at their current (already struggling) levels. As Sam Freedman notes, it is "important to remember when commentators talk about "headroom" this week re autumn statement that "headroom" is predicted on assuming that the state will not fix this or any other of our numerous social problems", such as growing hospital waiting lists and school roofs falling in. (Read Rafael Behr’s helpful explanation that the real objective of these cuts is to lay a trap for Labour.)

So what’s really going on? The government would like this Autumn Statement to be a story of an improving economy making space for feel-good tax cuts. But it is hard to make this case looking at the OBR’s numbers. As the IFS say: “the public finances haven’t meaningfully improved”. Or as Giles Wilkes puts it: “The government is financially benefiting from a real terms cut to departmental spending, and is using £20bn for tax cuts”. The main story of this statement is pre-election tax cuts paid for by post-election spending cuts.

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The great squeeze on living standards

Going from the macro to the micro, the other main story of the Autumn Statement is what is happening to living standards. Again, the Chancellor was keen to paint a picture of rising incomes, especially for those in work. The combination of stricter benefit conditionality for sick and disabled claimants with increases to benefits, the national living wage and state pension enable the government to frame their choices as in the interests of “working people”. But again the OBR tell a different story, noting that “living standards, as measured by real household disposable income (RHDI) per person, are forecast to be 3½ per cent lower in 2024-25 than their pre-pandemic level…it still represents the largest reduction in real living standards since ONS records began in the 1950s.” 

Why don’t the tax cuts make people better off? The New Economics Foundation’s Jeevun Sandher calculates that, while reducing National Insurance Contributions (NICs) by 2p may give the average worker around £400 a year, freezing tax thresholds costs the workers more – over £650 a year more on average, as more of their income becomes taxable. IPPR calculates that the gains disproportionately flow to higher income households. The irony of cutting real departmental spending to fund a cut in NICs is that increasing them in the first place was framed as a ‘health and social care levy’ to pay for increased demand on the NHS and social care after the pandemic, though this rise was ultimately reversed by Liz Truss and now cut even further by Sunak and Hunt.

What about wages? The government decided to increase the minimum wage to £11.44 per hour, but despite this real weekly average wages are expected to remain below 2008 levels until 2028 (two years later than the OBR expected back in March), representing 20 years of stagnant wages. 

Uprating honoured. Elsewhere the Chancellor trumpeted his decision to uprate social security in line with September’s inflation, unfreeze housing benefit, and honour the state pension triple lock. While these were announced as a package of ‘cost of living’ measures, they were close to the minimum of what the government could be expected to do. The TUC’s Alex Collinson points out that the real incomes from benefits are still £35 a month lower than before the Conservatives came into power.

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Politics trumps economics?

Many commentators note that the government have been ‘saving up’ fiscal headroom to spend it on a pre-election tax cut and win over voters. This fiscal event was clearly constructed with next year’s election in mind, frontloading the good news and pushing the difficult decisions into the next parliament. But if this was the rumoured pre-election tax cut, it is hard to escape the conclusion that it is rather underwhelming. 

A map to a May election? The accelerated introduction of the 2p National Insurance cut sparked speculation in Westminster that the Statement was a roadmap to an early general election next year. However, the chances that voters will feel significantly better off in the near term are remote. The government’s upbeat rhetoric seems out of kilter with the mood of the nation. Polling from Stop the Squeeze reveals that most of the public don’t expect their finances to improve any time soon, and that voters give the government little credit for falling inflation. Meanwhile polling for Tax Justice UK shows the public prioritise public service spending over tax cuts, and the latest British Social Attitudes survey shows only 8% of people support lower taxes and spending on public services. And, as the Resolution Foundation’s Torsten Bell notes, real household incomes will be falling in an election year. 

‍Fiscal fantasy land. What this Autumn Statement also told us is that both major parties will likely go into the next election committed to a set of spending plans that imply eye-watering public service cuts. Labour’s determination not to expose themselves to accusations that they are planning more borrowing or tax rises makes it difficult for them to attack these plans, raising the prospect that the next election will be fought with barely a reference to the issue that will dominate the next parliament – how to save public services from collapse.