Good afternoon from New Economy Brief.
In her Spring Statement on Wednesday, the Chancellor announced £8.4bn of cuts to welfare and departmental spending in order to meet her fiscal rules. Her decision was based on forecasts prepared by the Office for Budget Responsibility (OBR), which the OBR itself warns are highly uncertain. Most controversially, over half of these spending cuts have come from reducing disability benefits.
Over the next two weeks New Economy Brief will be delving into the OBR’s forecasts and the government’s response to them. This week we’re exploring the potential effect of the cuts on economic growth and the long-term sustainability of the public finances. Next week we’ll look at the impact of the cuts on the social security system.
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Why did the Chancellor cut spending?
The OBR’s latest forecast estimated that, without corrective policy action, government revenues would fall £4.1bn short of meeting day-to-day spending needs by 2029/30. The OBR largely attributes this to the rising cost of servicing government debt, driven by higher interest rate expectations, and to lower-than-expected tax receipts. It would put the government in breach of Reeves’ self-imposed day-to-day spending rule, and to avoid this – to ensure the OBR judges she is likelier than not to meet the rule – she has cut £3.6bn from departmental budgets and £4.8bn more from welfare. These changes leave the Chancellor with £9.9bn in ‘headroom’ – the amount by which government revenue is expected to exceed spending in the OBR’s most likely scenario, and a 54% chance of meeting her rule.
Why didn’t she raise taxes instead? Despite repeated calls from campaigners, backbench MPs and distinguished economists, the Chancellor avoided plugging the hole with tax increases rather than spending cuts. This was probably due to two manifesto commitments: 1. Holding only one fiscal event per year (the Autumn Budget); and 2. Not raising taxes further on ‘working people’.
What are the consequences of this decision? Many economists have argued that spending cuts harm the public finances in the long run, as they suppress growth and therefore also the government's ability to grow its tax base. Analysis from the Trades Union Congress found that spending cuts reduced growth in 32 of 32 advanced economies that tried them over the 2010s, which had self-defeating effects on debt sustainability. New analysis from NEF has calculated that the negative impact of the cuts announced in the Spring Statement could wipe out any 'savings' because to "the cost of poverty and public service cuts are likely to spill over and damage growth."
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Short-term bookkeeping vs long-term planning.
The UK’s current fiscal framework has some strong political incentives for the Chancellor to make short-term decisions in order to satisfy her choice of fiscal rules, even if this harms the public finances in the long term. A major problem is tweaking fiscal policy in order to meet a highly uncertain OBR forecast of how much ‘headroom’ there might be in 2029/30.
The OBR’s forecasts are extremely uncertain and prone to revision. OBR staff interviewed for their recent external review noted that this focus on short-term ‘fiscal headroom’ is “unhelpful, as it threatens to obscure broader assessments of UK fiscal sustainability… this focus on short-term fiscal space has gone hand-in-hand with very limited attention on long-term fiscal sustainability”. The reviewers also note that estimating the effect of the government’s policies on the rate of productivity growth is ‘notoriously hard’ to predict – and yet this is the prime objective of the £100bn additional spending in the Autumn Budget, and a key driver of fiscal sustainability, as growth leads to higher tax revenues for the government. (IPPR and NEF have challenged the OBR for underestimating the effects of this investment on growth.)
Why is this a “frankly ridiculous position”? Changing fiscal policy in order to meet highly uncertain forecasts of headroom is a ‘frankly ridiculous position’ in the words of Sir Charles Bean, former OBR Budget Responsibility Committee member and deputy governor of the Bank of England: “The OBR forecast embodies all sorts of adjustments, judgments – it’s pretty flaky … I think we want to get away from this idea that we continually have to be neurotically changing taxes and spending to try and control this OBR forecast so that it’s hitting our target.” A new briefing from Invest in Britain gives a similar warning: “Cutting spending to increase short-term ‘headroom’, based on highly uncertain and contested forecasts, will actively harm growth and undermine the government's missions.”
Was all this really necessary? As the Institute for Government (IfG) has argued, past borrowing forecasts have an average error of £15bn, more than the total value of changes announced yesterday. Given this, IfG suggests that “Reeves would be wiser to weigh up policy options over the summer and respond more strategically at the Budget.” They note this “would not be entirely without precedent” as George Osborne did not take short-term action to correct a projected breach of his debt rule in March 2016.
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Where do we go from here?
The government will be hoping that its growth plans start to bear fruit before the OBR’s next Economic and Fiscal Outlook in six months’ time, and that the economic picture looks brighter by the next Budget in Autumn. This could allow the Chancellor to avoid more cuts and quell further dissent from Labour MPs. But with potentially bruising local elections around the corner in May and a difficult Spending Review to navigate in June, Autumn feels like a long way away.
And there have already been media reports of tensions between the government and the OBR. According to the Times, “Ministers and senior allies of Sir Keir Starmer have expressed concerns about the accuracy of its forecasts and the constraints it puts on the government’s attempts to galvanise the economy. Some Labour backbenchers are also frustrated with the OBR, with one anonymous MP telling the Guardian that “The parliamentary Labour party needs to be raising its voice about the OBR and the fiscal rules.”
Global uncertainty is here to stay. The rapidly deteriorating geopolitical situation and global growth outlook can easily damage the UK’s macroeconomic outlook and derail the government's fiscal plans again (e.g. the OBR thinks Trump's tariffs could knock 1% off UK GDP), necessitating further cuts under the current fiscal framework. Without reform, we could be back here again in the Autumn, and at every fiscal event after that unless growth appears... Something has to give: if the PLP won’t stomach further cuts then it's either the Chancellor’s position on tax, or the fiscal framework itself.
The fiscal framework is harming debt sustainability. As previous OBR reviews have noted, the greatest risks to the UK’s public finances come from long-term issues like climate change, declining population health and demographic shifts. Mitigating and adapting to these risks requires preventative spending, with costs likely to be greater the longer we leave it to respond. The current fiscal framework, with its cycle of short-term forecasts driving decision-making, is poorly equipped to help us get ahead of these risks, which yesterday’s outlook warns are “putting the public finances on an increasingly unsustainable path.”
Time to review the fiscal framework? The most recent external review of the OBR suggests that the organisation ‘should move towards a broader assessment of fiscal sustainability.’ But it is ultimately the government’s responsibility to reform the fiscal framework and move away from the arbitrary and short-term timescales that discourage past, present and future Chancellors from making long-term improvements to the public finances. The fiscal framework is a tool to help the government balance its growth objectives with the need to keep the public finances on a sustainable footing. Given its ongoing failure to serve either purpose, there is a strong case for review.
Monetary and fiscal coordination. New research from the New Economics Foundation (NEF) explores the history of monetary and fiscal coordination in both the UK and the EU, showing how it can play a vital role in controlling inflation and investigating how it could be improved.
GB Energy’s role in the green transition. A new report by the Institute for Public Policy Research (IPPR) sets out how the government can ensure GB Energy delivers secure, clean and affordable electricity – its founding objective – and how it can play a more important role in the electricity sector in the future. IPPR argues that GB Energy will not reach its full potential if it “is reduced to a pure public financing entity”, and will struggle to lower bills or promote investment in renewables if it does not own and operate its own clean energy assets.
Building public luxury. The Autonomy Institute has launched a new Universal Basic Services (UBS) hub, with its first report outlining how UBS could unlock ‘public luxury’ – the idea that everyone has access to a ‘good life’ – through revitalised and expanded public services. The Institute has also published new polling conducted by Survation which finds that a huge majority (72%) of the population would rather the Chancellor prioritised spending on public services or clean energy than the military.
Doom loop to bloom loop. Cutting social security will undermine all five of the government’s missions, with poverty and ill health undermining productivity, social cohesion and growth, according to the Fairness Foundation’s Will Snell. Instead of this vicious circle or “doom loop”, Snell says that higher taxes, particularly on wealth, could reduce inequality, boost public services and security, and create work opportunities and growth.
The false economy of austerity. Social security cuts show that the government has failed to learn from the “moral and economic disaster” of austerity, argues Dominic Caddick, an economist at the New Economics Foundation (NEF). Caddick says that even the International Monetary Fund, originally a proponent of austerity, has “backtracked” and found that “austerity measures lead to debt-to-GDP measures increasing not decreasing.”
Paying for a decade of national renewal. Labour needs to embrace an alternative pro-equality and tax-reforming strategy aimed at economic reconstruction and faster social progress instead of “bet[ting] the house on growth” argues a new report by Stewart Lansley for Compass. Lansley says that faster growth alone is only a small part of how to improve the UK economy, and that “making the private sector take the lead in recovery risks … allowing excessive private returns and restricting the progressive capacity of the state”.
Global shipping: mega profits, micro taxes. The profits of the world’s 10 largest public shipping companies reached an all-time high of $300bn in the five years from 2019-2023, according to a new report by Opportunity Green. Yet they pay less than half the average tax rate: the paper finds that these 10 companies had an effective tax rate of just 9.7%, far below the average global corporation tax rate of 21.5%, and below the new Organisation for Economic Co-operation and Development (OECD) global minimum tax rate of 15% (from which shipping is exempt).
The outlook for living standards. The Joseph Rowntree Foundation (JRF) argues that families on the lowest incomes are “set to bear the brunt of the pain” from the Spring Statement and that a strategy for targeted living standards improvements needs to be at the heart of its growth mission. JRF suggests creating a ‘minimum floor’ in Universal Credit so that there is a line beneath which nobody can fall.
