Better than expected revenues over the last 18 months have left the Treasury with more money. In the 2018 Budget, the Chancellor, uncharacteristically, reallocated this windfall to future spending. The Office for Budget Responsibility (OBR), in its attempt to address its recent admission that it had been consistently too pessimistic, is also now forecasting additional future revenues. So how much more is Chancellor Philip Hammond forking out? By the end of the current Parliament, the government will spend an additional £17.9 billion while raising just an additional £280 million in taxes.
But remember, this is relative to the spending plans already set out. That is crucial to assessing the validity of Mr Hammond’s proclamation that ‘austerity is coming to end’. It’s no more than rhetoric and the politically-neutral OBR’s report tells a different story.
The Chancellor put together the Autumn Budget knowing that he borrowed over £5 billion less in the 2017-18 fiscal year than he thought he had at the time of the 2018 Spring Statement, and that borrowing between April and September in the current fiscal year was 35% lower than during the same period last year – twice as big a reduction as forecast.
Although earlier pledges to the NHS and to freeze fuel duties had to be honoured, the Chancellor still put through some additional expenditure items, including an extra £1 billion on cyber and nuclear defence, £560 million to local governments and £420 million to fill in potholes! There is extra money for house-building, and the personal allowance and higher rate thresholds for income tax will be increased to £12,500 and £50,000 a year earlier than planned.
It’s still going to get more austere
But a net giveaway Budget does not reverse eight years of austerity. Although total real spending has fallen by just 1.5% from a peak of £800bn in 2010-11, this must be seen in the context of an increasing – and increasingly aged – population that requires more government services, not fewer.
Mr Hammond previewed the forthcoming spending review by announcing that day-to-day spending limits will rise by an average of 1.2% a year. However, the OBR clearly illustrates that most of this will go to the Department of Health: real expenditure limits per capita will not rise at all once we exclude the NHS. Moreover, the government has discreetly slashed the money set aside for long-term capital spending in the coming years. According to the OBR, the capital spending budget has been cut by £7bn per year in 2020-21.
The fiscal rules
The Chancellor delivered his net giveaway budget while lowering the national debt to GDP ratio by 2020-21 and keeping the structural deficit below 2% of national income. But he had to jettison one of his fiscal rules and a manifesto pledge – to run a fiscal surplus from the mid-2020s. Reneging on the rule should not concern investors as we have had 12 fiscal rules since 1997 and 10 of those have been broken or abandoned. The UK is not known for consistent budget surpluses. It has been seven decades since there were four consecutive years without a deficit. They were not needed as strong growth kept the debt to GDP ratio on a downward path until 2008 (although wayward inflation in the 70s and 80s also helped – not something we would want to repeat!)
On Budget day, gilt yields were unmoved. Unsurprising given that the UK has the second lowest public debt to GDP ratio among the G7 economies.
Raising the minimum wage
The 4.9% rise in the national living wage to £8.21 per hour will help lower-income households. However, we do not expect the higher living wage to exert significant pressure on inflation. We must remember that the relationship between wages and prices is historically very weak – close to zero between 2001 and 2016.
Tax on big tech
The Chancellor unveiled a new digital services tax aimed at technology platform providers (think Facebook, Alphabet’s YouTube, Apple’s App Store) with large revenues. A new tax on business is not something one would typically expect from a Conservative Chancellor, especially a tax designed with explicit interventionist intentions. However, it could be seen as correcting a market distortion created by the tax loopholes online companies use so deftly.
Do we need Brexit ‘headroom’?
The Chancellor maintained headroom of around £15bn against his fiscal rule to reduce the structural budget deficit to 2% of GDP by 2020-21.
Post the EU Referendum, business investment has been very weak indeed, barely growing at all since June 2016, while it has grown strongly in other major economies, such as the US and Germany, which the UK had been keeping pace with in the few years before.
The size of the UK’s trade in services relative to the size of its economy is bigger than that of any other large advanced economy. Its manufacturing is one of the most specialised, involving above average use of overseas supply chains. Even if Brexit eventually turns out to be a great change of direction, the disruption to regulatory regimes and supply chains that a hard Brexit would entail over the short to medium term means that the likelihood of investment increasing meaningfully in such a scenario is very low indeed. So, in short, the Chancellor is wise to keep some fiscal headroom.
Economically, by preserving ‘business as usual’ for three years and giving more time to arrive at a trade agreement, a transition extension would likely be positive for the economy. That said, it sustains the cloud of uncertainty and could hold back investment decisions for longer too.
It may be a very long-running show – and it may have become boring to some – but we do not think this bull market will be cancelled in the coming months.
The Chancellor delivered on the Conservative Party’s manifesto a year earlier than promised by increasing the personal allowance to £12,500 and the higher rate band to £50,000 from 6 April 2019. Scotland sets its own rates of income tax, as will Wales from 6 April; the respective governments will announce their Budgets later this year.
The individual savings allowance (ISA) remains unchanged at £20,000 per annum. The junior ISA and the child trust fund (CTF) subscription will increase with CPI to £4,368. A consultation next year should ensure CTF accounts retain their tax-free status after maturity.
The capital gains tax (CGT) allowance will increase by £300 to £12,000 from 6 April.
Despite the usual pre-Budget scuttlebutt, there were no changes to the annual pension allowance - it remains at £40,000.The money purchase annual allowance stays at £4,000 and there were no changes to the high income allowance taper rules.
The Chancellor continues to limit total pension savings with the lifetime allowance, which is rising in line with CPI to £1,055,000.
As expected, the inheritance tax (IHT) nil rate band remains frozen at £325,000 until April 2021. The residence nil rate band will increase from £125,000 to £150,000, allowing couples who meet the criteria to leave up to £950,000 to future generations free from IHT.
31 October 2018