EY ITEM Club UK Budget preview
Despite a gloomy OBR forecast, now is not the time for further austerity.
We expect the Office for Budget Responsibility’s fiscal forecast to reduce the Chancellor’s margin for error against his fiscal mandate, providing Mr Osborne with a dilemma; does he move forwards with a wafer-thin buffer, or does he tighten policy to remain on track for a £10bn surplus in 2019-20? Though signs of faltering economic growth would favour taking the first option, the Chancellor has recently hinted that he will opt for the second, with deeper cuts to government spending a possibility.
Revisions to the historical data and evidence of a loss of momentum around the turn of the year mean that downward revisions to the OBR’s forecast for GDP growth in 2016 are certain. We expect growth to be revised down to 2.2%, bringing the OBR into line with the consensus of independent forecasters, but a move to as low as 2.0% is possible. However, there has been little evidence to justify any change to the OBR’s longer-term forecast for potential output, so downgrades to the near-term growth forecast should largely be offset to upgrades in later years.
The reduction in borrowing through the fiscal year to date has lagged some way short of the pace predicted by the OBR’s full-year forecast. Some of this shortfall reflects timing effects and is likely to be clawed back over the final two months of the fiscal year. However, with tax revenues lagging a little short and a small overspend on investment looking likely, we still expect the OBR to revise up its forecast for borrowing in 2015-16 from £73.5bn to £77.5bn. Weaker nominal GDP growth, higher borrowing and delays to asset sales may also see the supplementary target missed.
Beyond this year the fiscal forecasts will have to allow for shifts in a large number of moving parts, despite the short period of time that has passed since the OBR’s previous forecast. Weaker nominal GDP growth, lower oil and equities prices and softer earnings growth all point to the OBR having to scale back its expectations for tax revenues. However, this bad news will be mitigated by the prospect of lower government spending due to the impact of lower gilt yields and inflation on debt servicing costs. In aggregate and prior to policy changes, we expect the OBR to reduce the projected budget surplus in 2019-20 from £10.1bn to around £4bn, more than halving the Chancellor’s margin for error against his fiscal mandate.
In theory the Chancellor’s room for policy manoeuvre is fairly limited. Last year’s political storm over planned welfare cuts suggests that this area will be left alone. And departmental spending plans for the next four years were set in November’s Comprehensive Spending Review (CSR). Moreover, the Government’s ‘tax lock’ rules out changes to the main tax levers.
But the Mr Osborne has already hinted that a deteriorating fiscal outlook means that he will be on the lookout for fiscal support. And he will want to fund any ‘giveaways’, which could include a further rise in the tax-free allowance. The Chancellor has suggested that further spending cuts may be necessary, although these would worsen an already fragile economic situation and would require reopening the CSR. Revenue-raising is likely to take some of the strain. Reforms to the treatment of tax relief on pension were set to provide a potentially lucrative opportunity. But this option may now be off the table.
Another possible ‘takeaway’ is the introduction of a new tax on sugary soft drinks. The health benefits of such a tax are questionable, given the extent to which it might merely shift consumption towards equally (or more) unhealthy alternatives. But recent support for a ‘sugar tax’ from Parliament and health bodies and the cost to the NHS from health problems related to excessive sugar consumption would give the Chancellor cover for levying a new charge.
Given the extent to which petrol prices have fallen in recent months, the Budget would seem an opportune time to increase fuel duties, which have been frozen in cash terms since 2011. A rise in line with inflation would have only a modest effect on pump prices and re-establish the norm of increasing duties in a relatively painless manner. Meanwhile, implementing the recommendations on business tax arising from the OECD’s BEPS project may yield some extra revenue from companies.