Commenting on today’s Budget, Peter Arnold, EY UK chief economist, says: “What had been trailed as a ‘mini-Budget’ proved much more ‘major’ than ‘mini’. The biggest reduction in the tax burden since the 1970s and potentially significant reforms around planning and infrastructure added up to a much bigger fiscal event than expected. The cost of the tax cuts is undoubtably large, adding up to £45bn per year by the middle of the decade. But this will prevent the tax burden from rising to what would have been a 70-year high and could boost disposable incomes.
“But while today’s announcements should be helpful in supporting demand in the short-term and lifting depressed consumer and business sentiment, the difficulty of shifting the economy’s underlying rate of growth means they might struggle to have a significant impact on long-run GDP growth. On that front, a crucial factor, and a potentially serious risk to the Government’s growth agenda, will be delivery. Borrowing-funded tax cuts in a capacity constrained environment could simply translate into inflation if proposed supply-side reforms around planning and accelerating infrastructure projects fail to get off the ground. Dealing with that delivery risk will be key. And looming over today’s announcement is an issue beyond the Government’s control: energy prices.”
EY ITEM Club Budget Reaction
- The tax cuts announced today mean public borrowing will be higher and the Bank of England may raise interest rates more quickly than otherwise. But the new measures will rein back what would have been a significant rise in the tax burden at a time when the UK and global economies face the risk of recession. They might also help to lift declining consumer and business confidence. But whether the biggest reduction in the tax burden since the 1970s proves consistent with sustainable public finances will depend on factors – particularly energy prices – largely out of the Government’s hands.
- The risks of increasing borrowing to finance tax reductions needs to be weighed against the risks of inaction. Under previous plans, the tax burden as a share of GDP was forecast to rise to the highest in 70 years. Tax cuts should provide a short-term boost to demand, although their impact, and that of the other measures announced today on the economy’s growth potential, might prove underwhelming.
- A looser stance for fiscal policy will probably mean inflation being higher in the medium-term, so could prompt the Bank of England to raise interest rates faster than otherwise. This will offset any boost to the economy from lower taxes. But a different balance between monetary and fiscal policy would be expected to support sterling and give monetary policy more potency if the economy were to encounter further challenges in the future.
- The extra government borrowing to finance tax cuts might push borrowing costs up. That said, the ownership structure of gilts should offer some insulation against investor nervousness. Although the Bank of England is now running down its stock of gilts, it still owns around a third of the total issuance. Moreover, sterling weakness makes government bonds cheaper to foreign investors, which seems likely to provide some support to demand for government debt.
Martin Beck, chief economic advisor to the EY ITEM Club, says: “In today’s not-so-mini-Budget, the Chancellor delivered what had been a widely-trailed package of tax cuts worth £45bn by 2026-27, including the cancellation of the planned rise in corporation tax next April and a reversal of last spring’s increase in National Insurance Contributions. But there were also some surprises, notably the bringing forward of 2024’s cut in income tax to next year, the scrapping of the higher 45% rate of income tax and a sizeable cut in stamp duty for many buyers.
“These measures will add to the already major prospective uplift in government borrowing from the cap on energy bills for households and businesses coming into effect in October. With gilts yields at a decade high and sterling falling significantly in recent months, more borrowing presents risks, and its outcome will depend on the economy’s future growth performance.
“The fiscal backdrop to the mini-Budget is not all bad. The deficit has been improving, more than halving between 2020-21 and 2021-22. Furthermore, by raising nominal prices and incomes, inflation is boosting tax revenues in cash terms, particularly from the freeze in income tax thresholds, and potentially to a greater extent than the OBR is forecasting. And there is an economic case for lower taxes now. The impact of high energy prices and high inflation in general means economic growth is slowing across the world and it appears possible that the UK economy could already be in recession. Tax cuts are expected to reduce the risk of a prolonged downturn by boosting the resources of the private sector.
“Moreover, pursuing previously planned tax rises against a weak economic backdrop would have carried risks of its own. Under previous plans, the tax burden as a share of GDP was forecast to rise to the highest in 70 years, potentially worsening the economic slowdown.
“Today’s tax cuts could likely provide a short-term boost to demand. But their impact – and that of the other growth measures announced around planning and infrastructure – on the economy’s longer-run potential, will probably be small. The evidence suggests that an economy’s underlying growth rate is very hard to shift, and while the decision to cancel next April’s rise in corporation tax and maintain the Annual Investment Allowance at £1m is expected to support business investment – and while lower taxes in general may incentivise work and economic activity – the EY ITEM Club doesn’t think today’s measures will prove a game changer for GDP.
“On that front, the crucial factor will be what happens to energy prices. Were prices to maintain the substantial falls of recent weeks, the energy price cap would likely prove much less expensive than expected, economic activity could revive and lower taxes could be consistent with a sustainable fiscal position. But were energy prices to rise again, today’s measures could be seen in a different light.
“As hinted by the Bank of England in September’s policy statement, looser fiscal policy and the potential inflationary effects are likely to be met with tighter monetary policy. But given substantial disinflationary forces now in play – notably, falling commodity prices, including a fall in wholesale gas prices of over 50% in the last month – the EY ITEM Club doesn’t expect tax cuts to affect interest rate increases to any great extent. Moreover, a different balance between monetary and fiscal policy could support sterling and give the Bank of England more leeway to cut rates in the future were the economy to experience more challenges.
“The extra borrowing to fund tax cuts risks pushing up interest rates on government debt. But the ownership structure of gilts should offer some insulation against investor nervousness. Although the Bank of England is now running down its stock of gilts, it still owns around a third of the total issuance. Meanwhile, UK insurance companies and pension funds hold close to 30% of gilts. These institutions require the guaranteed income stream provided by long-dated gilts to match their long-term liabilities, so are effectively captive buyers. The near-30% of gilts held by foreign investors could be vulnerable to a sell-off. But sterling weakness makes these assets cheap to foreign investors, providing a natural stabiliser to weaker demand.”
