Last week’s Budget pleased nobody. But in a few years’ time we may look back on it as the point when the clouds started to lift, says Max King.
Budgets that are universally acclaimed the morning after soon unravel. But those that are widely criticised afterwards stand the test of time. On that basis alone, Philip Hammond’s offering last week, widely greeted with scepticism, deserves a second look. The spendthrifts complained it didn’t represent “the end of austerity” as only health spending was increased significantly in real terms. The puritans noted the national debt as a percentage of GDP wasn’t being trimmed fast enough. Both agreed that, with Brexit approaching, the Budget was just a stop-gap until Armageddon struck or nirvana unfolded.
In truth, Hammond did what he had to do. Raising both the standard and higher-rate income-tax thresholds was a Conservative commitment in its 2017 manifesto. Increasing NHS spending by £27.6bn over five years (22% in nominal terms, perhaps 10% in real terms, taking the annual real increase to 3.4%) was unavoidable, though spending the extra money wisely will, as always with the NHS, be a challenge.
Universal credit is crucial
The extra £2.7bn to ease the introduction of universal credit, which many expected to be scrapped, was more important than it seemed. The relentless rise of entitlement spending has resulted in both a historically high level of overall taxation and a squeeze on departmental expenditure such as health, education and defence. The rise in welfare spending is due largely to the lack of incentive in the current system for part-time workers to work longer hours, given the loss of benefit payments that ensues. The introduction of universal credit is crucial to restoring that incentive. But the previous chancellor made the mistake of
trying to combine structural reform with short-term savings in welfare costs. Hammond, rightly, takes a longer-term view – spend now to save later.
Elsewhere, spending increases were modest. The national living wage was increased by nearly 5%, benefiting those who gain little from the rise in tax thresholds. Balancing the government’s books may have been postponed, yet again, but the deficit this year at 1.2% of GDP is modest and debt as a percentage of GDP will fall steadily.
Growth forecasts are too gloomy
Where the numbers get interesting is future projections. The Office for Budget Responsibility forecasts economic growth of just 1.3% this year and 1.6% next, numbers likely to be exceeded. This would bring in extra tax revenue and, therefore, lower than forecast budget deficits. Better-than-expected tax receipts this year financed the extra NHS spending but Hammond will have a much freer hand with future windfalls, which should finance increased expenditure in other departments, bringing austerity to a more conclusive end. Or he could simply let the budget deficit undershoot, bringing down debt as a percent of GDP.
This, however, is not really necessary. The gross national debt may be 85% of GDP, but a quarter of the debt is owned by the Bank of England as a result of “quantitative easing”. Since the bank is a nationalised industry, the government has effectively bought back its own debt in exchange for a liquidity injection into the economy.
This injection may have to be reversed by the bank selling the debt again, as the US is now doing with its “quantitative tightening” programme. But the bank would only do this if banks were significantly to increase lending against a backdrop of already robust growth, thus injecting more liquidity into the economy and threatening inflation if monetary policy wasn’t tightened. Such credit expansion would give growth and tax revenues a fillip, negating the impact of quantitative tightening.
Brexit fears will be unfounded
What about the economic risk from Brexit? The media is expecting an economic crash but crashes are very rare in economics, especially in peacetime. Following the referendum, growth slowed to below 2% and has remained there; it is perhaps 0.5% lower than it would otherwise have been. This reflects the squeeze on consumption from weaker sterling and lower private-sector investment, owing to the uncertainty. Short-term disruption following a no-deal Brexit might cause the economy to dip for a few months but it would soon bounce back. With even a basic deal and in the absence of a global shock, growth would be more likely to pick up than weaken, maybe even recovering the shortfall since 2016.
With the eurozone economy in the middle of another slowdown, the UK could move near to the top of the G7 growth league. With the pressure on public spending eased, more tax cuts, a falling debt burden and a return of the feel-good factor, people may look back on the 2018 Budget as the point at which the clouds started to lift.