Overview

“In normal times the state should not be borrowing to pay for everyday public spending” announced the Chancellor in the March 2021 Budget. Balancing the books might be considered an unfashionable government pursuit of late, but in spite of unprecedented continuing demand on public finances from the pandemic and the UK’s exit from the EU, it remains Treasury policy to close the deficit. This challenge accompanies (and depends upon) a broader one of intervening to stimulate and secure economic recovery in the years ahead.

This paper aims to summarise the fiscal consequences of the government’s plans to achieve this and set out the likely public spending envelope for the rest of the Parliament.

Political Context

On 27 October, for the first time since 2015, there will be a multi-year government spending review, alongside an Autumn Budget, which will set out in detail the spending priorities, changes to the tax system, as well as confirm the overall spending envelope with a departmental breakdown. In a letter to colleagues across government, the Chancellor set out the high-level, political objectives of the Spending Review, which are:

• Ensuring strong and innovative public services – making people’s lives better across the country by investing in the NHS, education, the criminal justice system, and housing;
• Levelling up across the UK to increase and spread opportunity – unleash the potential of places by improving outcomes UK-wide where they lag and working closely with local leaders; and strengthen the private sector where it is weak;
• Leading the transition to Net Zero across the country and more globally;
• Advancing Global Britain and seizing the opportunities of EU Exit;
• Delivering our Plan for Growth – delivering on our ambitious plans for an infrastructure and innovation revolution and cementing the UK as a scientific superpower, working in close partnership with the private sector.

All these priorities – in one form or another – have grown from pledges in the 2019 Conservative manifesto. Even before the pandemic Boris Johnson favoured an investment-led strategy for growth, over the fiscal restraint and austerity of previous Conservative governments. There were no tax rises in the manifesto though, and undoubtedly the pandemic has been useful in steamrolling the usual barriers controlling access to the public purse strings – both in terms of spending and, as recent weeks have shown, tax. Once broken, the Treasury might struggle to put to the genie back in the bottle. Boris Johnson is a big-ticket spender with a penchant for infrastructure and suffers no ideological dogmatism of the sort that defined the Thatcher government’s shrinking of the state. Those on the backbenchers who still subscribe to this philosophy are increasingly politically homeless, with challenges like meeting net zero now fixed party positions attached to inescapably expensive price tags.

One way the Treasury will bargain with MPs is through the distribution of levelling up money, the Towns Fund of £3.6 billion is a good example of led targeted support – now sitting in the rebranded Department for Levelling Up, Housing, and Communities. Not without accusations of pork-barrel politics, it is indicative of a new approach to funding.

There are rumblings of discontent in government itself of course, with a rift appearing to have grown between the Prime Minister and his Chancellor. Tension is unlikely to escalate to the level of rivalry between Blair and Brown, but Boris Johnson’s desire to stay in the job for the next decade must rub against Rishi Sunak’s ambition as his likely challenger. A joint economic unit of special advisers has created a policy bridge between Number 10 and 11, but that could serve to make disagreements more intractable in the long run.

Outside of this circle, the Labour Party are focused on giving workers a pay rise (something in the public sector the government have come unstuck on) and fighting for a fair tax system. These pressures are not easy to dismiss for a government with an uncanny knack of doubling down on unpopular policies before U-turning down the line.

All of this is set against a backdrop of rising inflation, fuel shortages, and supply chain issues, which – compounded by government jobs support winding down – mean individual households are set for a winter of strained finances, and many businesses having to push up their operating costs.

Fiscal Context

Overall, it is intended that the envelope set out in the Spending Review will follow the path of resource and capital spending presented at the Spring Budget, with the addition of some revenue raised by the new Health and Social Care Levy and increase to dividends tax rates announced on 7 September.

Ultimately however, what will determine the final figure is the performance of the economy. GDP appears to have made a better recovery in recent months than originally forecast by the Office for Budget Responsibility (OBR) at the start of the year. If confirmed in October, then there is potential for some fiscal breathing space vis-à-vis March commitments. However, there is still considerable uncertainty in the UK’s projected economic performance into the next financial year, and any favourable consequences for the Treasury (i.e. growth in tax receipts) will likely be deployed to reduce borrowing or kept back as reserves for future Covid measures.

The Chancellor will also need to leave some headroom to account for a rise in interest rates that makes debt more expensive to service. Indeed, the most recent figures available from the OBR show that Government borrowing was higher than expected in August for exactly this reason.[1] Nonetheless, there are indicators that the Treasury is in a better place overall than anticipated; public sector net borrowing totalled £78.0 billion in the first four months of the fiscal year (April-July), £26.1 billion below the monthly profiles in the OBR’s March forecast. Net debt in August stood at 97.6 per cent of GDP. This is 1.6 per cent of GDP higher than a year earlier but 6.6 per cent of GDP below the OBR’s March forecast.

The Chancellor’s letter which promises that “core departmental spending will grow in real terms at nearly 4% per year on average over this Parliament” goes on to state that government “will need to make trade-offs to ensure that this increased spending is focused on the delivery of our key commitments.” Departments have been instructed to carefully prioritise their bids, and have reportedly been told to identify cuts in day-to-day budgets to pay for it (up to 5%). In particular they have been asked to reverse headcount increases that occurred as a result of implementing the UK’s exit from the EU and responding to the Covid-19 pandemic.

Policy decisions and commitments

There is a general consensus (indeed hope, for many households and businesses) that the current tax framework will remain largely in situ until later in the Parliament, not least because 2021 has seen a record number of tax rises already. There is however a sense of keeping the tax system adaptable, and the Treasury might have in its sights the “winners” of the pandemic like supermarkets, online shopping markets, and other technology platforms whose tax contributions may come under increased scrutiny. Similarly, business rates reform and VAT may prove invaluable tools for supporting some of the losers of the pandemic – particularly those in the tourism and hospitality sectors – and areas of the country where tax breaks can assist in the levelling up agenda.

There will be a stronger focus on capital investment, building on the multi-year commitments made at the previous Spending Review in 2020, and plans to deliver £600 billion in gross public sector investment to 2024-25. More broadly, there are numerous expensive policy commitments and challenges that will be at the forefront of the Chancellor’s mind in the autumn Budget including:

• The UK’s transition to a net zero economy
• “Levelling up” areas across the UK outside of London
• Education catch-up premiums for pupils in England
• NHS waiting list reduction
• NHS hospital expansion and new building programme
• Reform of business rates
• A new social care system

There are existing expensive Treasury projects – outside of departmental expenditure limits – due to be wound down, including the Jobs Retention (furlough) Scheme, and the temporary uplift to Universal Credit (which has not been without considerable political opposition), alongside an abandonment of the pensions triple lock uprating guarantee.

Projected envelope

The government have released projected resource and capital departmental expenditure limits (DEL) for the remainder of the Parliament, based on the Spring Budget plus projected new resource spending for Health and Social Care across the UK (DHSC and Barnett consequentials) as part of reforms to health and social care. These figures will be updated at the Spending Review but represent the best estimate so far. As noted above, economic performance will determine if and how the envelope will vary.

(£ billion)

The table shows that core departmental spending will grow in real terms at nearly 4% per year on average over this Parliament – a £140 billion cash increase, and, as the Chancellor points out in his letter “the largest real-terms increase in overall departmental spending for any Parliament this century.” Capital expenditure is not forecast to increase at the same rate, but this is partly explained by the new Health and Social Care funding being categorised under resource DEL (hence boosting those numbers when compared to the March Budget).

Impact

Though final figures are unknown at this stage, the narrative of the 2021 Spending Review is clear: departmental resource reductions to fund capital projects; projects that will fulfil the government’s priorities of levelling up the UK, meeting net zero targets, putting public services and social care on a sustainable footing, and delivering an infrastructure revolution.

There are some immediate direct impacts of the new social care policies on businesses, who will be required to make employer contributions initially on the National Insurance increase before the move to a separate Health and Social Care Levy. A 1.25% increase in dividend tax rates will also apply to shareholders.

Outside of this sit “known unknowns” including the flavour of investment decisions relating to levelling up. It may be that thrusting the Johnsonian platitude into the Department’s name focuses minds on delivery, but without additional funding to support the end of austerity for local government and improve the day-to-day services that people across the country experience, it could be window dressing. There are likely to be measures directed from DLUHC on the reform of local government and devolved powers (including on spending itself). There are also major funding issues for Local Authorities, with an estimated £3 billion shortfall nationally by 2023/24.[2] At least 10 councils have asked to borrow £300 million of emergency cash from central government already, with many others making large spending decreases.

While the tax system is not expected to change significantly (outside of implementation of preannounced measures), and the DELs are expected to roughly align with the March Budget models, exactly where infrastructural investment is deployed to give life to the Chancellor’s priorities will be the key exercise of the Budget.

There are also longer-term strategic decisions that must be fleshed out and funded. Global Britain has taken a knock with the botched withdrawal from Afghanistan, and while the recent “Aukus” defence pact renewed friendships in Washington and Canberra, it has soured them in Paris and Brussels. There is no detail on how the Health and Social Care Levy will be practically applied to deliver social care, and thus no estimate of how much it will need to be supplemented by regular taxation.

There will also be extraordinary demand on the health services as cancelled procedures are reinstated and the repercussions of the population’s worsening health due to the pandemic adds to demand. Changes to commuting patterns will have implications for the subsidisation of the railways, the commercial rental market and business rates.

Traditionally the Treasury likes to roll the pitch on big changes to the fiscal framework ahead of major announcements – though September’s Health and Social Care Levy launch shows what happens when a determined government bypasses testing the water and drops a policy straight in the deep end. Corralling troops to accept once-in-a-generation policy change at short notice is impressive but not an easy feat to pull off twice. Choosing to announce this earlier in the year may have been a ploy to avoid it sinking the rest of a Budget, but it also shows the government is still on an emergency footing and willing to make ad hoc adjustments outside of the formal fiscal events. For these reasons, the likihood of the public being blindsided by snap tax changes is relatively low, and businesses will be hoping the only surprises are in the expenditure column of the red book.

Daniel Regan

Account Director, Public Affairs

For further information on the spending review and how it could impact your business, contact Alan Boyd-Hall: alan.boyd-hall@grayling.com

[1] Office for Budget Responsibility. Commentary on the Public Sector Finances: August 2021. 21 September 2021.

[2] BBC News. Covid leaves UK councils with £3bn financial black hole. 9 July 2021.