Stickier-than-expected inflation is leading to higher tax
receipts and lower borrowing that will increase the Chancellor’s
fiscal headroom to around £13 billion in his Autumn Statement.
But this extra headroom is a ‘fiscal illusion’ founded on
pretending the higher inflation that boosts tax revenues won’t
push up spending too, according to new Resolution Foundation
research published today (Monday).
The Foundation’s pre-Autumn-Statement analysis says that while
the Office for Budget Responsibility’s (OBR’s) forecast for the
UK economic outlook will be for stagnation or recession, the
fiscal outlook is likely to improve compared to its forecast in
March.
This largely reflects stickier-than-expected inflation and
stronger wage growth. The Bank of England now expects CPI
inflation will be 6 per cent between 2022-23 and 2023-24,
compared to the OBR’s forecast of just 4 per cent in March.
Looking over the medium term, the latest Bank forecast has
consumer prices rising by around 13 per cent between 2022-23 and
2026-27, compared to around 6 per cent in the OBR’s most recent
forecast.
Higher inflation is already flattering the public finances, with
tax receipts coming in £15 billion higher than forecast six
months into the current fiscal year. This trend is set to
continue, with annual receipts around £40 billion higher in
2027-28 than expected in March.
These higher tax receipts will only be partially offset by higher
interest rates and debt interest costs, which are expected to
rise by around £16 billion in 2027-28, compared to the OBR’s
previous forecast.
As a result, overall borrowing will be reduced and the
Chancellor’s headroom against his fiscal mandate, of having debt
fall as a share of the economy in the final year of the forecast,
will increase to around £13 billion (up from £6.5 billion in
March).
The Foundation notes that while this level of headroom is still
historically low (it’s been £25 billion, on average, since 2010),
it is still likely to lead some to believe that there is now
space for pre-election tax cuts. Scrapping plans to raise fuel
duty next April by 5p, as is very likely, will cost £4 billion.
However, the Foundation cautions that this level of headroom is a
fiscal illusion, founded on the idea that higher inflation and
wage growth can drive up tax revenues without also pushing up
public spending. For example, the government’s current plans have
not been changed to reflect recently agreed public sector pay
settlements, which would cost a further £13 billion.
Looking ahead, public service spending plans were set in cash
terms before the recent inflation surge. This means that per
person spending on unprotected departments, such as the Home
Office, Transport, Justice, and Levelling Up, Housing and
Communities is now set to fall in real terms by 16 per cent, or
£20 billion a year, between 2022-23 and 2027-28.
This is up from 11 per cent at the time of the March Budget, and
would mean cuts being implemented at a similar pace to those
overseen by in the early 2010s – when
per capita spending on unprotected departments fell by 16 per
cent between 2010-11 and 2013-14.
While the Chancellor may choose to allow these fiscal illusions
to run until after the next election, that does not remove the
fiscal reality of the pressures involved, the authors say.
Other decisions cannot be put off, however. These should include
confirming that working-age benefits will rise in line with
prices next April (by 6.7 per cent), and carrying out his welcome
proposals to reform pension funds in order to encourage greater
private investment in UK plc.
The Foundation warns that not uprating benefits in line with
prices would worsen an already bleak living standards outlook for
nine million low-and-middle income families. Freezing benefits in
cash terms would cut the incomes of affected families by nearly
£500 on average, and increase absolute child poverty levels by up
to 400,000.
James Smith, Research Director at the Resolution
Foundation, said:
“As well as causing a huge cost-of-living crisis, Britain’s bout
of high inflation is also flattering the public finances, with
higher pay growth feeding through into higher tax revenues.
“But while this will give the Chancellor the appearance of extra
wriggle room in his Autumn Statement, it is in fact a fiscal
illusion founded on the idea that higher inflation will increase
tax revenues without also pushing up spending on public services.
“While these fiscal illusions may be parked until after the
election, higher public-sector costs and wages cannot be wished
away. It’s increasingly clear that spending plans pencilled in
for after the next election cannot be delivered. Fiscal forecasts
that ignore that reality aren’t worth the paper they’re written
on.”
