IFS responds to Budget 2021

The Chancellor has delivered his Spring Budget and the Office for Budget Responsibility (OBR) has published a new set of forecasts for the economy and public finances. IFS researchers provide an initial reaction to these below.

IFS Director Paul Johnson said:

“What we can be sure of is that Rishi Sunak has spent big again, extending some support right through 2021 at a cost of an additional £60 billion or more. As a result borrowing is now forecast to again be above 10% of national income in the coming financial year. Whether the big fiscal tightening planned for subsequent years will actually happen is less certain. It continues to depend on spending being lower than planned prior to the pandemic. And it also depends on a large increase in corporation tax actually being implemented without additional measures to at least ease its long-run impact. Make no mistake, this proposed increase in the main rate of corporation tax is a big reversal of decades of policy direction and a significant risk. For all the rhetoric about it leaving the headline rate here below that in other G7 countries, our effective tax rate will be relatively high.

Mr Sunak made much of his desire to be honest and to level with the British people. The fact that he felt constrained to raise taxes by hitting companies and through freezing allowances, rather than through more explicit rises in people’s taxes, suggests there are limits to how far he wants to level with us as he attempts to raise the overall tax burden to its highest sustained level in history.”

INITIAL REACTION FROM IFS RESEARCHERS - IN FULL

Public finances

Under the OBR’s central scenario the biggest tax-raising Budget since the first Budget of 1993 is forecast to be sufficient to eliminate the current budget deficit in 2025-26. This would mean that the government would only borrow to invest, with day-to-day spending covered by revenues. Around half this consolidation is achieved by the large increase in corporation tax, and around a quarter by the freezing of income tax thresholds. But the outlook for the economy - and with it the outlook for revenues - remains enormously uncertain: Under the OBR’s downside scenario the current budget is forecast to still be running a deficit of something like £85 billion in 2025-26, in which case further tax rises would be likely if the Chancellor is to balance the current budget within this timeframe.

Isabel Stockton, a Research Economist at the Institute for Fiscal Studies, said:

“A healthy economic recovery, combined with a substantial tax increase, would be enough to allow the government to cover its day-to-day spending with revenues by the middle of the decade, borrowing only to invest. This is one definition of ‘balancing the books’, but this success would be at risk if the recovery falters or tight spending plans - or for that matter the large tax rises announced today - prove undeliverable.”

Public services

Public service spending was not a central focus of this Budget. The Chancellor set detailed allocations for the coming financial year in the Spending Review last November and he left those plans largely unchanged. Under those plans, Mr Sunak is planning to spend £14 to £17 billion less on public services each year after 2021 than he had planned pre-Covid. Given the mounting pressures on the NHS, schools, courts and other services, the credibility of such a tight settlement is questionable. There will certainly be strong pressure for future top-ups.

Ben Zaranko, a Research Economist at the Institute for Fiscal Studies, said:

“The Chancellor largely stuck to his pre-existing plans for public service spending – plans which imply spending less in the medium-term than the government was planning pre-pandemic, and rest on the assumption that the NHS will revert to its pre-Covid spending plans after March 2022. Given the substantial and mounting pressures on the NHS, schools and other services, one has to wonder whether these spending totals have been set implausibly low so as to flatter the public finance forecasts.”

Benefits

The government has extended the temporary £20 per week boost to universal credit (UC) and working tax credit by six months, benefiting around 6.5 million families. It delays until October the point at which benefit receipts will fall from month to the next, by more than 20% for some. Clear advance communication of this to families will be crucial before the time comes. Tapering the boost away incrementally over a number of months would have been another way of facilitating a less troublesome adjustment for families.

Those still claiming the out-of-work benefits that preceded UC - most of whom were already out of work before the crisis struck - did not benefit from the temporary boost to benefits last March and the Chancellor did not change that today. Most of the 2.5 million claimants of these benefits have health conditions which limit their ability to work.

Tom Waters, a Senior Research Economist at the Institute for Fiscal Studies said:

“The labour market isn’t much stronger than it was this time last year, so there’s a clear rationale for extending the UC boost a bit longer. But in six months’ time the end of the boost will mean overnight reductions in incomes. As the government has found already, this can create political pressure; but it can also create real difficulties for families in adjusting to the change, especially if their awareness of it is limited. A more gradual removal may have been easier for many, and the government needs to communicate the policy clearly to recipients so they know what to expect.”

Income tax

The personal allowance has risen by almost 60% in real terms over the past decade, reducing income tax revenue by an eye-watering £25 billion per year and meaning that 40% of adults do not pay any income tax at all. The planned freeze, representing a 7% real-terms cut, undoes only a small share of that rise, and brings another 1.3 million people into the income tax system.

By contrast, the higher-rate threshold is already 9% below its 2009 peak in real terms, and the freeze will bring it 16% below. It has not kept up with earnings growth over recent decades, meaning that steadily more and more people have become subject to it. While fewer than 4% of adults paid higher-rate tax in 1990, by the time the freeze is over that figure will likely be more than 10%.

Tom Waters, a Senior Research Economist at the Institute for Fiscal Studies said:

“Freezing the income tax personal allowance and higher-rate threshold is a straightforward, broad-based and progressive way to raise what, at least in normal times, we would think of as a significant chunk of revenue. It also means that more people will pay higher-rate income tax. The steadily rising number of people subject to the higher rate was of course a concern that Boris Johnson raised during his campaign for the Conservative Party leadership, when he proposed increasing the threshold to £80,000. Freezing it means that, for the first time ever, more than 1 in 10 adults will pay higher-rate income tax.”

Corporation tax

Corporation tax will reverse course, rising from 19% to 25% in 2023. This is forecast to raise £17bn per year by 2025–26, pushing corporation tax receipts to 3.2% of national income.

Unfortunately, a small profits rate will be reintroduced. There is no distributional motive for such a rate (because low-profit companies do not correspond to low-income people), and it introduces unnecessary complexities and distortions into the tax system.

In each of the next 2 years, around £13bn will be spent on a massive subsidy to investment, which will help to stimulate the economic recovery. This provides a large incentive to undertake investment – even investment that would not be commercially viable without the subsidy – and to bring forward as much investment as possible, with an inevitable ‘hangover’ afterwards.

The temporary extension of relief for losses is welcome – the pity is that it is only temporary.

Stuart Adam, a Senior Research Economist at the Institute for Fiscal Studies said:

“The UK’s headline rate will be in the middle of the international pack – and still the lowest in the G7 if USA state taxes are included. But the large rate increase will lead firms to invest less in the UK in the medium run, which will in turn depress economic activity and reduce the revenue generated by the tax rise.”

Coronavirus support for households

The welcome extension of the furlough scheme in full until June, and then phasing it out through the summer, means continued support for jobs while restrictions on daily life continue and provides employers with a few months’ transition back to a world without furlough. The OBR expects most of the 4.7 million furloughed people at the end of January to be back in their jobs by then, and is currently forecasting this to fall down to 2.0 million by September.

The self-employed income support scheme (SEISS) has also been extended for a fifth payment covering May to September. The “newly self-employed” who first started self-employment in 2019-20 will also be included in the scheme. Although around 600,000 people could be in this group, many - perhaps a majority of them - will still be ineligible for SEISS as they will have had less than 50% of their income from self employment in 2019-20.

The Chancellor has decided to reduce the SEISS scheme over the summer by giving smaller payments (worth 30%, rather than 80% of pre-pandemic profits) to people whose turnover has fallen by less than 30%.

Jonathan Cribb, a Senior Research Economist at the Institute for Fiscal Studies, said:

“It makes sense for the government to extend the furlough and SEISS schemes through to June in full while there are still restrictions on economic activity, and then to phase it out so that by October the schemes are gone, but they are still not including 1.5 million self- employed people who earn over £50,000 or have less than 50% of their income from self employment.”