What is the fiscal end game?
On Wednesday, the Chancellor delivered her Spring Statement. Initially branded as an update on the UK’s fiscal situation, the statement had morphed into a quasi-budget in anticipation of the OBR’s Economic and Fiscal Outlook (EFO).
The OBR’s report confirmed that its central forecast for 2025 real GDP growth had fallen from 2% to 1%. Coupled with higher borrowing costs, this reduction in expected growth has effectively wiped out the fiscal headroom the Chancellor had created in the Autumn Budget.
The not-a-budget-announcement then included welfare cuts and the previously announced increase in defence spending. The latter will be financed primarily from long-overdue cuts to the international development budget and counts as capital spending.
In anticipation of the announcement, the usual suspects were hitting the airwaves to complain about welfare cuts and the Chancellor’s “fiscal rules.”
I don’t want to dwell too much on the politics of the budget announcement; you can read about that elsewhere. Instead, let’s take a step back and focus on the bigger fiscal picture. One of the things that often gets lost amid these announcements is the long-term context in which they are made.
Last autumn, the UK’s tax burden reached an 80-year high, public spending is now 45% of the UK economy, borrowing costs are still elevated—even though the Spring Statement seems to have reassured markets—and the economy has been stagnating for the last decade and a half. Any serious macroeconomist would conclude that markets have been signalling for quite some time that there is very little appetite for more government borrowing.
The long-term forecast does not look great either. An ageing population and unchecked migration will put additional pressure on the welfare system. If you are into this stuff, take a look at the OBR’s long-term fiscal sustainability report.
One piece of good news is that the gilts market has remained relatively quiet since the statement. Given that the OBR’s projection allows for only about 50 to 60 basis points in yield movements for the Chancellor to stay within her fiscal rules, another seven months of speculation and bickering are likely ahead.
The reality is that arguing over a few billions of fiscal headroom misses the point. As this statement-not-budget has illustrated again, there is only one way out of this disastrous fiscal situation—and that’s growth. A lot of growth.
The government will hope some supply-side messaging will reassure markets and has taken steps in the right direction on planning and defence spending. Unfortunately, both planning reform and a military build-up are only expected to boost growth in the medium run.
That leaves the Chancellor with relatively few cards to play in the short run. The next fiscal event will be the Spending Review in the summer, ahead of the Autumn Budget.
So, what is her fiscal end game?
On tax, the tipping point for geographically mobile high earners has been reached. Calls for new wealth taxes ignore all evidence on their efficacy. The UK’s tax intake is already heavily concentrated, and tinkering with wealth taxes might risk a fiscal catastrophe.
On welfare, any further cuts will be politically difficult to push through, given that backbench Labour MPs are already signalling rebellion. The current set of reforms is expected to save the government around £4.8 billion in 2029–30. In October, the OBR projected a fiscal deficit of around £55.5 billion.
On pensions, the government has arguably shot itself in the foot by cutting the winter fuel allowance, which is expected to save a meagre £1.3 billion. Instead of targeting the triple lock, the government has spent its political capital on a reform with relatively little fiscal impact.
It will be interesting to see how the Treasury manoeuvres over the coming months, ahead of what promises to be a hugely consequential set of decisions this autumn.
Any big changes to the fiscal situation until then seem highly unlikely.
There is only so much tinkering around the edges that the government can do. At some point, a big decision has to be made.
Johannes Matt