The Chancellor’s Spring Statement was something of a non-event. The forecasts were only revised slightly, and as promised there were no new tax or spending measures. However, while nothing much changed this time around substantial challenges remain. The Government’s overarching fiscal objective requires eliminating the deficit by the mid-2020s, but at the same time growth is set to be sluggish and it may become harder for the Chancellor to resist the clamour of those calling for higher public spending.
The growth forecasts over the next few years are exceptionally gloomy – annual growth is not set to exceed 1.5% in any year, when the norm before the financial crisis was 2% or more. If there was any good news from the forecasts yesterday, it was perhaps that the Office for Budget Responsibility (OBR, the government’s official forecaster) does not believe that this sluggish growth will continue forever. However, this is a pretty thin silver lining given that they judge we will not return to the kinds of growth we became accustomed to before the financial crisis until 2030.
Slow economic growth means slow growth in tax revenues, which in turn puts pressure on the government’s finances. It is possible that these economic forecasts will prove to be too pessimistic – in that case tax revenues would likely grow more strongly than expected, making it easier to eliminate the deficit as the Chancellor intends. However, even though the forecasts are for low growth, they are still predicated on stronger productivity performance than we’ve experienced over the past eight years, meaning that even these forecasts could prove to be too optimistic. Furthermore, there are a number of other risks to the path of the economy over the next few years – most notably the nature of Brexit – which could further dampen economic performance.
Even if growth is somewhat stronger than forecast, the next few years look challenging for the Chancellor. Most of the effects of benefit cuts announced since the 2015 General Election have yet to be felt by working age households. There are also further day-to-day departmental spending cuts in the pipeline over the next two years, when the current spending review period ends.
Assuming these cuts can be delivered as planned, further deficit reduction will be required over the next spending review period (from 2020). Time will tell whether he will decide to rein in spending further on top of what will have been a decade of spending restraint by that point. If the Chancellor chose to maintain spending relative to the size of the economy, any further reductions in the deficit would need to be achieved through tax increases. But the tax burden is already at a level not maintained since the 1950s. It would perhaps be more likely that a tax rise of the required scale is not delivered and that the Chancellor abandons his deficit elimination target. The last twenty years of UK fiscal policy contains numerous examples of such targets being missed or abandoned.
While abandoning his target would give the Chancellor some more wiggle-room, it would not change the fact that substantial challenges lie ahead for the government’s finances. While the deficit is back to its pre-crisis level, debt as a share of national income is more than twice as large as in 2008. That ratio is set to fall only slowly over the next few years, and would fall more slowly still if the government choose to borrow more. The pressures of an ageing population on health, long-term care and state pension spending also look substantial over the next decade or so (and beyond). At some point we have to be honest about the tough choices we face – either meet the demands of an ageing society and raise taxes, or fail to meet these demands in some way. While this trade-off is politically difficult, it is too important to ignore.
So the outlook for the government’s finances is extremely challenging over the next decade. A failure to eliminate the deficit by the mid-2020s would not be a surprise. There are even bigger challenges around the corner too – in particular as a result of the pressures of an ageing society – that mean the job of this Chancellor and his successors looks very difficult indeed.
Thomas Pope is a Research Economist at the Institute for Fiscal Studies