This week the Chancellor delivers his second Budget. Since his first, just a year ago, the UK has experienced a health and economic crisis, and seen its budget deficit soar. The ratio of debt to GDP is now above 100%, the last time it was at a comparable ratio was in the early 1960s when debt to GDP was still falling from its peak after the Second World War.
Our experience then, of reducing the ratio of debt gradually, while the economy grew solidly, is a useful reminder for now and suggests that there is no need to panic.
On Wednesday, we will be given the latest update from the Office for Budget Responsibility (OBR) on the economic outlook. As with the Bank of England recently, the OBR is likely to predict a solid recovery in the second half of this year and next, with the economy returning to its pre-crisis level sometime in 2022. Given the scale of pent-up demand, even though they will project a solid recovery, it may prove cautious.
The focus of attention will, naturally, be on the Chancellor’s fiscal judgement.
Despite volatility, there is no great need for concern
The budget deficit is high. Thus, it is easy to understand why some are calling for action. But there is no need to be worried. Despite last week’s market volatility, rates, yields and debt servicing costs are low.
Recently there has been talk of the need for the Chancellor to take action to close a future structural budget deficit gap. I think it would be premature to take such action and am not even convinced that there will be such a structural gap. It depends, crucially, on how the economy performs.
The margin of error on the one-year ahead official forecasts for the budget deficit are huge. Now, in even more uncertain times, this margin of error may be even higher.
Moreover, recovery over the next year will reduce the deficit. In fact, the economy could be very strong this year – regardless of what the Chancellor does on Wednesday.
If this was a Budget that was about to unveil austerity or large-scale tax rises then there might be reason to be worried. But we are not going to see that. Instead, it will be a statement of intent and there will still be infrastructure spending alongside the tax changes.
I expect his statement of intent will be well received by the public, as he is likely to highlight that he is being honest about the challenge from the budget deficit; demonstrate he is taking the need to address the public finances seriously; that he is prepared to hike taxes if needed; but that he will not destabilise recovery.
In my view the focus should be on support, not stimulate or squeeze. The Chancellor should aim for a fiscally neutral Budget, with a focus on providing additional support to the people and sectors that continue to need help.
There is no need to stimulate the economy. As unlocking occurs, pent-up demand and a return to work should trigger a strong economic rebound.
There is also no need to squeeze the economy through higher taxes. Although I think recovery is imminent, there is still much uncertainty and parts of the economy are fragile. That suggests waiting until the economy has started to recover and is in far better shape to cope with any planned fiscal tightening.
Further spending is likely
Ahead of the Budget, there has been much focus on tax increases. We should not overlook, though, that there will be likely be further spending, too. Infrastructure spending already figures prominently as part of the levelling-up agenda. The furlough scheme looks set to be extended, which is sensible, as it will improve the chances of those on furlough being kept in work. And there will be other targeted measures, including help to first time buyers.
The tax increases rumoured are unlikely to prevent a strong post-Budget rebound. The main focus is on higher corporation tax. If the Chancellor is to raise corporation tax from 19% to 23% over this Parliament, as has been suggested, then he will need to ensure other measures are taken to help firms cope with issues such as skills and technology, as well as having to reassure international firms about the attraction of investing in the UK.
I would like the Chancellor to avoid any new fiscal rules. Previous ones have lacked credibility and not stood the test of time. His preference should be on fiscal principles. I discussed these in a research paper for the Policy Exchange think tank last year, including the importance of having a clear plan to reduce the deficit within the context of a credible pro-growth economic strategy.
My impression is that this will be a well-received Budget. Whether it will be the right Budget judgment – as always – will depend upon how the economy reacts and performs.
Please note, the value of your investments can go down as well as up.