Budget 2023: sailing close to the wind

Jeremy Hunt’s second set-piece fiscal statement brought few surprises. The giveaways had been well trailed, with little held back for the big day. The statement was framed as a strategy for growth, designed to improve the economy’s productive capacity, based around the four “e”s of everywhere (that’s to say levelling-up), enterprise, employment, and education. With the net effects of the measures that were announced delivering a maximum annual stimulus of £22 billion in the 2023/24 fiscal year, this fully-fledged Budget was on a modest scale compared with other recent fiscal events.

The only surprise was that the Chancellor not only increased the Annual Allowance for pension contributions from £40,000 to £60,000, but also opted to do away with the Lifetime Allowance (LTA) altogether. Most pundits had expected the LTA to be increased, but not abolished. The LTA was originally introduced in 2006 when it was set at £1.8 million. It was subsequently reduced to £1 million, and was at £1,073,000 before this Budget.

Otherwise, the announcements were much as expected. The Energy Price Guarantee (EPG), which capped gas and electricity charges at £2,500 for a typical domestic customer, will not increase to £3,000 in April, as was announced last November, but will instead be held at its current level until the end of June. This will cost the government an additional £2.9 billion, with other smaller energy price measures adding a further £1.6 billion. But with gas now priced at only about €40 a megawatt hour for month-ahead delivery on the Dutch TTF platform, which is the benchmark for Europe, it’s likely that Ofgem’s price cap will fall to below the EPG from July. Barring any adverse developments in the gas market this will end the need for government support, albeit that utility bills will remain high by historic standards.

The government has also decided not to reverse the 5p cut in vehicle fuel duties announced last November. While this was widely expected, at a cost of £4.6 billion in the 2023/24 fiscal year, it nonetheless represents a clear choice about how to deploy scarce resources. With the benchmark Brent crude price currently at under $80 a barrel, this might have been an opportunity to garner some much-needed tax income.

The aforementioned pension tax changes are aimed at keeping senior doctors in work and reducing incentives to retire early. But the Chancellor is also seeking to improve workforce participation at the other end of the working-age spectrum, and announced a widely-anticipated extension of childcare support: parents of children aged from nine months to two years will be eligible for up to 30 hours of free nursery provision, in line with what’s available for three- and four-year-olds. These arrangements will be phased in gradually, and won’t be fully in place until September 2025. While the Chancellor cited the time it will take to increase capacity as a reason for this phased approach, which is a valid point, a gradual deployment will also help with costings, pushing expenditure out to the latter part of the five-year forecasting horizon and after the next general election. Additional childcare support will cost just £400 million in the 2023/24 fiscal year, but will climb to around £5 billion from 2026/27 onwards.

There were no changes announced to rates of personal taxation, although with inflation running high the government is collecting more revenues from so-called “fiscal drag”, as taxpayers find that increased earnings take them into higher tax bands. Businesses may be upset that the increase in the headline rate of Corporation Tax from 19% to 25% will still go ahead, but they can hardly say that they weren’t warned – the measure was announced in 2021 – and in any case the pill has been considerably sweetened. The Super Deduction investment scheme which ends in April will be replaced by “full expensing” of qualifying capital expenditures for three years, which means that anything spent on IT and equipment can be deducted from profits before Corporation Tax is levied. This was the biggest measure of this Budget, and is reckoned to cost the Exchequer £30 billion over the three years.

Taken together, the measures announced in the Budget are forecast to cost around £90 billion over the period to 2027/28. The fact that no new tax increases were thought necessary is, in part, due to the improvement in the economic and fiscal situation since November’s Autumn Statement. With commodity prices having continued to fall, and especially the price of gas, the Office for Budget Responsibility (OBR) no longer expects that the economy will suffer a recession. Back in November, the OBR had expected that GDP would fall by 1.4% in 2023, but now thinks that the annual decline will be just 0.2%. It then anticipates a return to annual growth of 1.8% in 2024, and of 2.5% in the following year, with continued growth of around 2% in 2026 and 2027.

No economic forecasters would quibble with the improved assessment of the prospects for this year, but they might well take issue with the OBR’s relatively rosy assessment of growth prospects for following years. The OBR has itself raised the issue of the economy’s weak growth potential, but has presumably been convinced that the government’s measures in relation to workforce participation and business investment will provide a significant fillip to the economy’s supply capacity.

The OBR also believes, in common with the consensus among economic forecasters, that the outlook for inflation has brightened significantly in recent months. With energy prices having fallen sharply, and with the government having extended the EPG at £2,500, the OBR expects that the annual rate of CPI inflation will be down at around 3% by the end of this year. In other words, barring new adverse economic shocks, the government should have little difficulty in meeting its goal of halving the rate of inflation during 2023.

As a result of its more robust growth projections, and improved outlook for inflation and interest rates, the OBR was able to take an axe to its assessment of how much it will cost the government to service its borrowings. With net interest costs expected to come in at £103 billion for the current fiscal year, the good news is that the eye-watering sums will now start to come down. In 2023/24 the OBR thinks that the government will need to shell out £75 billion to service its borrowings, a reduction of £50 billion from what was penciled in last autumn.

Thanks to these favourable fiscal winds, the OBR’s assessment is that the government will just about meet its key fiscal rule of having debt falling as a proportion of GDP by the end of the forecast period. The government’s preferred measure, which strips out the effects of Bank of England activities, continues to increase gradually over coming years, reaching a peak of 94.8% of GDP in 2026/27, before falling back a touch to 94.6% in 2027/28. But the OBR has also admitted that the amount of headroom, at just over £6 billion, is the narrowest in any of its forecasts going back to its founding in 2010. The more widely-used internationally-comparable measure of debt, which doesn’t strip out the Bank of England, has outstanding borrowings in relation to GDP rising to 108.3% in 2026/27, before easing back to 107.7% in the following year.

As regards the trajectory for the annual budget deficit, the OBR thinks that the government will be running a surplus on its current budget (its day-to-day activities) by 2026/27. This is generally regarded as a happy state of affairs by Chancellors of the Exchequer, as it allows them to claim that they are only borrowing to invest. Meanwhile, the overall deficit, as measured by public sector net borrowing (PSNB) is forecast to come in at a better-than-expected £152 billion for the fiscal year just ending, compared with an expectation in November that it would amount to £177 billion. It’s expected to be £132 billion in the upcoming fiscal year, falling to just £50 billion in 2027/28. In relation to GDP, the deficit is forecast to shrink from 6.1% in 2022/23 to under 2% at the end of the forecasting horizon.

The government will naturally be hoping for favourable forecasts from the OBR in years to come, so that this very small margin for error doesn’t get eaten up. To put it in perspective, if the forecasts were to remain as they are now, there would be no scope for taking a penny off the rate of Income Tax in the run-up to the next general election, as that would cost around £7 billion. Further improvements in the forecasts would also be needed for the government to be able to deliver on its implicit promises which have not, so far, been factored into the arithmetic. Every year since 2010, Conservative chancellors have chosen not to increase fuel duties in line with inflation. But the OBR’s sums always assume that it will, and also that the recent cut of 5p will only be temporary. It’s highly unlikely that Jeremy Hunt will be wanting to raise fuel duties in the run-up to an election. He also made it clear that he would like to extend the 100% expensing of capital spending beyond the initial three years. But that will mean being able to find around £10 billion a year from 2026/27 onwards. Ultimately, these items on the Chancellor’s wish list, which also includes additional allocations for defence, will only be deliverable if the fiscal arithmetic gets even better, or if tough choices on tax increases or spending cuts are made.