Pre-Budget perspective

By way of background to today’s much-anticipated budget, I thought I should provide some subjective perspective on some of the key underlying issues that Rachael Reeves will be talking about later today. If you want to read on, you will find that much of what I have to say will not feature in either the Chancellor’s speech or the consensual commentary that will accompany the statement. However, I think these issues are of pivotal importance in any discussion about public finances, taxation and spending.

The politics surrounding the budget and its aftermath often drown out a more rational debate about the fundamental economic issues that drive the revenue-raising, borrowing, and spending decisions we will hear about today. So, as a counterbalance, I will focus on that in this preamble.

First, to the recent history of tax revenue and government spending.

As I have written in previous blogs, what is abundantly clear but now hardly mentioned is that the pandemic and the war in Ukraine both led to significant government interventions that have left their mark on the deficit and government debt. As the table above shows, even though both these events’ economic implications are largely past, their legacy can be seen very clearly in both the scale of the UK’s public sector net debt position and the deficit. Of course, what this highlights is that once government spending has increased, even when the events that led to the increase have passed, governments find it very difficult to return spending back to where it arguably should be.  

As I have also mentioned in previous blogs, it seems somewhat ironic that the very same politicians who were arguing for greater government interventions (longer lockdowns) during the pandemic and during the energy price crisis, and more government support for struggling families, are the very same ones who are now complaining about black holes in the Nation’s public finances.

Fundamentally, this again comes back to an economic debate about how effective the government is at allocating resources, how to measure that effectiveness and ultimately, once the answer to this question is quantified, to then make some judgements about what role the government should play in the economy. This is a relatively straightforward question that I realise is not easy to answer. Nevertheless, history has surely taught us that the right answer cannot be that the starting point for the debate should be that the baseline for future spending should be what the government spent last year.  At some stage, the “return” on the spending, whether investment or current, should be a key input in the discussion. Higher taxes ultimately require popular consent, and if what the public sees is higher tax, a larger public sector, but less output from public services, that consent will ultimately, rightly, be withdrawn.

To help put this into context, here are some interesting numbers in relation to government spending on a per capita basis. Government spending has risen from £13,500 per person immediately before the pandemic to £18,000 today. £1,000 of that increase is on additional debt interest. So, excluding the increase in debt interest, spending has increased per head by just over 24%.

I will comment later, in as much detail as I think you can bear, on the most important economic measures in the budget and their likely impact on the economy. My expectation is that for all the hype, I doubt very much that I will have to change my underlying forecasts for the UK economy, albeit that in the long term, some of the measures that the media seem to believe will be announced may undermine its longer-term growth potential.