Schroders Quickview: UK Budget 2016 - Weaker growth prompts more fiscal tightening

In his Budget announced on Wednesday 16 March, UK Chancellor George Osborne chose to focus on small tax breaks, reforms and micro spending announcements, while glossing over the extra austerity planned.

16 March 2016

Azad Zangana

Azad Zangana

Senior European Economist and Strategist

The Chancellor’s latest update could not have come at a more politically sensitive moment in time.

With his party split on the UK’s future within Europe, the main opposition playing on those divisions, and the Scottish National Party (SNP) threatening to call another independence vote for Scotland, George Osborne had to deliver bad news to the public without giving his enemies too much ammunition.

Downgrade to economic outlook

The key headline from the Budget was the downgrade to the UK’s economic outlook.

The independent Office for Budgetary Responsibility (OBR) lowered its forecast for real GDP growth in every year, with the cumulative downgrade worth 1.5% by 2020/21. Combined with a lower forecast for inflation, the inevitable hit to tax receipts was unavoidable.

The OBR expects the weaker macroeconomic outlook to reduce tax receipts by £16.4 billion by 2019/20, with related additional spending adding just over another £2.4 billion.

Without action, this would have meant that the Chancellor would break his fiscal rule of running a budget surplus by 2019/20.

Fiscal tightening

In order to put the public finances back on track, Osborne announced a plan to tighten fiscal policy by £10.4 billion, which in addition to an expected saving of £5.4 billion from lower interest payments, would leave the Chancellor with an even larger surplus than previously forecast for 2019/20 (to £10.4 billion).

The details of these plans have only been partially revealed. For example, the £3.5 billion of new departmental cost savings have not yet been found.

Public sector net borrowing has been revised up in most years, and is now forecast to be reduced to a surplus with a delayed profile. The impact of this will mean more borrowing over the interim years.

With the exception of this fiscal year, net debt will still be falling over the forecast period, but the level will be 3.4% of GDP higher by 2020/21 (albeit lower in cash terms). Note, the rise in debt as a share of GDP this fiscal year means that the Chancellor has already broken one of his fiscal rules.

Boost to small businesses

The worse-than-expected outlook for the economy and public finances did not stop the Chancellor from unveiling a whole host of measures designed to appeal to business owners and low and mid-level earners.

A further cut in the corporation tax to 17% from 2020 was a significant change, while the increase in the threshold for small business rate relief could also spur small-and-medium enterprise (SME) activity along with the move to a marginal tax system on commercial property (as is currently present with residential property).

Help for the North Sea oil and gas industry produced glum faces on the SNP’s bench, as the Chancellor highlighted the importance of the UK’s support for Scotland.

Personal tax allowance increased

For personal taxes, the Chancellor announced an increase in the personal allowance to £11,500, and an increase in the higher rate threshold to £45,000 – both effective from April 2017.

On the savings front, the annual ISA allowance will rise from £15,240 to £20,000 from next year, and a new lifetime ISA for under-40s will be made available, offering a 25% government bonus on savings up to an annual limit of £4,000. This will be combined with the existing help-to-save ISA.

The tax and spending sweeteners were also extended to motorists who will see another year of fuel duty frozen, with duty on alcohol also remaining unchanged. But the Chancellor did announce a tax on sugary drinks, which he hopes will encourage a reduction of the use of sugar in drinks, and also a fall in demand.

No show-stopping giveaway

Overall, this was a relatively low-key budget with Osborne pulling just a few small rabbits out of his hat rather than the usual show-stopping populist giveaway.

He was unable to push through the pension reforms he wanted which would have netted the Exchequer a significant sum for him to play with. Instead, he chose to focus on small tax breaks, reforms and micro spending announcements, while glossing over the extra austerity planned.

However, his showmanship, the lack of credible opposition and the impending vote on the UK’s membership of the EU may temporarily avert the public’s gaze from the worsening outlook.

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