Budget 2021: Why Rishi Sunak must balance Covid support with paying off debt
Finance minister to focus on stimulus rather than fiscal consolidation to reboot UK economy
British Finance Minister Rishi Sunak is ready to spend his way out of the Covid-19 crisis in his March 3 budget with extra support for sectors particularly hurt by the pandemic as he looks to stimulate a post-lockdown boom.
Mr Sunak is expected to keep tax increases to a minimum and instead focus on propping up jobs and businesses to bolster the economy and help harder-hit sectors such as hospitality, tourism and retail to recover from the cycle of lockdowns.
While Mr Sunak had hoped to use the budget to set out a path towards restoring the battered economy, analysts questioned whether he will make any moves towards balancing the books.
Corporation tax is thought to be on the agenda, with Mr Sunak expected to increase the rate to 25 per cent or higher from its current level of 19 per cent.
However, Tim Pitt, partner at Flint Global and a former adviser to Philip Hammond and Sajid Javid, said next week’s budget is “really a budget for the next six months” because the country still needs support as it moves into recovery phase with only “half an eye on the longer term”.
It’s a lot easier to announce a tax rise at the same time you are announcing lots of big giveaways.
Timothy Pitt, Flint Global
While it is too early to say how big the fiscal repair job will be for Mr Sunak, Mr Pitt said the autumn will offer a better indication of the measures needed. He expects Mr Sunak to lay out some tax rises at the March budget even if they do not kick in straight away.
“The politics of debt and deficit are about to make a serious comeback. There's definitely been strong backing for the chancellor's short-term support packages, but over the last year, a very clear view has developed amongst the public that eventually we're going to need to do something to get borrowing back under control," Mr Pitt told an online news seminar.
“He will want to get the bad news out on the tax side as early as possible ahead of the next general election. It’s a lot easier to announce a tax rise at the same time you are announcing lots of big giveaways.”
Finding the right balance between taxation and stimulus will be key for Mr Sunak, Simon Wren-Lewis, emeritus professor of economics at the University of Oxford, told a separate Institute for Government webinar.
However, in this era of low interest rates he said Mr Sunak should forget about fiscal consolidation until the recovery is complete.
“As recoveries from recessions don't happen overnight but take years … we really should be thinking about how to stimulate the economy to get a quick recovery, rather than how we should consolidate public finances,” Mr Wren-Lewis said.
While boosting support falls in line with US President Joe Biden’s stimulus plan in America, where policymakers are still wrangling over the size of the additional support package, the debate in the UK involves the amount of taxation required to rebuild the economy, not only in the short term but over a longer time period.
Ruth Gregory of Capital Economics said Mr Sunak “appears intent on extending some of the temporary support for the economy for another few months”, but his focus will undoubtedly switch to increasing taxation in the longer term.
Mr Sunak told the Conservative party conference last year that “this Conservative government will always balance the books”, but the economic fallout of the crisis has forced the government to borrow £270.6 billion ($377.16bn) in the first 10 months of the fiscal year to the end of January.
This takes Britain's debt mountain to £2.1 trillion, equivalent to 98 per cent of GDP.
Mr Sunak now faces the delicate task of presenting a budget that will revive the economy after a year of lockdowns, while also trying to restore public finances to sustainable levels through taxation.
“The risk is that over the next two years he will be tempted to pull the rug out from under the feet of households and businesses by reducing the budget deficit at a faster pace than is currently scheduled,” Ms Gregory said.
“Not only would that undermine the economic recovery, but it could also cause more problems for the public finances than it solves.”
The government has already spent £285bn, 13.7 per cent of GDP, on direct support measures, mainly because Britain has had one of the highest infection and death rates in the world.
The cost of the country’s Job Retention Scheme to protect livelihoods has reached £53.8bn, according to ONS data, while the number of people on furlough rose to 4.7 million at the end of January, the highest level since July.
While this total is far below the almost 9 million seen at the peak of the crisis last spring, the ONS’s BICS business survey found just 72.2 per cent of businesses are currently trading, with a quarter of companies putting operations on pause between June 7 last year and February 21.
Meanwhile, Britain’s unemployment rate rose to 5.1 per cent in the fourth quarter of last year, its highest level in about five years, with Mr Sunak already pledging more support.
Before the crisis, the 2020/21 budget deficit was set to be £68bn but it is now expected to be £370bn, far exceeding the previous peak of £158bn in 2009/10 in the wake of the global financial crisis.
In the past Mr Sunak has said he is prepared to wait until “the economy begins to recover” before returning “the public finances to a more sustainable footing”.
On Thursday, British think tank the Resolution Foundation called for a £100bn stimulus push to support businesses and jobs in next week's budget, while Ms Gregory expects a more modest £25bn of further fiscal stimulus.
Measures expected next week include business rate cuts for the retail, hospitality and leisure sectors; an extension to the VAT cut to 5 per cent from 20 per cent for the hospitality and tourism sectors; and an extension of the furlough scheme from its April 30 deadline, possibly until the summer at a cost of £4bn a month.
New grants for the self-employed are also on the cards with plans for an immediate fuel duty increase of £0.05 shelved and an extension of the stamp duty land tax holiday until the end of June.
Sir Robert Chote, former chairman of the Office of Budget Responsibility, expects Mr Sunak to offer an indication of his fiscal consolidation plans for the medium term at next week's budget to give a flavour of how the debt-to-GDP ratio will come down to create fiscal space for when the next crisis comes along.
“You don't know how far away and how big the next shock is going to be; we've had two in less than 12 years,” Mr Chote said. “It means you think quite hard about what to do in the good times if the bad times are more frequent.”
Britain’s economy has been pummelled by the pandemic, with GDP plunging 9.9 per cent last year in the worst economic slump in more than 300 years,
If the crisis permanently scars economic output through business failures, job losses and lost capital investment, it could leave investors concerned about the country’s growth potential and in turn its ability to repay its debt.
Sarah Carlson, senior vice president, sovereign risk group at Moody’s Investor Service, said it was very difficult for a country to reduce its debt burden if it is struggling to grow.
The ratings agency cut the UK’s debt rating in October over concerns about the country’s longer-term growth potential “in part due to Brexit but also recognising that this productivity growth challenge that has persisted since the global financial crisis is something that has not been alleviated”, Ms Carlson said.
With the vaccination programme now well under way and Boris Johnson’s lockdown exit roadmap on track to lift all restrictions by June 21, the Bank of England expects the economy to recover to pre-Covid levels by this time next year.
This could lead to Mr Sunak starting a "fiscal repair job" in April 2022, said Mr Pitt, although a slower recovery may delay that process.
Mr Wren-Lewis said the best way for Mr Sunak to decide when fiscal action is needed is to follow interest rates.
“The way we decide when we should start thinking about consolidation and stop thinking about stimulus is when interest rates are revised, rising to 2 per cent or above levels, and we're a long way away from that,” he said.
The Oxford University professor said he was also concerned about telegraphing future fiscal retrenchment because constant debate over when fiscal consolidation should take place puts the country at risk of talking itself into “into an inbuilt pessimism”.
If the government talks about having “to do lots of tough things in the future, then people are going to hold back on spending, investors are going to hold back on investment … and you get into a kind of a pessimistic circle whereby the economy doesn't recover very strongly, because everyone's anticipating this fiscal retrenchment", Mr Wren-Lewis said.
"If I was chancellor, I wouldn't be talking about fiscal consolidation. At this point, I will be talking about what areas we need to stimulate the economy to get a good recovery.”
However, Mr Pitt said that having some kind of fiscal framework in place was essential because it was key to the UK's institutional credibility and helps the Treasury control government spending.
Ultimately, Mr Sunak has a very tricky job on his hands to ensure spending is balanced out with the right tone over fiscal consolidation.
If he puts his political aims before economic sense and lays out his taxation plans too soon, he may lose the public trust he has built up over the past 12 months.
“That would get some bad news out of the way before the next general election in 2024. But if it puts the economic recovery on shaky ground, the risk is that it could cause precisely the fiscal hole the chancellor is aiming to fill,” Ms Gregory said.
Published: February 27, 2021 11:00 AM