Last week, October’s inflation data was published which showed that inflation had finally gone below 5%. The Consumer Price Index was 4.6% in October, driven by the much lower energy price cap we have now compared to October 2022.
This has set the scene for some fairly optimistic commentary on what can be expected from this week’s Autumn Statement, coupled with an extraordinary level of “kite flying” by various sources. This is when the Government essentially puts potential measures out in the world to see how they go down in advance of a large statement like this.
In particular, there has been intense speculation that – if as is expected – the outlook for the public finances has improved, the Chancellor may choose to cut taxes in advance of the general election. The speculation about tax cuts has included, as the Chancellor touched on in his Sunday interviews, just about every tax that the Government collects, and the story has evolved considerably over the weekend.
It is worth pointing out that despite the noise over the weekend the numbers would have been finalised on Thursday or Friday of last week (based on published timelines by the OBR for previous forecasts). Therefore all of this speculation is really about trying to ensure that the decisions that have already been made land as well as possible.
Why have the public finances improved?
The optimism about the public finances has been somewhat surprising. Compared to March, inflation has been higher for longer than was expected, and government borrowing costs are also higher than was expected.
Higher inflation can look positive for the public finances on the face of it. If wage rises are higher than was expected as a result of higher inflation, then it is likely that the Government will raise more from taxes like income tax over the period of the forecast horizon. This is particularly the case because the government has chosen to freeze thresholds for many taxes in cash terms, which means as inflation pushes wages up more people are brought into paying tax (and into higher rates of tax). In the case of income tax, this may well mean reversing the trend under previous Conservative administrations to lift people out of income tax altogether by increasing the Personal Allowance.
Overall though, this “fiscal drag” is one of the main reasons that the tax burden as a percentage of the economy is the highest since the Second World War.
If this is the main source of the “fiscal headroom” that the Chancellor has, then to some extent it is a bit of an illusion. It is unlikely that the Government will also have taken into account that this is likely to mean that spending will also be higher, which means that either (i) spending will be higher than the current Departmental Expenditure Limits suggest or (ii) if the limits are stuck to, then in practice there will be huge cuts in services as public sector wages also rise.
How much fiscal headroom will the chancellor have?
When people talk about fiscal headroom, this is the gap between what the Chancellor is doing and how much more he could spend or cut taxes by and still meet his fiscal rules. To be clear, this is not extra money in the bank, or a surplus – just that he is still meeting his self-imposed rules.
So what are these rules? The current Chancellor made the choice to change the fiscal rules when he took up the post a year ago. Successive chancellors, from George Osborne onwards, have made the rules easier over the years as they have taken up post.
The most difficult rule to meet out of the current set is that debt will be falling as a proportion of GDP by the final year (year 5) of the forecasts relative to the previous year (year 4). In the previous set of figures in March, the Chancellor met this for 2027-28 by £6.5bn.
It is worth pointing out that if this is only ever met in the final year of the forecast in subsequent years then it will never actually happen, as the debt pile continues to mount up. Putting in measures in the final year of a five-year forecast to dip below the previous year’s debt to GDP ratio is not necessarily a mark of sound fiscal planning – to meet the government’s pledge to “get the debt down” implies that it does actually need to fall over a sustained period.
Tax proposals being discussed
We have already discussed that despite the noise, the tax decisions have already been made. Given the way the chancellor played down the chances of inheritance tax cuts yesterday probably means that they have not been included, and rather the briefing over the weekend was to give him cover about why he could not do this.
More likely in terms of the briefing yesterday afternoon and this morning seems to be personal tax cuts, in income tax or national insurance, with a 1p or 2p cut in the basic rate being some of the ideas being floated. If it happens, it is not clear whether this will be an announcement of a cut very soon (for the 2024-25 financial year, which begins on 6 April for personal taxes) or a cut in the future years.
If there is a cut in income tax, this will not apply to earnings in Scotland, as income tax is devolved. The changes though would have an impact on the Scottish Budget given it would affect the amount that the Block Grant is adjusted by to reflect tax devolution. This is based on tax raised per head in the rest of the UK, so this would mean the deduction would be smaller and therefore actually result in the Scottish Budget being better off.
However, it would also mean that it would no longer be true that most taxpayers in Scotland pay less income tax in Scotland than they would in the rest of the UK (something the Scottish Government is fond of saying), and would increase the differentials between the two territories. It may well force the Scottish Government’s hand in the budget in December to reduce these differentials.
As ever, we’ll be looking hard at the fiscal risks that have been built into the forecasts. Some of these are assumptions that are built into the forecasts by the OBR that they know are unlikely to be reasonable, but the OBR feel that they are constrained by their mandate to take the Government at their word.
As well as the risk on spending that we have already flagged, other examples include:
- Fuel Duty – it is always assumed that this goes up in line with RPI inflation, with an additional 5p increase from the “temporary” cut first implemented in 2022-23. The last time fuel duty increased in cash terms was in 2011 – so long ago that the UK still had its top credit rating and Pep Guardiola was still managing Barcelona. So it is unlikely that this increase in revenues will actually come in practice.
- Alcohol duty – It is also assumed that every February that alcohol duties will go up in line with inflation (by the forecast of the Q2 RPI – we’re not sure why this is the inflation measure chosen). This did happen in the last year (although delayed to August), but quite often these increases are ditched as part of budget announcements.
Benefit changes being considered to save money – but at what cost?
The UK Government have floated that there will be changes to the sanctions regime around Universal Credit, in order to ensure that more recipients are encouraged to look for and participate in employment. This is seen by poverty charities (and by many recipients) as forcing the most vulnerable in our society to do work that is not suitable or face sanctions, which will not necessarily put them in the best place to get the best out of employment opportunities even if they are suitable.
The coverage so far suggests that the Government thinks this could save in the order of £4 billion over 4 years, with some of these savings being invested in a package of measures to support people, including through work placements.
Research by the Department of Work and Pensions shows that sanctioned individuals are often less likely to be in work and also are likely to have poorer wages if they are in work, so it is not clear whether increasing sanctions is likely to be effective in increasing participation.
The other possibility that has been floated is that the Government are considering uprating benefits by the October inflation rate rather than the one in September as is traditional. This would have implications for recipients given the difference in the rates (4.6% rather than 6.7%) – but would save the UK government £2 billion.
In addition, this also have implications for the Scottish Budget envelope, as it would mean that the addition to the block grant to reflect the fact that some benefits are devolved would also be smaller. Given that it is unlikely that the Scottish Government would be happy to follow suit with this, it may mean even more pressure on the Scottish Budget.
Look out for our analysis on Wednesday!
We’ll be doing our usual immediate analysis (look out for our thoughts on socials following the Chancellor’s statement, and we will also be doing media work in the hours following the statement) and should have a round-up analysis published on the blog by 4.30/5 on Wednesday afternoon.
Mairi is the Director of the Fraser of Allander Institute. Previously, she was the Deputy Chief Executive of the Scottish Fiscal Commission and the Head of National Accounts at the Scottish Government and has over a decade of experience working in different areas of statistics and analysis.
João is Deputy Director and Senior Knowledge Exchange Fellow at the Fraser of Allander Institute. Previously, he was a Senior Fiscal Analyst at the Office for Budget Responsibility, where he led on analysis of long-term sustainability of the UK's public finances and on the effect of economic developments and fiscal policy on the UK's medium-term outlook.