25 Apr 2017

Deficit reduction – a touch overstated, but on the right track

Philip Shaw

Chief Economist

Figures on the UK public finances for March showed the principal PSNBx measure standing at £5.1bn, above the £3.1bn consensus (Investec £2.1bn) and £0.8bn higher than March 2016.

We have no specific concerns over today’s outturn given that at this juncture, the figures are more sensitive than usual to specific shifts in the timing of government inflows and payments (such as dividend income forestalling and contributions to the EU). Indeed this has led to some very low outturns for PSNBx recently. We note too that borrowing for previous months was revised lower to the tune of £0.5bn.

Given that the data applied to March, today’s numbers completed the set for the 2016/17 financial year. This showed the deficit closing considerably to £52.0bn from £72.0bn in 2015/16, close to official forecasts at last month’s Budget of £51.7bn. The timing of tax inflows has also helped the outturn for the year as whole, and so the underlying pace of improvement has been moderately overstated. Even so, the reduction in the deficit in recent years has been substantial. As a proportion of GDP, public sector borrowing stood at 2.6% in 2016/17, its lowest level since 2007/08. This compares with a peak of 9.9% in 2009/10, in the aftermath of the financial crisis.

More broadly the latest General Election campaign should have a direct bearing on fiscal policy issues in a couple of ways.

First, the government will have to decide whether to maintain a manifesto commitment not to raise the main rates of taxes over the next parliament. Second, it must make a call on whether to keep, amend or ditch the ‘triple lock’ on the state pension, which sets out that the level of pensions will rise by whichever is the greater of 2.5%, CPI inflation or average earnings growth. At the weekend, the PM seemed to refuse to rule out tax increases and our sense is that some watering down of the triple lock is possible.

The current fiscal position is not crying out for higher taxes. But with pressures on spending on education, care and other areas beginning to bite and demographic pressures providing a longer-term squeeze, the government might want the flexibility to respond should it need to. And reform of various tax anomalies (such as the effect of the tapering of the personal allowance at £100k), or wider reform might require raising some headline rates to achieve tax neutrality. Certainly the Conservatives’ current 20% plus lead in the polls gives them more wiggle room to avoid making populist but unaffordable tax promises.

Second, Chancellor Philip Hammond has indicated that a post-election Budget is a likely option at some point after 8 June. This is standard practice in a post-election environment. However it does mean that unless the pre-planned autumn Budget is scrapped or downgraded to an Autumn Statement, the UK will have three Budgets in this calendar year, a phenomenon never seen before in recent history.