Rishi versus Boris: There may be trouble ahead

Rishi Sunak had plenty of figures to spray around today when presenting his Spending Review to the House of Commons. Some were dismaying, such as new economic and fiscal forecasts. Others were largely commendable as the Chancellor of the Exchequer totted up the sums that will be spent on combating the epidemic. There were also upbeat announcements, as he made the most of commitments to rebuild the country’s infrastructure. One number was notably absent: an indication of the tax rises that will be needed to fill the gaping hole that has opened up in the public finances.

The new economic forecasts from the independent Office for Budget Responsibility (OBR) were sobering. The fiscal watchdog now thinks that GDP will shrink by 11.3 per cent in 2020, the biggest drop in over 300 years. In its central forecast, it expects a recovery of 5.5 per cent next year followed by growth of 6.6 per cent in 2022. National output will not return to its pre-pandemic level until the final quarter of 2022. Unemployment will rise to a peak of 7.5 per cent in the spring of 2021.

The OBR’s fiscal forecasts were just as bleak. In the current financial year ending in March 2021, the government will borrow £394bn, equivalent to 19 per cent of GDP. As Sunak himself acknowledged, that will be Britain’s biggest peacetime budget deficit. To put the number in perspective, it’s almost double the borrowing as a share of GDP (10 per cent) in 2009-10 following the financial crisis, which was regarded at the time as alarmingly high. Public sector net debt will vault to 105 per cent this financial year, the first time it has exceeded 100 per cent since the start of the 1960s.

Despite the economic recovery that is expected in the next two years, public borrowing will remain high, especially in 2021-22 when it will amount to £164bn, which at 7.4 per cent of GDP will itself be one of the highest on record. The OBR then envisages the deficit falling back to around £100bn, or 4 per cent of GDP, a year until the middle of the decade. Debt will still be 105 per cent of GDP in 2025-26.

One response to such troublesome fiscal forecasts would be to scale back public expenditure. But there was not much sign of that in Sunak’s address to MPs. The Chancellor announced a partial pay freeze for public sector workers next year. He also sliced a chunk out of the overseas aid budget. But despite announcing such economies with more to come in future years, the overall gist of his statement was that of a government determined to soldier ahead with its ambitious plans to improve public services and renew infrastructure.

The snag in sticking to a plan conceived before the pandemic is that the post-Covid economy will be smaller than previously envisaged. On the OBR’s central forecast, even when the economy has bounced back and resumed its previous growth trajectory it will be permanently 3 per cent lower than it would otherwise have been. Since GDP is the tax base, that feeds through to revenues, which will be correspondingly lower than previously projected.

Something has to give. If Boris Johnson is unwilling to curb his spending ambitions, the only way to repair the public finances is to raise taxes. But the closest that Sunak came to admitting that in his statement was when he spoke obliquely of “a responsibility, once the economy recovers, to return to a sustainable fiscal position.” Though this was not a budget, it was the first formal overview of the public finances since the pandemic struck and thus a missed opportunity to spell out the need for—and the possible scale of—eventual tax rises.

At the moment the Treasury has no difficulty in borrowing as much as it likes at dirt-cheap rates. But, as the OBR points out, that depends on investors’ continuing trust in the safety of lending to the government, which in turn rests on their “confidence that responsible fiscal and monetary policies will be maintained.”

The relationship between chancellor and prime minister is the most important one in government. Sunak hints that he wants to do the responsible thing. Johnson seems more inclined to take his chances, carrying on dancing “before they ask us to pay the bill.” As in the Irving Berlin song, there may indeed be trouble ahead.