Another Chancellor; Another Fiscal Event
The new chancellor, Kwasi Kwarteng, has announced that on Friday 23 September there will be a “mini budget”. This means that we will have yet another fiscal event—that is, a set of announcements about taxes and/or government spending—without any independent analysis from the Office for Budget Responsibility as to the effect of the announcements on the government’s deficit and debt. This adds to the announcements by then-Chancellor Rishi Sunak on 26 May (support for households’ energy bills and a windfall tax on energy companies) and that of Prime Minister Liz Truss on 8 September (further support for households’ energy bills.)
My colleagues at NIESR have argued—in particular, in the paper on “Designing a New Fiscal Framework”—that an important underpinning of the credibility of the fiscal framework is independent oversight. Indeed, as chancellor, George Osborne set up the OBR precisely to do this. Its role is to provide such an independent assessment of the long-term sustainability of the public finances and the likely medium-term evolution of the deficit and debt against the fiscal targets set by the chancellor. It is worrying that we are seeing important announcements about taxes and spending without the OBR being asked to assess the medium-term implications for fiscal sustainability. At the same time, we are likely to hear of yet another failure to meet the fiscal rules.
Leaving that aside, what is likely to happen on Friday?
We know that the Energy Price Guarantee will fix the price per unit that households will have to pay for their energy for two years at a rate that implies an annual bill of around £2,500 for a typical household. In addition, the government laid out a plan to support businesses with their energy bills by capping the wholesale cost of energy for six months. NIESR has already responded to the original announcement on household support, arguing that, though we welcome the support for households, we do not think that the support is sufficiently targeted. We also believe it is unnecessarily expensive compared to our suggestion of a variable price cap. In addition, the guarantee removes the incentive for households to cut down on their energy use that would have resulted from a rise in prices. Add this lack of incentive to the close to zero gas storage capacity within the United Kingdom and the scene is all but set for shortages this winter. Further, this policy of subsidising the energy retailers—as well as the likely temporary scrapping of the green levies on energy bills—goes against the need to encourage households to move to carbon-free technologies (such as heat pumps) and energy suppliers to move to using renewables to generate electricity.
Looking beyond support for households against the cost-of-living crisis, we can also expect taxes to be cut. In particular, it is likely that the rise in National Insurance brought in earlier this year will be reversed and possible that the rises in corporation tax planned for 2023 are also reversed. The government have argued that these moves are good for growth. This may be true in the longer run—though the evidence is mixed at best—but, in the short to medium run, they mainly support richer households and shareholders.
This will substantially worsen the government’s fiscal position. Indeed, when added to the cost of the energy price guarantee, we could be looking at an increase in the budget deficit of between £100 and £200 billion over the next two years (approximately 5 per cent of GDP). Such an increase would make it close to impossible for the government to achieve its current fiscal targets of balancing the current budget by 2025-26 and to have public-sector debt falling as a proportion of GDP by the same date. Because this will have to be financed by borrowing, the government will have to issue a large quantity of gilts at exactly the same time as the Bank of England is likely to start selling gilts as it moves to “quantitative tightening”. The result is inevitably going to be a rise in gilt yields—the government’s cost of borrowing—and this will further worsen the fiscal position. At the same time, the tax cuts and additional spending will add to demand at a time of already high inflation. With inflation likely to go higher, the Monetary Policy Committee of the Bank of England will be forced to raise interest rates by more than previously needed, again increasing the government’s debt interest payments and further worsening the fiscal position.
Perhaps to counter this, the chancellor has instituted twice-weekly meetings with the governor of the Bank of England. Although (at least according to the Treasury website) he has “affirmed the UK Government’s long-standing commitment to the Bank of England’s independence and its monetary policy remit”, there is a suspicion that the government is reconsidering the Bank of England’s remit and, in particular, its operational independence over monetary policy. This would be an extremely worrying development, particularly given what looks suspiciously like an inflationary fiscal event—reminiscent of Maudling in 1963 and Barber in 1972—encouraging a boom ahead of an election in late 2024, exactly the sort of “political business cycle” that making central banks independent was supposed to stop happening.
Finally, to return to our call for a new Fiscal Framework, our main point was that when setting fiscal policy what matters is the well-being of all the population, not just the most fortunate. Let us hope the new chancellor follows this maxim.
This article first appeared in Prospect Magazine on 22 September 2022 and is reproduced here with their kind permission.