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The Chancellor presented his Spring Budget 2021 today (3 March), and the Office for Budget Responsibility (OBR) published its latest forecasts.
Here we discuss the OBR’s assessment of the extent of damage that Covid-19 has caused to the UK’s economy and public finances. We also look at what the Chancellor has done to mitigate this damage and his general approach to “fixing the public finances”.
The OBR expect the economy to return to pre-crisis levels by mid-2022
Prior to the pandemic, the economy was at its largest in the last quarter of 2019. The OBR thinks that the economy will return to a similar level by the middle of 2022 – this is six months earlier than it thought in its November 2020 forecast.
Some long-term damage to the economy expected
The OBR continues to expect that the pandemic will cause some lasting damage to the economy. Its best estimate, as shown in its central forecast, is that economic output will remain 3% below its pre-virus path in the long term. Put another way, it expects “scarring” of 3%.
Future government borrowing is forecast to be around £74 billion
Scarring results in a smaller economy which, among other things, isn’t good for the public finances.
Pre-pandemic, the Government was forecast to borrow £58 billion in 2024/25, equivalent to 2.2% of GDP. The OBR now forecasts borrowing of £74 billion (2.9% of GDP) in 2024/25. If the Chancellor hadn’t increased taxes and cut spending in this Budget (in the medium-term), the new forecast would have been closer to £100 billion.
Taxes and spending are forecast to be larger than pre-pandemic
New Budget tax policies, such as increasing the main rate of corporation tax and freezing income tax thresholds, are forecast to bring in an additional £23 billion in 2024/25 and a little more in 2025/26. The policies mean that, relative to the size of the economy, tax receipts are forecast to be higher in 2024/25 than was forecast pre-pandemic.
The OBR forecast that tax receipts, relative to the size of the economy, could rise to levels last seen in the mid-1980s or late-1960s, depending on which measure is used.
Government spending in 2024/25 is also forecast to exceed the pre-pandemic forecast, relative to the size of the economy. For instance, spending on welfare is forecast to increase because of higher medium-term unemployment and health-related welfare benefits.
Government debt interest payments are forecast to be lower than they were forecast to be pre-pandemic. This may seem a little odd given the large increases in government debt, but it’s a result of inflation remaining low, interest rates dropping, and the Bank of England buying lots of government bonds (see Section 5 of Coronavirus: Economic impact).
The Chancellor’s approach to making the public finances sustainable
Going into the Budget the Chancellor said he would return the public finances to a sustainable position. We’ve now seen more of what this means in practice. Broadly speaking, the Chancellor has raised taxes in the medium-term to get closer to what he sees as being a sustainable position.
The Chancellor says that in normal times, day-to-day public spending should be covered by taxes. The medium-term Budget measures mean that this is nearly achieved in the final year of the OBR’s forecast. In 2025/26, day-to-day spending is forecast to be around £0.9 billion higher than tax receipts, which means there will be what is known as a ‘current budget deficit’. Without the Budget’s medium-term tax rises and cuts to spending, the current budget deficit in 2025/26 would have been forecast at over £37 billion.
The Chancellor says that government debt needs to stop rising. The tax rises and spending cuts announced by the Chancellor mean that this is achieved in the forecast. The underlying debt-to-GDP ratio (which excludes the Bank of England) peaks in the forecast in 2023/24 and falls by around 0.1% of GDP in the subsequent years. Debt is, however, still forecast to be around 20% of GDP higher than pre-pandemic.
Later in the year we are likely to hear more on the sustainability of the public finances. The Government’s policy for managing the public finances (its fiscal framework) remains under review, but the Government intends to set out new targets for the public finances (sometimes called fiscal rules) later in the year.
These are forecasts and need to be treated cautiously
Much of the above discusses forecasts. The OBR stress that there is a huge amount of uncertainty surrounding all the figures. Since there is no way of predicting the future with any precession, forecasting is difficult at the best of times and is particularly hard now. That isn’t to say that forecasts aren’t important. They are essential for setting policy and provide a basis for assessing the Government’s progress.
The Library’s briefing Spring Budget 2021: A summary sets out the Budget’s key announcements and briefly analyses public spending and the OBR’s forecasts.
About the author: Matthew Keep is a researcher specialising in the public finances at the House of Commons Library.
Image: ©UK Parliament / Jessica Taylor under CC BY 3.0, cropped
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