The Institute for Fiscal Studies released its annual ‘Green Budget’ earlier today, predicting that the UK’s tax burden will rise to its highest level in over 30 years by 2022.
The full report, from one of the UK’s most respected think tanks, includes more than 300 pages highlighting the main issues facing the UK economy ahead of the chancellor’s first full budget next month.
Here’s FastFT’s handy roundup of some of the key stories:
1. The next few years could be a bit of a rollercoaster
Economists haven’t received the best press for the predictive powers in recent months, with the UK’s unexpected resilience since the Brexit vote and the surge in US stock markets since Donald Trump’s election victory prompting widespread criticism of so-called experts.
The IFS’ report however, avoids making too many concrete assertions and uncertainty is a common theme, as illustrated by the varying estimates for global economic growth.
Like most recent estimates, the IFS – along with Oxford Economics – are expecting a continuation of recent trends towards relatively subdued growth, with a modest improvement on last year.
However, they note that risks around the forecast are “unusually large” this year, with growth liable to be damaged by events such as difficult Brexit negotiations and systemic problems with the European banking system.
On the other hand, they also say there is “an increasing chance that forecasts may be too pessimistic” – if the new US administration manages to agree a greater than expected fiscal expansion in exchange for fewer protectionist measures, for example, the resultant boost to US growth could provide a positive spillover to the rest of the world.
2. The UK is vulnerable to an inflation-induced slowdown
While growth is forecast to pick up slightly in most of the world this year, in the UK it is expected to pull back after finishing 2016 as the fastest-growing economy in the G7.
The IFS notes that consumer spending was the only component of gross domestic product to deliver “a robust performance” last year, but rising inflation prompted by higher energy prices and a weaker pound will put a dampener on spending growth.
Real household incomes will increase by a meagre 0.6 per cent this year, down from 1.7 per cent in 2016, according to the IFS. That’s likely to contribute to a near-halving in the rate of consumer spending growth, which will drag down the overall economic growth rate.
3. The UK is heading for a difficult Brexit
Unsurprisingly, the outcome of Brexit negotiations are the biggest unknown in the IFS’ calculations for UK growth prospects.
While Theresa May has gone some way to giving an outline of what the government’s priorities will be, her counterparts in the EU have remained tight-lipped.
The IFS reckons the most likely outcome is an EU exit in 2019 with a three-year transitional agreement that will ultimately end with a free trade deal between the UK and EU.
Once again, however, uncertainty abounds. The report says there is a one in three chance that the country is forced to fall back on WTO rules after it leaves the EU. That would be the only outcome worse than the IFS’ baseline assumption from an economic perspective, which assumes the government focuses on “populist” measures such as clamping down on migration.
4. Austerity is here to stay
With growth expected to slow, the government has already retreated from earlier plans to run a budget surplus by the end of this parliament, promising only to reduce borrowing below 2 per cent of national income by 2020-21 and to zero “as soon as possible” after the 2020 election.
Under current plans the deficit will fall to 0.7 per cent of national income by 2021-22, according to the IFS, but if the rate of deficit reduction between 2019 and 2020 were to be maintained, the budget would not reach surplus until 2028, meaning that “further austerity will be required in order to deliver the commitment to eliminate the deficit in the next parliament”.
Planned measures this year mostly include tax rises, but over the course of this parliament the majority of the tightening is expected to come through “departmental spending restraint”.
The think tank adds:
Whatever level of borrowing the government aims for, achieving its plans will be more difficult – either public spending on pensions, health and social care will be less able to match demand, taxes will be higher, or spending on other areas will be lower. Given large spending cuts already achieved (and with more planned over the next five years), these additional pressures could make even a relatively modest reduction in borrowing during the next parliament more difficult.
5. Tax rises will hit employees more than the self-employed
The prospect of tax rises, together with increasing evidence of shifts in employment patterns, has renewed attention on perceived unfairness in the UK’s tax system.
As the chart above shows, employees can expect to pay significantly more tax on self-employed workers and particularly owner-managers on the same income, a fact the IFS says “is unfair and creates myriad problems, including avoidance opportunities that require complex legislation and suck in the talents of civil servants and accountants”.
Growing numbers of owner-managed companies is expected to reduce government tax revenues by £3.5bn by 2021-22 compared to if the small company population and employment grew at the same rate. In response to the trend, Philip Hammond has said the government “will consider how we can ensure that the taxation of different ways of working is fair between different individuals”, but the IFS’ report calls for more urgent and concrete measures to change the system.
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