Schroders: Budget 2015 brings pre-election pause in austerity

With an election looming, Osborne took the opportunity to highlight the achievements of the coalition government, along with delivering a vision of what his party would aim to deliver if they were returned to government.

Economic outlook: migration impacts growth forecast

The independent Office for Budgetary Responsibility (OBR) was able to revise up its forecast for real GDP growth in 2015 from  2.4% to 2.5% (the Schroders forecast is for growth of 2.6%), along with its 2016 forecast, which was lifted from 2.1% to 2.3% (Schroders expects 2.0%). The main driver of the upgrade is the fall in global energy prices, which has helped to lower energy inflation and increase real disposable income for households. Together with a lower unemployment forecast, the growth outlook looks more positive for the domestic economy. 

Lower oil prices also dominate the inflation forecast. The OBR has cut its 2015 forecast for CPI inflation from 1.1% to 0.2% (Schroders projects 0.6%), and the 2016 forecast from 1.7% to 1.2% (Schroders expects 1.3%). Although the fall in oil prices is a global and largely external phenomenon, the Chancellor took full advantage of the opportunity to highlight the positive implications for living standards and public finances.

The longer-term forecast was, in our view, the most interesting part of the OBR’s analysis. The OBR has revised up its trend-growth estimate from 2.2% to 2.3% due to recent trends in migration. While growth in the working age population is still expected to slow, the OBR has been forced to lift its expectations for inward migration, especially as the latest figure for annual net inward migration has been about three times larger than the OBR had estimated. While the OBR assumes the next government will seek to reduce migration, it cannot continue to assume such low numbers. This suggests that the economy will be able to grow at a slightly faster pace without generating excessive inflation. However, its latest update of the output-gap suggests that there is less spare capacity than previously thought. Indeed, the OBR estimates that the output-gap will close by the end of 2017 – two years earlier than its previous estimate. 

Energy prices to boost fiscal position

Public sector net borrowing (PSNB) as a share of GDP is unchanged in the OBR’s forecast for this financial year and 2015/16. It has been slightly nudged down for the following three fiscal years, but then revised up by 0.7% of GDP in 2019-20. The OBR expects the government to achieve a budget surplus in 2018/19 (unchanged), but for debt as a percentage of GDP to start falling by 2015/16 (one year sooner than previously forecast).  Upward revisions to the growth forecast help improve the public finances, but again, lower oil prices have been key. The OBR estimates that lower oil and gas prices along with lower inflation more widely, will increase tax receipts by £8.2 billion and cut public expenditure by £30.1 billion. 

Another important boost has been lower-than-expected expenditure on interest payments on existing debt. The Chancellor stated that he will look to lock in ultra-low interest rates by redeeming several old debt issues and replace them with long-dated bonds. The OBR assumes lower interest rates will cut spending by £15 billion over the forecast horizon, and also increase tax receipts by £2.5 billion.

Policy changes to reward savers

Most of the policy changes announced in the Budget focused on key areas for the government. Help for savers, help for struggling industries, and ensuring fairness in terms of contributions continues to be a key theme.

For savers, the big change was the introduction of a new personal savings allowance, where the first £1000 interest on savings for basic rate tax payers will be tax free (£500 for 40p tax payers). In conjunction with the already generous annual ISA allowance, the government wants to show that it is rewarding savers in an attempt to change the country’s excessive borrowing and spending culture. Of course, the best way to do so would be to raise interest rates, but I doubt the Chancellor wants that.

ISAs will become flexible, allowing users to withdraw and then returning money into their annual allowances. Also, there will be more help for those struggling to get on to the housing ladder. “Help to Buy” ISAs will boost the deposits for first time-buyers by 25%. This is an entirely political move in our view that aims to win over struggling entrants to the market, but inflames the problem of an expensive, poorly supplied market. 

For pensions there were two significant changes. The lifetime allowance will be cut from £1.25 million to £1 million from April 2016, while pensioners who want to cash in their annuities will no longer be charged 55%, but the marginal tax rate instead. The reduction in the lifetime allowance is an issue of fairness (and the need to raise more revenues), but will the allowance now be indexed to inflation? Also, the ability to sell annuities certainly offers more flexibility for those unfortunate enough to have had to buy policies in the low interest rate environment of recent years. 

Tax in the spotlight 

For businesses, the most significant change will be the introduction of a Diverted Profits Tax – also dubbed the “Google Tax’” by the press. This is designed to make multinationals pay a fair share of corporation tax, which many are accused of avoiding through aggressive transfers of profits and the use of charges. Whether this will be workable is yet to be seen, but there is a growing international consensus that the practice has gone too far. 

Another significant change will be for North Sea Oil and Gas companies, who will see the Supplementary charge cut from 30% to 20%, and petroleum revenue tax fall from 50% to 35%. The industry was in sharp decline even before the huge fall in oil prices. These tax cuts will help slow the rot, but with the cost of extraction rising as easy to reach wells are depleted, the sector may yet see further help from the next government. 

Banks were again at the sharp end of the Budget. The annual levy was increased as expected, which should disarm the opposition who has been calling for such a move. Otherwise, the Chancellor announced a review of business rates, and new tax credits for various struggling sectors. 

With regards to personal taxation, the tax free allowance will increase to £10,600 in 2015/16, to £10,800 in 2016/17 and £11,000 in 2017/18. The threshold for paying the higher rate of 40% will also rise, but not until 2017/18.

Otherwise, there were various other tweaks including the supposed “death of the annual tax return”, but overall, not a great deal of change on the personal tax front. Finally, duties and excise on beer, cider and Scotch whisky were all cut, but other spirits including wine were unchanged. The scheduled rise in petrol duty was cancelled again, while tobacco duties will rise as usual by 2% plus inflation. 

Austerity is far from over

Overall, the Chancellor’s final budget of the parliament turned out to be one of the most uneventful. The economic outlook looks favourable, while the public finances are slowly improving. The measures announced are broadly fiscally neutral, and will have a negligible impact on growth and inflation in the near term.  The Chancellor promised a gimmick-free Budget, but he may have had little choice in the matter given the still significant budget deficit. While Osborne claims that he is taking the nation from “austerity to prosperity”, the truth is that there is a lot more of the former to come. According to the OBR, the annual growth rate of the budget for day-to-day spending on public services and administrations is expected to fall in real terms from -1.3% in 2015/16 to -5.4% and -5.1% in 2016/17 and 2017/18. In other words, the next government spending review will see spending cuts in the first two financial years that are greater than the previous six years! 

Austerity is far from over, which makes us question whether the next government will really be able to deliver anything as robust as the OBR’s assumptions – especially as we are very unlikely to see any political party win an overall majority in May’s election.