Has Brexit put the Chancellor in a Jam?

On 23rd November 2016, the Chancellor Philip Hammond delivered his first Autumn Statement to the House of Commons in which he declared he would prepare the UK economy to be resilient as we exit the EU. This represents the first financial statement from the Government since the EU Referendum and was set against the backdrop of gloomy news from the Office of Budget Responsibility (OBR) on the state of public finances and future growth.

Hammond’s sober and unflashy style was a marked contrast to his predecessor, George Osborne, and he spent a significant portion of his speech outlining the fiscal and economic challenges ahead. This statement also represented a political challenge for the new Chancellor, who was aware that he needed to satisfy some of his own backbenches and use this opportunity to provide an optimistic vision of the UK’s “new chapter” post-Brexit. This involved addressing some of the concerns over economic imbalances, long-term weaknesses and levels of inequality across the UK – all of which are widely thought to have underpinned the Brexit vote – as part of the government’s pledge to “build an economy that works for everyone.”

While he noted the UK’s strong economic performance in 2016, Hammond was explicit in setting out the negative impact that the Brexit vote will have on future UK growth – outlining OBR forecasts that predict growth of 1.4% in 2017 (down from the 2.2% forecast in the March Budget), which was attributed to lower investment and weaker consumer demand driven by greater uncertainty and higher inflation. Longer term, UK growth is now expected to be 2.4 percentage points lower over the next five years than would otherwise have been the case, as a result of the Referendum.

While Hammond stated the Government’s continued commitment to fiscal discipline, figures from the OBR showed a significant and immediate deterioration in public finances, with borrowing in 2016 hitting £68.2 billion (up nearly £13 billion from the £55.5 billion predicted in March) and projected borrowing in future years expected to be significantly higher than previously forecast. Given this news, it was unsurprising that the Chancellor set out a new approach to public spending and deficit reduction. As part of this, he unveiled “three fiscal rules”: the budget would be balanced by the next parliament (2020-2025); debt is to fall as a share of GDP by 2020 and welfare spending is to be capped.

This loosening of fiscal policy would, in the Chancellor’s view, provide sufficient headroom to support the UK economy through the transition of leaving the EU and allow an increase in public spending in “high-value” infrastructure and innovation to raise Britain’s productivity. While new day-to-day spending pledges would be funded by increased taxation, infrastructure investment would be funded through increased borrowing. This would finance a range of new initiatives, such as the new National Productivity Investment Fund, worth £23 billion over the next five years, to be spent on rail, telecoms and housing. Hammond also confirmed the additional £2 billion annual investment in R&D, as trailed earlier in the week, and a new £2.3 billion Housing Infrastructure Fund to provide 100,000 new homes in areas of high demand by ‘unlocking land’ through targeted infrastructure investment, addressing local concerns over the new housing developments’ impact on local infrastructure. Hammond also stated that much of this investment would be focused outside the South East, addressing the productivity gap that exists between London and regional cities. Aside from big infrastructure investment, there were a few eye-catching announcements designed to demonstrate the Government is on the side of working people and the so called “JAMS” (Just About Managing), by confirming the rise in the National Living Wage and banning of letting fees to tenants, as well as raising the personal allowance.

In concluding his speech, the Chancellor announced that it would be his ‘last Autumn Statement’, before confirming that, in fact, he was reordering annual Budget timetables. It remains to be seen whether these key announcements in his Statement will be successful in addressing the fiscal, economic and political challenges facing the Government. Despite the Chancellor’s understated tone, today’s announcement represents a significant shift in the Government’s role towards economic and, in particular, fiscal policy. Hammond is essentially attempting to offset slowing UK growth through increased infrastructure expenditure, financed through increased borrowing. In addition, it is clear that he believes that uncertainty caused by Brexit will give him licence to drop his predecessor’s deficit reduction plans and adopt a longer-term plan for balancing the books. As a result of this approach, Hammond may find himself attracting a number of critics who disapprove of increased public borrowing – although he is likely to feel more exposed to attacks from his own backbenchers than from the Labour Party.

Autumn Statement Highlights

Economic Outlook and Public Finances

Growth: OBR forecasts economic growth of 2.1% in 2016 – up slightly from the 2% it forecast before the EU referendum. It expects the economy to grow by 1.4% in 2017 – down from the 2.2% predicted in March. Growth in 2018 is expected to be 1.7% – down from the 2.1% forecast in March and is predicted to return to the 2.1% rate previously forecast in 2019. The OBR concludes that the referendum result means that potential growth over the forecast period will be 2.4% lower than would otherwise have been the case.

Debt: The fiscal forecasts are markedly worse than in Budget 2016. Public sector net debt is forecast to be higher, peaking at 90.2% as a share of GDP in 2017-18. In the March Budget, debt was projected to start falling as a share of GDP this year, and be down to 81.3% by 2017-18.

Borrowing: Public sector net borrowing is higher than forecast at Budget 2016 in every year and by £32 billion in 2020-21. In 2020-21, public sector net borrowing is now forecast to be £20.7bn compared to a £11bn surplus forecast in March.

Deficit: The deficit – as measured by public sector net borrowing as a percentage of GDP – will fall from 4% last year to 3.5% this year. It is forecast to continue to fall over the next five years, reaching 0.7% in 2021-22. This represents the lowest deficit as a share of GDP in two decades.

Surplus:  The Chancellor confirmed the government will no longer seek to return the economy to a surplus by 2019/2020. The Government will publish a new Charter for Budget Responsibility, underpinned by three fiscal rules: that public finances should return to balance in the next Parliament, and in the interim, cyclically adjusted borrowing should be below two per cent; public sector net debt must be falling by the end of this Parliament; and that welfare spending must be within a cap set by Government.

Employment: The OBR forecasts that the number of people in employment will continue to increase, reaching 32.3 million in 2021. The OBR has revised its near-term forecast for the unemployment rate up slightly, compared to the forecast at Budget 2016. The unemployment rate is now forecast to be 5.2% in 2017, 5.5% in 2018, and 5.4% from 2019 to 2021.

Inflation: The OBR forecast the UK’s decision to leave the EU will, in the near term, lead to higher inflation, largely caused by post-referendum sterling depreciation. CPI inflation next year is expected to be 2.3%, up from the March Budget forecast of 1.6%, and is predicted to be 2.5% in 2018, up from the 2% March forecast.

Savings:  Government Departments will continue to deliver overall spending plans set at the Spending Review 2015. The Efficiency Review announced at Budget 2016 will update in autumn 2017.

Taxation

Corporation tax will fall to 17%, the lowest overall rate of corporate tax in the G20

Carbon Price Support will continue to be capped out to 2020

A Business Rates Reduction package worth £6.7 billion will be implemented

Transitional Relief Cap will be lowered by the Communities Secretary from 45% next year to 43%, and from 50% to 32% the year after

Rural Rate Relief will be increased to 100%, giving small businesses in rural areas a tax break worth up to £2,900 a year

Employee and Employer National Insurance thresholds will be aligned at £157 per week from April 2017. This will cost nothing to employees and the maximum cost to business will be an annual sum of £7.18 per employee

Insurance Premium Tax will rise from 10% to 12% next June

Salary Sacrifice Schemes will be abolished from April 2017, but ultra-low emission cars, pensions saving, childcare and the cycle to work scheme will be excluded. Certain long-term arrangements will be protected until April 2021

Money Purchase Annual Allowance will be reduced to £4,000 to prevent inappropriate double tax relief

Tax benefits for disguised earnings will be removed for the self-employed and employers, extending its current remit and raising £630 million over the forecast period

Inappropriate use of the VAT Flat Rate Scheme will be stopped

Tax advantages linked to Employee Shareholder Status will be abolished

A new penalty for those who enable the use of tax avoidance schemes that HMRC later challenges and defeats will be introduced

Tax relief for Corporate Interest Expenses will face new restrictions, reforming the way that relief is provided for historic loses, as described in Budget 2016. They will take effect in April 2017 and raise over £5 billion from the largest businesses

The Personal Tax Allowance will rise to £11,500 in April 2017 as planned and will rise to £12,500 by 2020. It will then rise automatically with inflation. The higher rate threshold will be £50,000.

The National Living Wage will increase from £7.20 to £7.50 in April 2017

The Universal Credit taper rate will reduce from 65% to 63% in April 2017

Tax-free childcare will be rolled out in early 2017, providing a saving of up to £2000 per child

The fuel duty rise will be cancelled for the seventh successive year

Public Spending and Infrastructure Announcements

To help boost UK infrastructure, the Chancellor has said he will launch a fund to invest £23 billion in rail, telecoms and housing infrastructure over the next five years. The National Productivity Investment Fund will be spent on infrastructure and research and development to help improve the nations productivity which lags behind Germany, the US and France.

Work and welfare: Welfare spending will be capped, set by the Government and monitored by the OBR. The Government has no plans to introduce further welfare saving measures in Parliament beyond those that have already been announced.

There will be a Universal Credit taper from 65% to 63% from April 2017, allowing individuals to keep more of what they earn and it is estimated that three million households could benefit from this change.

The adult education budget will be devolved and London will receive greater control over the delivery of employment support services for the hardest to help.

The National Living Wage will be increased from £7.20 to £7.50 from April 2017, making George Osbourne’s target for a £9.00 minimum wage by 2020 unlikely to be achieved.

Roads: An additional £1.1 billion of investment in local English transport networks will be provided, £220 million of which going towards addressing traffic pinch points on strategic roads.

Rail: £450 million of funding has been allocated to trial digital signalling on railways. This is to achieve improved reliability and to increase functional capacity from existing rail infrastructure.

Housing & Planning: The Government will be focusing infrastructure investment on unlocking land for housing through a new £2.3 billion housing infrastructure fund to help deliver the infrastructure needed for 100,000 new homes in areas of high demand. On top of this, there will be an additional £1.4 billion of funding made available to deliver an additional 40,000 affordable homes. London will receive £3.14 billion at its share of the national affordable housing fund to deliver a commitment of over 90,000 affordable homes.

Restrictions on government grants will be relaxed to allow for a wider range of housing types whilst a large-scale regional pilot of right to Buy for Housing Association Tenants will be launched. There will be continued support for home ownership through the Help to Buy: Equity Loan scheme and Help to Buy ISA.

These moves will more than double in real terms annual capital spending on housing by the government, satisfying ambitions to greatly increase the housing supply for both buying and renting.

Energy: The government will continue to deliver commitments made to the oil and gas sector. To ensure a stable tax regime that maximises economic recovery from the North Sea, the government has recommitted to the long-term plan for the oil and gas ring-fence fiscal regime. The reporting process will be simplified and administrative costs of Petroleum Revenue Tax for oil and gas companies will be reduced.

The Carbon Price Support will continue to be capped out to 2020.

Growth corridors: In backing the National Infrastructure Commission’s future infrastructure recommendations, £110 million of funding will go towards East West Rail and the new Oxford to Cambridge Expressway will be delivered. This is aimed to create a transformation growth and tech Oxford-Cambridge corridor, capitalising on the world-class research strengths of the UK’s two “best-known universities.”

Digital: Over £1 billion will be invested in digital infrastructure and a full fibre network to improve speed, reliability, catalyse private investment and make the UK a world leader in 5G.

From April, 100% business rates relief will be introduced for a five-year period on new fibre infrastructure; supporting further roll out of fibre to homes and businesses. For future infrastructure investment needs, the government will invest between one and two per cent of GDP every year towards economic infrastructure.

Devolution: As a result of extra infrastructure spend across England, the block grant contributions to the devolved nations will increase by £250m to the Northern Ireland Executive, £400m to the Welsh Government and £800m to the Scottish Government. The Chancellor reaffirmed his support for a City deal for Swansea and North Wales.  The Government announced it would work with the Scottish Government towards a city deal for Stirling and confirmed funding for city deals in Aberdeen and Inverness, and will consider proposals for similar deals with the Tay cities – meaning that all major Scottish cities are on course for city deal status.

There will be investment in every local region in England through the allocation of £1.8 billion from the local growth fund. £556 million will go towards local enterprise partnerships (LEPs) in the North of England, £542 million to the Midlands and the east of England, and £683 million will go to LEPs in the South West, South East and London.

The Government will work towards a second devolution deal with the West Midlands Combined Authority and plans to begin talks on future transport funding with Greater Manchester.

Reaction

John McDonnell MP, Shadow Chancellor

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John McDonnell stated that it provided a record of the “abject failure” of the last six years and argued that it offered no hope for the future. He said that the Government’s long-term economic plan had failed, with growth, wage growth and business investment being revised down. He added that Mr Hammond had spoken of a ‘reset’ in economic policy, but had not delivered one.

The Shadow Chancellor said that business investment could increase if there was confidence of having access to skilled workers. He said: “The Chancellor must now do the right thing for British workers and businesses. He must insist on full, tariff-free access to the single market. He and the Treasury know that’s what will give the best deal for jobs and prosperity here. It may not be in the Chancellor’s nature, but in the national interest I urge him to stand up to the Prime Minister and the extreme Brexit fanatics in her Cabinet.”

Carolyn Fairbairn, CBI Director General

carolyn-fairbairn

Carolyn Fairbairn praised the Chancellor’s emphasis on R&D, housing and local infrastructure, which “will help businesses in all corners of the UK to invest with greater confidence for the long-term.” She also advised that these measures must lead to action, arguing: “that means tarmac, tracks and telecoms being laid”.

She also praised the new fiscal rules which will “provide the Government with welcome flexibility, while remaining prudent in uncertain times” as well as the Government’s decision to accept the Low Pay Commission recommendations on low pay. Finally, she warned that the Chancellor will have to keep a “watching brief on the challenges created by higher inflation and uncertainty weighing on near-term business investment”

Stewart Hosie MP, SNP

stewart-hosie-mp

Responding to the 2016 Autumn Statement, SNP Westminster Economy Spokesperson, Stewart Hosie noted that there had been no significant remarks on Brexit, referencing that the tax yield could reduce significantly as a result of leaving the EU. He also asked why there had been no plan to retain membership of the Single Market.

The SNP welcomed the Bank of England’s monetary policy decisions, but said that the key aspect of the Autumn Statement was the increase in total managed expenditure. He said that the Statement did not provide the fiscal stimulus to match the monetary policy discipline of the central bank.

 

If you would like to discuss this further, please contact:

Simon Gentry, Newgate Communications

DL: 020 3757 6772

simon.gentry@newgatecomms.com

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