Chancellor of the Exchequer Jeremy Hunt faces an unenviable backdrop to the Autumn Statement on 22 November. Economic growth has ground to a halt and is expected to stay stagnant. Inflation may be declining, but it remains high and is expected to stay above the 2 per cent target throughout 2024. There is very little fiscal room to manoeuvre and hence there are no quick fixes to get the UK out of trouble. Whoever wins the election next year will face an uphill climb.
There are three courses of action the chancellor could take in this Autumn Statement: 1) resort to short-term tax cuts; 2) focus on incremental structural reforms to boost growth; or 3) harness the power of technology and long-term policy thinking to overhaul the role of the state. We expect him to sidestep option 1 and follow option 2, but we urge him to also choose option 3. The UK needs deeper structural reform to drag the economy out of its 15-year stupor. We need a new longer-term policy approach that looks beyond the current budget cycle and uses technology to unlock new modes of public-service delivery and new drivers of growth.
Option 1: (Just Say No to) Tax Cuts
Although higher inflation has meant tax receipts have come in stronger than expected, it has also pushed up borrowing costs and will increase the cost of government spending. Consequently, the fiscal situation remains exceptionally tight, and the chancellor should continue to resist calls for large tax cuts, particularly to any of the three major revenue raisers – VAT, income tax and national-insurance contributions.
Not only are major tax cuts unaffordable, they also risk stoking inflation. Fiscal and monetary policy are currently pulling in the same direction. High interest rates and fiscal drag – when inflation-driven earnings growth pulls more people into higher tax brackets – are both sucking demand out of the economy and helping to bring down inflation. By contrast, a major tax cut would likely force the Bank of England (BofE) to keep rates higher for longer to keep a lid on inflation, raising government borrowing costs and worsening the fiscal situation. The BofE and chancellor need to continue moving in lockstep.
Tax cuts would also leave even less fiscal room to deal with future shocks. The shocks of the past four years have required the government to provide colossal support to soften the domestic economic effects of the pandemic and the war in Ukraine. Public-sector net debt has soared from 80 per cent of GDP in 2019 to almost 100 per cent today. That’s half a trillion pounds of extra debt in just four years, or more than £7,000 per person in the UK. The UK cannot afford to continue spending any fiscal headroom immediately, only for debt to ratchet up when the next shock hits.
Option 2: Structural Reforms to Boost Growth
The chancellor is most likely to focus his attention on incremental structural reforms that support future growth. Rumoured policies focus on investment, net zero and public-sector productivity.
Boosting Investment
Business investment has been stagnant since 2016 and continues to hold back growth. To improve this, the chancellor is likely to set out changes to pensions, full expensing and the way government helps land foreign investment in the UK.
Pensions: As we’ve previously highlighted, the UK’s fragmented pension sector is holding back growth. At the Autumn Statement, the chancellor is likely to announce several measures to help funnel more capital from pension funds into domestic investments. These could include: 1) expanding the number of pension funds agreeing to allocate at least 5 per cent of their default funding to UK companies that are not traded on open stock markets by 2030 as laid out in the Mansion House Compact; 2) announcing a new joint-investment initiative with the British Business Bank designed to make it easier for pension funds to invest in smaller, high-growth UK companies; 3) setting out a path forward to consolidate different segments of the pension industry following the outcomes of several reviews. While these are positive steps, the absence of a pension-reform bill in the King’s Speech raises questions about how much substantive progress will be made before the election. TBI continues to advocate for a faster response to generate better, more secure returns for pensioners and unlock billions of pounds of long-term capital to improve the dynamism of the UK economy.
Full expensing: In March, the chancellor enabled companies to deduct 100 per cent of the cost of investment in certain equipment and machinery from their taxable profits between April 2023 and April 2026. The temporary nature of the current policy is problematic as it incentivises businesses to bring forward capital investment but not to increase overall investment in the long term. Recognising this, the chancellor has signalled his intent to make this full-expensing policy permanent as soon as the fiscal situation allows – likely at the Autumn Statement. Doing so would likely nudge up business investment in the long-term and be broadly cost neutral. This should be a first step on a longer road to streamlining the UK’s corporate-tax system. That road should also include reforms to the UK’s research and development tax credit, which is a key carrot to entice innovative companies to set up in the UK.
Attracting foreign direct investment (FDI): Since March, Lord Harrington has been conducting a review to understand why inward FDI flows to the UK have been declining and what the government can do to reverse the trend. Several announcements are likely in the Autumn Statement, including a beefed up Office for Investment, a new high-level minister for investment who reports directly to the chancellor and a cross-government investment board chaired by the chancellor that will set the UK’s detailed investment plan. These changes are designed to help land foreign-investment projects in the UK by providing a more powerful cross-government mechanism to unblock barriers that prevent those deals from going through. Such changes are sensible, but they largely build on existing Whitehall structures and so it is debatable how transformative they will be.
Net Zero
In the spring, the government pointed to the Autumn Statement as the key moment when the UK would respond to the United States Inflation Reduction Act (IRA). This response cannot come soon enough. Over the past five months the UK has slipped from fourth to seventh in EY’s Renewable Energy Country Attractiveness Index. The failure of the fifth “contracts for difference” round to attract any new offshore-wind bids, plus the weakening of some green policies in recent months, has left investors with reduced confidence in the UK. How might the chancellor respond?
Speeding up grid connections: Grid connections are a key barrier to investment in renewables. The Autumn Statement is likely to build on three proposals from the prime minister in September: 1) a spatial plan for UK energy infrastructure; 2) fast-tracking major transmission projects through the nationally significant infrastructure planning regime; and 3) a new approach to grid connections whereby energy projects that are ready first will be connected first. Such measures are welcome and overdue, but they are only one part of the reform package needed to deliver a decade of electrification. Without additional changes to the regulatory architecture and policy changes to create longer-term certainty for investors, the UK is likely to remain off track to meeting its net-zero goals.
Green industrial subsidies: The government has provided significant targeted funding in recent months, including £500 million to Jaguar Land Rover owner Tata to build a gigafactory in Somerset and another £500 million to Tata to convert its Port Talbot steel production site from high-emission blast furnaces to greener electric-arc furnaces. The government is also rumoured to be in discussion with Jingye, the owner of British Steel, to provide £500 million for a similar green conversion to its Scunthorpe steel plant. The chancellor may use these interventions and a possible further funding announcement for an advanced manufacturing plan to clarify how the government is adopting a targeted-subsidy approach that offers better value for money to taxpayers than the blanket subsidies in the IRA. More clarity would be welcome. We encourage the government to copy, compete, and collaborate in assessing which aspects of the IRA the UK should adopt and which it should avoid.
Carbon Border Adjustment Mechanism (CBAM): The chancellor may also announce that a new UK CBAM will come into force in 2026. This border tax on the embedded carbon content of iron, steel, aluminium, fertilisers, concrete, energy and hydrogen imports would be a direct copy of the EU’s policy and thus a major win for the EU’s regulatory leadership. Such an announcement could be the first step on the road to the UK relinking its emissions-trading scheme (ETS) with the EU market. These are pragmatic steps from the government and should be welcomed, but the EU’s CBAM is far from perfect. It is administratively complex, its varying level of tax creates uncertainty for businesses and, perhaps most significantly, it places a heavy compliance burden on third-country exporters – particularly in emerging markets and developing countries – that have to prove the carbon content of their production meets the EU’s standards. The latter amounts to a non-tariff barrier, which will restrict trade. But the government has boxed itself in here: by bailing out the UK’s major steel producers with up to £1 billion in grants to transition to electric-arc furnaces, it now needs to introduce some form of green-steel trade shield to ensure the viability of that industry. If the UK had been more active in engaging in the CBAM debate earlier, it could have played more of a role in shaping the policy. By reacting late, the UK is now a regulatory-price taker.
Public-Sector Productivity
The chancellor will also announce the conclusions of the review by John Glen, former chief secretary to the Treasury and now paymaster general following the November 2023 reshuffle, into public-sector productivity. The aim of the review is to identify ways to cut administrative spending in areas like the National Health Service (NHS), police, schools and the justice system, including through the use of artificial intelligence (AI). Glen has signalled the work should generate savings in the next spending review, which begins in 2025. TBI has long advocated for the need to harness the power of technology to reimagine the role of the state – including the role of AI in enhancing public-service delivery – and this review should help deliver these outcomes.
Option 3: Harnessing Technology to Reimagine the Role of the State
The above reforms are welcome steps, but they are unlikely to be enough to turn the UK’s economic fortunes around. Successive chancellors have announced numerous plans for growth, yet the economy has been stuck in the doldrums since 2008, the tax burden is at its highest level in 70 years and public services are crumbling – a record 7.8 million people are on NHS waiting lists.
To be truly transformative, reforms need to go beyond refining existing policy and delivering existing services more efficiently. The challenges ahead are too great to continue with the same playbook. Pressures on public spending are only set to grow as the population ages, defence spending rises and additional investment is needed to catalyse the net-zero transition.
The one trend that offers hope to deal with these structural challenges is technology. We are living through a technological revolution enabled by AI that has the potential to reshape our economy and the role of the state. The chancellor’s starting point, then, should be to ask how he can harness the benefits of this revolution to unlock growth and use data and technology to drive down the cost of public services while improving outcomes.
For example, technology could have helped contain the recent rise in UK debt by better targeting fiscal support during the recent crises, such as the pandemic furlough scheme. At £70 billion, the cost of the scheme was far higher than more targeted schemes in other countries that delivered similar outcomes. The National Institute of Economic and Social Research estimates that if the UK had targeted its support rather than offering blanket coverage, it could have saved upwards of £50 billion – or 2 per cent of GDP. But the UK did not have the data and technical capability to administer such a scheme at pace – even though the technology already exists elsewhere.
The role of technology in improving public services is not confined to crisis response. Our Future of Britain programme has proposed many radical-yet-practical ideas for how a reimagined state could harness technology to both boost public-sector productivity and unlock growth. For example:
Our Future of Learning report highlights how AI, underpinned by the right national digital infrastructure, can significantly improve educational outcomes by supporting teachers with tools like automated marking, providing pupils with bespoke learning support akin to a private tutor and driving school improvement. This would not only increase pupil attainment but also produce a more skilled and productive workforce to support future economic growth.
Our Fit for the Future report highlights how poor health is holding back the UK’s growth and putting undue strain on the NHS. Yet the vast majority of public-health spending goes towards treating the symptoms of ill health rather than promoting good health. Advances in AI, genomics and data science mean it is now possible to see around the corner and equip people with the information they need to lead healthier lives. Doing so offers the prospect of improving health outcomes, raising worker productivity and lessening pressure on health spending.
One of the reasons the UK has not tapped this potential is fiscal short-termism. For much of the past decade, UK borrowing costs were at historic lows, which offered the chance to fund transformative investment at low cost. Yet that opportunity was missed. Now, with borrowing costs elevated, the government has doubled down on short-termism and squeezed investment spending to deal with current challenges. This approach of dealing with the symptoms of the UK’s economic malaise rather than investing to address its causes only perpetuates a cycle of short-term crisis management and ever-deepening crises. We are robbing the future to pay for today.
TBI’s Take
The chancellor knows there are no quick fixes to turn around the UK’s economic fortunes before the election. The interventions that will make the biggest difference to the UK’s growth prospects will take longer than a parliamentary cycle to achieve. Such long-term initiatives are currently deprioritised in the UK’s existing fiscal and institutional framework, which is a major failing. But institutional reform is possible. To be bold, the chancellor needs to use his Autumn Statement to not just do existing policy better, but to reimagine the role of the state and lay the foundations for a better long-term future built on technology. The chancellor has the chance to begin the UK’s renaissance next week – we hope he grasps it.
Lead image: Getty