Autumn Budget and Spending Review 2021 Response

The Chancellor’s statement was laced with references to returning to spending levels not seen since 2010, a remarkable recantation of much of the past 11 years. The post-2010 austerity agenda embodied two beliefs. One was that getting the deficit under control was key to safeguarding the economy and the public finances. The other was that this should be achieved by cutting deep into the functions of the state. Sunak has doubled down on the first but repudiated the second.

Rishi Sunak shares George Osborne’s commitment to balancing the day-to-day budget. His new fiscal rule commits the Treasury to making sure all current spending is tax funded by 2024-25. But unlike in 2010, he has addressed the risk of overhasty withdrawal of fiscal support from a still-fragile economy, loosening the purse strings by £25bn next year compared to previous plans.

But the Chancellor’s decisions on public spending were more remarkable. After a year of record tax rises, the Chancellor showered more additional money of public services than anyone anticipated. And while spending in some areas will remain tight, the big picture is that this government wants to undo the failed experiment of shrinking the state, which his predecessors made the key dividing line of British politics. Sunak has concluded that running the public services on a shoestring is incompatible with winning elections.

Unfortunately, of course, these ambitions come with the highest tax burden since the 1950s, with taxes rising to 36.2% of GDP by the middle of the decade. But this wasn’t inevitable. While the Chancellor trumpeted newfound "Brexit freedoms" to reform alcohol duties, what he didn’t mention was that Brexit has cut annual tax revenues by around £30bn. This means that without the Brexit shock most of the past year’s £40bn tax raid would have been unnecessary.

We could have had respectably funded public services and avoided record tax rates. But the legacy of Brexit has forced the Chancellor to choose. Sadly, that’s one legacy of the past 11 years that the government doesn’t yet seem willing to fix.

The Chancellor has tweaked his fiscal rules rather than adopting a completely new approach. The key target will be to have debt falling as a share of national income by the third year of the forecast horizon. Three existing fiscal rules will be retained as supplementary targets: to have the current budget in balance by the third year of the forecast horizon, a limit on capital expenditure at 3% of GDP and a cap on welfare expenditure.

The Chancellor also for the first time has added a clause to the Charter for Budget Responsibility that will allow him to suspend his rules in the event of a significant negative shock. At each subsequent Budget, the Chancellor would be required to update Parliament on the government’s plan for lifting the temporary suspension of the fiscal rules.

Given the number of fiscal rules that have come and gone in recent years, introducing this flexibility to respond to shocks is a welcome development, similar to what Labour has proposed, and may rehabilitate the idea of credible rules.

But other aspects of the framework seem to repeat old mistakes. In the current ultra-low interest rate environment, it is questionable whether falling debt levels are appropriate, especially over such a short time horizon. This risks entrenching a bias towards fiscal retrenchment that may not be wise with monetary policy impaired.

Our "all-weather" fiscal framework would allow for more investment in the near term: even if gilt rates increase to 1.2% as the OBR forecast, it would allow a deficit limit of 3.3% of GDP compared to the government’s investment plans averaging 2.7% of GDP over the forecast period. This is particularly the case given the need for more investment to reach net zero over the next decade.

In the same month that Universal Credit (UC) rates fell by £20 a week, the Chancellor had some good news for working families. As well as the widely-trailed rise in the National Living Wage (NLW) to £9.50 an hour, working families will see their benefits increased again from next month. Families will now be able to earn an extra £500 a year before UC starts to be reduced, and the benefit will be withdrawn more slowly as income rises: the withdrawal rate will fall from 63% to 55% of every extra pound earned. This will both strengthen the financial incentive for families to have someone in work, and for those in work to increase their earnings.

Although welcome, these measures will not be sufficient to replace the hole in families’ incomes left by the end of the UC uplift. Only a quarter of families on UC have someone who will benefit from the higher NLW, and those that do will see most of the gain lost to a combination of higher taxes and withdrawn benefits.

The more generous benefit withdrawal will only offset the loss of the additional £20 a week for a further quarter of UC claimants. Moreover, these tend to be the better-off claimants: only 13% of claimants in the bottom two income deciles will be fully compensated for the loss of the £20 uplift compared to around a third of the remainder. Half of families on UC, including the most vulnerable with no one in work, will see no benefit from either measure.

The Chancellor’s skills package falls far short of the government’s much-hyped “skills revolution”, and risks levelling down when it comes to post-16 technical education.

Further Education (FE) has long played second fiddle to other parts of the education system. The budget delivers a long-overdue cash boost: over the next three years, the Chancellor will spend £3.8bn on skills, including a fair chunk on delivering the government’s new ‘T-Level’ qualifications (vocational alternatives to A-levels).

However, the T-levels strategy includes a plan to defund existing vocational qualifications that overlap with T-levels. In effect, this would crowd out most BTEcs and other applied general qualifications that blend academic and vocational learning, meaning that pupils choose between a hard academic option (A-levels) or a vocational one (T-levels or apprenticeships) at 16. Although the symmetry here might appear sensible on paper, it obfuscates some important truths.

First, we have no idea how well T-levels will ultimately land. Not all employers will necessarily recognise them, and it may be hard to get enough employers to offer students 45-day work placements (a core tenet of the T-level design).

Second, T-levels’ relatively high admissions bar will squeeze out lower achievers. While we should be ambitious for all pupils, the reality is that many pupils will simply not make the grade, even with a transition year built into the mix. Over a third of working aged adults in England are already only qualified to level 2 or below, and if more pupils spill out of the school system underqualified, we risk compounding that effect.

Third, the government’s current proposals risk corroding social mobility. BTECs are disproportionately studied by disadvantaged individuals. This hardly amounts to a levelling up strategy.

None of this is to say that T-levels don’t have a part to play in a mixed economy of qualifications at level 3. Some 16-year-olds may be laser-focused enough to justify specialising that early, and a rigorous technical alternative to A-levels may be just the tonic. But for many, a rigid binary choice at 16 will not be suitable and they will need other options. The government should at least wait to see how well T-levels land before thinking about muscling out good BTECs.

The tax increases announced by the Chancellor in the last two budgets make the reduction in the tax surcharge on bank profits hard to ignore.

The chancellor has announced a more than 60% reduction in the tax surcharge on bank profits from 8% to 3%. Banks currently pay tax at a rate of 27 per cent on their profits, comprised of 19 per cent corporation tax plus the 8 per cent surcharge, a rate broadly in line with New York and Paris.

In the March Budget, the Chancellor announced a 6% increase in the corporation tax which would have taken the taxes paid by UK banks above those levied on some of their competitors. After today’s reduction in the surcharge, the total tax banks will be asked to pay will ultimately only go up by 1%.

The Chancellor says reducing the surcharge will help balance out the corporation tax increase and keep the financial sector competitive post-Brexit. The reduction will cost the Exchequer £1bn a year by 2025-26. However, this comes at a time when taxes on most citizens and other companies has been increasing. On top of this, inflation has significantly increased the cost of living of UK households. In fact, asset price inflation means financial services have performed remarkably well compared to other sectors of the economy.

Arguably, this measure will not address the root cause of the problem, either. The main challenge faced by the UK’s financial sector is Brexit and the reduced access to EU markets. This is better addressed through a deal with the EU which includes financial services. Unfortunately, such an agreement was not part of the Brexit deal and isn’t on the cards.

In what is an increasingly characteristic approach from the Chancellor, he’s prioritised short-term tweaks over long-term strategy by freezing fuel duty yet again, while saying almost nothing about the much bigger challenge ahead: the loss of over £30 billion of tax revenue as we transition to electric vehicles.

While the freeze to fuel duty can be justified by recent increases in fuel prices – and will have a relatively small impact on UK carbon emissions – the decision to ignore the implications of a transition with impacts on this scale is harder to defend.

As our report earlier this year made clear, a failure to take action now to replace that lost revenue will have disastrous implications: more congestion, as driving becomes cheaper; a revenue hole; and unfairness, as wealthy motorists in new EVs pay 98% less tax to drive than those still in petrol and diesel cars.

Source: Author’s calculations using DfT vehicle licensing statistics 2021, Tables VEH0101 & VEH0203, DfT Road Traffic Forecasts 2018, Scenario 7, National Travel Survey statistics & OBR tax by tax data on fuel duty and vehicle excise duty. Rebased to 2020 prices.

Introducing an alternative scheme, such as road pricing, won’t be easy. But by starting a process now, providing clear vision on the shape of a future replacement scheme – and being clear that it is a replacement for, not an addition to, existing taxation, and that it will be implemented in a gradual and fair way – the Chancellor can avoid much bigger problems down the line.

While last week’s Net Zero Strategy got a reasonably positive reception, one area which was lacking was public investment in reducing energy use, and today’s announcement didn’t fill in the gaps.

At the moment, the UK has some of the least energy efficient building stock in Europe. We know that improving that efficiency can both save money and make the net zero transition easier, by reducing the amount of low carbon energy we need. And we know that energy efficiency investment has fallen off a cliff in recent years.

The government recognises the problem – but the scale of the challenge is huge. In total, government figures say that we need £97 billion of investment in the decarbonisation of our buildings between 2020 and 2030. And the government committed, in its manifesto, to £9.2 billion of funding to support that.

But even that relatively small commitment has not been met. With the new £3.9 billion funding announced in the Heat and Buildings strategy last week, and confirmed in the Budget today, total government funding commitments amount to £6.3bn – only 7% of the total funding needed, and almost £3 billion short even of the government’s manifesto commitment.

The Chancellor’s response to that might be that funding for energy efficiency should come from the private sector, not the taxpayer. But if that’s the case, there’s an urgent need for the government to set out how it will get the regulatory and fiscal incentives in place for that funding to flow – or what has already been a lost decade on energy efficiency will turn into a lost 20 years.

The Chancellor unexpectedly announced a cut in Air Passenger Duty from April 2023. The change is said to support the levelling up agenda and provide a boost to regional airports, but it will cause concern ahead of the COP26 conference next week.

Rishi Sunak argued that the majority of emissions come from long haul flights and claimed that the government would tackle aviation emissions by introducing a new tax on “ultra-long haul” flights covering distances of more than 5,500 miles.

Reducing tax rates for domestic air travel flies in the face of efforts to reduce emissions at home. Passengers should be incentivised to use rail rather than air for domestic travel with the former resulting in roughly 87% lower emissions for a London to Edinburgh journey. Today’s announcement, therefore, presents a real risk of damaging the UK’s credibility on climate just days ahead of negotiations starting at COP26.

The budget document announced £1.7 billion of direct government funding to enable a large-scale nuclear project developer to take a final investment decision. This follows yesterday’s announcement of a new funding model for large-scale nuclear power. Nuclear will be a key technology in a future net zero UK power mix providing reliable zero emission electricity to complement the dominant future power source – intermittent renewable technologies such as wind and solar.

If the UK is to hit its target of 68% emissions reduction by 2030, we need roughly double the low-carbon power generation that we have today. But we are on track for less nuclear generation in 2030 than we have today. The seven operating UK nuclear power stations currently provide around 17 per cent of annual electricity generation, but six of those assets are due to be decommissioned by 2030. And with only Hinkley Point C in construction – the first nuclear project since 1995 – we are on track for a 30% reduction in nuclear output by 2030. It will be hugely challenging to rely on renewables alone to cover the low carbon generation gap, so this renewed support for nuclear is a positive step.

However, the chosen financing model – the so-called Regulated Asset Base (RAB) model – is not without problems. In principle, the model should lead to cost savings. The government has suggested these would be on the scale of £30 billion over the life of each project, which implies future projects being 30% cheaper than Hinkley Point C. However, these savings would be eroded if the project was to run over on construction time and cost. And such overruns have been a common theme of nuclear projects in the past.

So, whether this investment and financing model can deliver new large-scale nuclear at reasonable cost or not remains to be seen. But given the urgency of the need to deploy low-carbon generation at scale, it is positive to see decisive action from government.

The technology revolution was largely absent from the Chancellor’s speech. There were welcome announcements for the tech sector, foremost amongst them the inclusion of cloud computing and data costs in R&D tax relief from April 2023. These costs are a significant burden to startups and scale-ups (a recent analysis pegs them at 50% of a tech company’s cost of revenue), although the impact of targeting R&D credits at domestic spending will be interesting to see: the largest cloud providers are all based outside the UK. A new scale up visa and more funding for regional tech startups through the British Business Bank are also positive developments. 

Reassuringly, the earlier commitments to an uplift in R&D funding are present in the Budget, if somewhat diminished. The two-year delay on reaching the target of £22 billion a year is disappointing given the UK’s low base relative to competitors, but the increase is still significant and there is a noteworthy focus on research commercialisation through Innovate UK. 

Conspicuously absent from the Chancellor’s plans is any kind of strategy for digital government. There is a string of discrete investments in digital transformation, including new investments for DWP (whose IT systems buckled under pressure at the start of the pandemic) and HMRC (which performed admirably well in setting up the furlough scheme), over £800m for a Customs digital platform (a flashback to the seamless IT systems promised as a solution to post-Brexit border issues) and £65m for a digital platform to support planning applications. Apart from that last point, there is nothing in the Budget for digital transformation at the local level, where it would be most visible in citizens’ everyday lives. 

Any progress on digital transformation is welcome, but there is no coherent unifying thread. Some initiatives seem to work at cross-purposes: a separate HMRC project for a Single Customer Record and Account is funded alongside the development of the Digital Government Service’s ‘One Login’ system, the foundations of a true digital ID that should make the HMRC platform redundant. And the largest announcement – the £2.1b for digital transformation in the NHS, or 1.5% of NHSE’s annual capital expenditure – falls far short of what is required to truly tackle the backlog crisis and prepare our healthcare system for the future. 

One of the Chancellor’s flashier announcements was the timing of the reduction in the Universal Credit taper. ‘Changes like this,‘ he said, ‘normally take effect at the start of the new tax year’ – but it will be introduced within weeks instead. For all the troubles with its rollout, it is the IT system behind UC that makes such a rapid change possible. A digitally savvy government would take note. Instead, the Chancellor has yet to take advantage of what digital transformation has to offer to both the government and the citizens.