Addressing UK public finances after the mini-budget crisis

Question 1: How necessary was it for the UK government to lower its deficit through tax increases or spending cuts in November 2022?

Question 2: Relative to the Autumn statement, would the UK be better off reducing public debt

Question 3: Given the desired amount of deficit reduction, the Autumn Statement on balance:

Summary

The November 2022 CfM survey asked the members of its UK panel about the need for deficit cuts following the mini-budget crisis. A large majority of 86% of panellists thinks that deficit cuts were desirable or necessary in late 2022. In addition, a majority of 60% endorsed the pace of deficit reduction. Finally, although a third of the panel thought the government got the mix of public spending reduction and taxes about right, more than 40% of the panel would have liked the budget to have further tax increases to limit cuts to public spending. 

Background

The November 2022 CfM survey asked the members of its UK panel about the Chancellor’s Autumn Statement.

Austerity 2.0?

The incoming UK government headed by Rishi Sunak put forth its first budget in its November 17 Autumn statement. This followed a turbulent month of failed budgets, U-turns, soaring gilt yields and cracks showing in the UK’s financial stability. With the impression that the previous government’s crisis was triggered by irresponsible budgetary policies, the Autumn Statement naturally centred on fiscal rectitude. The budget made efforts to address head-on the ‘black hole’ in UK public finances that was estimated to be as large as £50 billion. The dire state of public finances contrasts with the UK’s fiscal condition earlier this year, with the Office for Budget Responsibility (OBR) predicting that the government was on track to hit both of its fiscal targets with £30 billion of “headroom” to spare In March 2022.

High fiscal spending to mitigate the effects of the cost-of-living crisis has put considerable pressure on government finances, threatening an ever-rising trajectory of underlying debt in the absence of appropriate policy action. While similar problems have affected other European countries, certain UK-specific factors have raised borrowing costs relatively more than other advanced economies. These include short-term issues like the infamous September mini budget, which is estimated to have been responsible for about £30bn of the fiscal hole, and long-term factors such as Brexit

The Autumn Statement included a fiscal consolidation package of £55 billion of higher taxes public spending cuts. Much of the tax revenue will be raised by freezing tax thresholds in face of higher inflation until 2028, lowering the income threshold facing the 45% tax rate, and a windfall tax on energy companies and energy generators. All departments other than the protected health and education departments will face lower growth in their budgets than previously planned. Alongside these deficit-reduction policies, the budget loosened the UK’s fiscal rules allowing a slower pace of deficit reduction. Under the new rules, debt will be on course to fall in the fifth year (2027/28), rather that the three-year timeframe in previous rules. In accordance with the new rules, most of the tightening in fiscal policy is back-loaded, coming into effect in the last 3 years of the 5 year planning period – after the next UK general election.

Reactions to the Autumn Statement have been mixed across experts and think tanks. The Institute of Fiscal Studies (IFS), which first rung alarm bells by claiming that there was a £62 billion hole in the UK’s finances, commended Hunt’s fiscal tightening measures as ‘a belated recognition of harsh realities.’ The IFS recognised Hunt’s choice of back-loading the tightening measures as the right one, given the great degree of uncertainty and high costs of a large up-front fiscal tightening. However, they questioned the credibility of the government’s plans, given that they had delayed most of the harsher tightening measures till after the next general election. The EY ITEM CLUB echoed these thoughts, claiming that the ‘threat to the economy from tighter fiscal policy isn’t as great as it could have been’, but simultaneously questioned whether some of the harsher measures would be enacted in the future. Other organisations such as the National Institute of Economic and Social Research (NIESR), the Centre for Policy Studies, and the Policy Exchange, also labelled Hunt’s response as sensible and prudent from a fiscal tightening perspective. However, they also stressed the need for the government to devise long-term plans to boost growth and productivity levels in the UK. The IMF also commended the budget for striking “the right balance between fiscal responsibility and protecting growth & vulnerable households.”

While there is near-unanimous agreement on the precarious state of the UK economy, leading to fiscal pressures, several commentators have questioned the size, and even the existence, of the UK’s fiscal black hole. The Institute for Public Policy Research’s Centre for Economic Justice argued that reducing public spending and harming growth prospects to close a hole of the government’s own creation was a ‘short-sighted’ move. The Adam Smith Institute and the Institute of Economic Affairs characterised the measures as a recipe for ‘managed decline’, due to their detrimental effect on people’s after-tax income, and criticised the government for their lack of pro-growth reform.

Some economists argue that the fiscal black hole inherently depends on the set of fiscal rules that the government chooses to follow, and as such, is simply the consequence of a set of arbitrary rules. The October 2021 CfM survey found that nearly a third of the expert panel supported the scrapping of fiscal rules, claiming that they harmed macroeconomic policy more than they helped, although the survey was held last year – well before the recent fiscal crisis. Several academics have also questioned the targets set by fiscal rules, describing them as ‘arbitrary’, and “relying on special ‘magic numbers’ for debt or deficit levels”. Chadha, Küçük, and Pabst (2021) propose rethinking fiscal rules, emphasising the need for greater parliamentary and academic scrutiny, clear objectives and a stronger focus on social welfare and productivity. Furthermore, some organisations have criticised the government for the measure of debt used to assess the size of the hole. The Progressive Economy Forum found that small changes in forecasts for future interest rates and growth, and what is counted as government debt, dramatically alter the size of the predicted gap in the public finances.

Other criticisms included questioning the feasibility of the government’s public spending cuts, as they would require years of holding down public sector wages relative to the private sector. The Institute for Government also claimed that while the new set of fiscal rules introduced are ‘permissive’, there is only a small margin for error against the rules, meaning any further deterioration of the forecast could necessitate additional action next year. The Labour Party has also criticised the government for laying a ‘trap’ for a potential Labour government in the future, given that the new government would have to implement most of the harsh tightening measures which would significantly affect its popularity.

This month’s CfM survey asked the members of its UK panel about the need for fiscal consolidation in the UK. They were first asked whether the UK had a fiscal gap that needed to be filled with higher taxes or spending cuts. They were then asked whether the measures taken by the government go far enough or too far in addressing the government’s financing needs. Finally, they were asked about the mix between public spending cuts and tax increases in the budget.

Question 1: How necessary was it for the UK government to lower its deficit through tax increases or spending cuts in November 2022?

Eighteen panel members responded to this question. There was near unanimity supporting the need for deficit reduction, with 56% believing deficit reduction was desirable and an additional 28% thinking it was absolutely necessary. Only 17% thinks that deficit reductions were undesirable.    

Most panellists feel that deficit reduction is important to restore the credibility of the government following the September mini-budget crisis. Martin Ellison (University of Oxford) summarises this stating that “a show of fiscal responsibility was necessary to start the slow and painful process of rebuilding the government's reputation.” Ricardo Reis (London School of Economics) seconded this view, claiming that any “sensible fiscal reaction function [of the UK government] would have some policy change towards lowering deficits.” Panellists also stressed the need to ensure fiscal spending was sustainable in the long run, with Sir Charles Bean (London School of Economics) pointing towards the deterioration of the government’s medium-term fiscal position on account of “the global rise in short and long-term interest rates and the associated increase in debt interest.” He notes that the government needed a “a credible plan to lower its medium-term deficit in order to bring the public finances back onto a sustainable path.”

A few panellists disagreed with the government’s measures, characterising the Autumn Statement as going “too far” and “overcompensating” for the September mini-budget. Roger Farmer (University of Warwick) argues that “moderate deficits are sustainable [in the] long term and large deficits are possible in times of crisis,” adding that the current crisis did qualify as one of these instances. Some panellists were also worried about the effect of these measures on the already-stunted UK economy. Wouter Den Haan (London School of Economics) highlights that “another round of austerity is likely to negatively affect productivity (e.g., because of insufficient NHS funding) and economic growth.” 

Question 2: On balance, relative to the Autumn statement, would it be better for the UK to reduce public debt faster or slower?

Fifteen panel members responded to this question. A majority of 60% of the panel endorsed the pace of deficit reduction in the budget. 13% of the panel would have liked to see a slower pace and 7% a faster pace of deficit reduction.

Several panellists supported the current pace of deficit reduction but emphasised the potential need for adjustments in the future to ensure fiscal consolidation in a reasonable timeframe. This view is summed up by Sir Charles Bean: “The present speed of planned consolidation strikes a reasonable balance between providing near-term support to the economy and getting the public finances onto a sustainable trajectory further out.” He adds that should economic conditions improve in the future, the government should “bank the surprise as a faster pace of consolidation,” instead of taxing less or spending more. Echoing these sentiments, Martin Ellison supports the “the back-loading of fiscal consolidation and an almost glacial paydown of the debt,” but urged the UK government “to demonstrate commitment to reducing the debt in a reasonable timeframe” to restore its credibility.

However, a small fraction of the panellists felt that the costs of decreased growth, productivity and economic welfare were too high to justify the proposed pace of debt reduction. Stephen Millard (National Institute of Economic and Social Research) advocated for a substantially slower pace, stressing that “the need at the moment is to loosen fiscal policy so as to help struggling households deal with the cost-of-living crisis.” Michael Wickens (Cardiff Business School & University of York) argues that given the UK’s lower debt-GDP ratio than Germany and the US, and the fact that the UK “has never defaulted on its debt”, market concerns about a slow pace of debt reduction would be unwarranted. He adds that as “the debt-GDP ratio is already falling due negative real interest rates”, “fiscal austerity just reduces growth and economic welfare.”

Question 3: Given the desired amount of deficit reduction, should the Autumn Statement have, on balance, relied more on greater reduction in public spending reduction or more tax increases?

Nineteen panel members responded to this question. 42% of panellists thinks the deficit reduction should have relied more on tax cuts compared to only 5% (one panellist) who would have liked to see more public spending cuts. 32% of the panel believes the government’s tax-spending balance was about right.  

A sizeable proportion of the panellists questioned the government’s greater reliance on spending cuts given that – as put by Stephen Millard – “public services have already been cut to the bone.” Martin Ellison doubted the government’s ability to deliver the proposed cuts as they “relate to essential services that people expect to be provided.” He points to the trade-off between the cost and quality of public services, claiming that “it is not possible to repress public sector wages without severe cuts in the quality of services provided across many government departments.” This point was reiterated by Sir Charles Bean: “The departmental spending plans require either a further reduction in the public sector pay relative to that of the private sector, which will create significant recruitment and retention problems, or an unacceptable deterioration in the quantity and quality of public services delivered.”

Ricardo Reis expressed contrary views, arguing for greater reliance on spending cuts instead of tax hikes. He advocates reducing fiscal spending rather than increasing taxation, because “tax revenues/GDP already increased by 1.4% between 2020 and 2021 in the UK, versus only 0.5% in the OECD average.”

However, some panellists felt the government had got the tax-spending balance right and supported the back-loading of contractionary measures. Jumana Saleheen (Vanguard Asset Management) describes the tough trade-off the government had to manage: “They had to walk the tightrope between (a) convincing markets they were fiscally prudent and (b) not hurt growth excessively through austerity at a time of rapid monetary policy tightening.” She expressed her support for the government’s plan, adding that “they did a good job at providing short-term stimulus to the economy and convincing markets of their medium-term fiscal orthodoxy.”

A few panellists also believed that the discussion surrounding the tax-spending balance should not be restricted to just the balance between the two, but the type of tax hikes and spending cuts. Roger Farmer summarises this view: “It's not just a question of tax increases of spending cuts. It matters a lot which taxes are increased and which expenditures are cut.”

References

Chadha, J S, H Küçük, and A Pabst (eds), (2021), “Designing a new fiscal framework: Understanding and Confronting Uncertainty”, National Institute of Economic and Social Research Occasional Paper LXI.

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How the experts responded

Question 1

Participant Answer Confidence level Comment
Jumana Saleheen's picture Jumana Saleheen Vanguard Asset Management Absolutely necessary Very confident
It was important for the new government to announce fiscal plans that were prudent and sustainable. That means ensuring the debt-to-GDP ratio was falling in the medium term. The starting point for this government was the mini budget (including the U- turns). That put debt-to-GDP on a rising trajectory out to 2027/28; markets did not like this. To course correct, it was necessary to raise taxes and announce spending. After all of that and the debt-to-GDP path does fall slightly by 2027/28.
David Cobham's picture David Cobham Heriot Watt University Desirable Confident
Desirable only because the Truss-Kwarteng mini-budget had had such a bad affect on confidence and expectations.
Alessandra Bonfiglioli's picture Alessandra Bonf... Queen Mary University of London Absolutely necessary Confident
Nicholas Oulton's picture Nicholas Oulton London School of Economics Desirable Very confident
It was highly desirable for the government to have a plan to reduce the deficit but the speed at which the deficit shoud be reduced is a matter for debate. The picture painted by commentaors that the UK was facing some kind of financial meltdown was convenient for the new chancellor and prime minister, and the governor of the Bank of England, but was always exaggerated. More attention should be paid to the views of ex-deputy Governor of the BoE Paul Tucker. He has argued that the initial turmoil following Kwasi Kwarteng’s mini budget was due not to market panic at unfunded tax cuts on the part of international investors but rather to the unforeseen consequences of allowing large scale use of liabilities-driven investment by pension funds. In other words it was a massive regulatory failure by the various authorities involved (the Pensions Regulator and the PRA to name two).
Sir Charles Bean's picture Sir Charles Bean London School of Economics Desirable Very confident
The government probably did not need to lower its near-term deficit but it did need a credible plan to lower its medium-term deficit in order to bring the public finances back onto a sustainable path. Since March, the medium-term fiscal position had deteriorated by around 2pp of GDP on account of the (global) rise in short and long-term interest rates and the associated increase in debt interest. In addition, the scrapping of the Health and Social Care Levy and the adverse impact of higher energy prices on potential output had added around another 2pp to borrowing. Roughly speaking, the tax rises announced in the Autumn Statement replace the foregone revenue from the Health and Social Care Levy, while the reductions in future planned departmental spendiing go some of the way towards offsetting the higher debt interest. Even so, borrowing is higher than was planned in March and a falling debt-GDP ratio is achieved later and with less margin for error than in the spring. In light of the market turmoil following the disastrous September mini-budget, doing any less than this would in my view have risked a rebound in bond yields and further financial market instability. The present fiscal plan is certainly 'Augustinian' in nature, with a large near-term public deficit in order to support households and businesses through the energy price shock but planned consolidation further out. That is a broadly sensible strategy, although one can quibble with the individual measures taken (or in some cases not taken). In practice, I think it highly unlikely that whichever party is in power will be able to stick to the present spending plans and will instead need to find additional sources of revenue.
Ricardo Reis's picture Ricardo Reis London School of Economics Desirable Very confident
The fiscal situation deteriorated noticeably relative to when the last budget was approved at the start of the year. With such a large negative news, any sensible fiscal reaction function (Ricardian to use a jargon) would have some policy change towards lowering deficits.
Martin Ellison's picture Martin Ellison University of Oxford Desirable Confident
The credibility of the government took such a hit with the mini budget of September 2022 that a show of fiscal responsibility was necessary to start the slow and painful process of rebuilding the government's reputation. This needed to happen, independent of fundamentals.
Paul De Grauwe's picture Paul De Grauwe London School of Economics Desirable Confident
Gino A. Gancia's picture Gino A. Gancia Queen Mary University of London Desirable Confident
Michael Wickens's picture Michael Wickens Cardiff Business School & University of York Desirable Confident
The aim of government policy should be to improve people's welfare. The main practical implication of this is to keep inflation low and growth high. At present inflation is high and growth is low. Reducing the deficit or government debt is justified only if it is consistent with improving welfare. As far as the fiscal position is concerned, the aim should be to reduce debt. Reducing the deficit achieves this and historically the UK has run primary surpluses. But historically inflation has been a larger influence on reducing the debt-GDP ratio while growth has not been a large factor. At present, thanks in part to the incompetence of the Bank of England, the real rate of interest less growth is heavily negative. This implies that the debt-GDP ratio will steadily fall over time without any deficit reduction. So reducing the deficit is not strictly necessary. Moreover, it will reduce growth which will slow the automatic reduction in the debt-GDP ratio. If, of course, real interest rates were to become positive then, given the UK's low growth, deficit reduction would become essential for the debt-GDP to fall.
Stephen Millard's picture Stephen Millard National Institute of Economic and Social Research Absolutely necessary Extremely confident
The point was not whether or not they had to lower the deficit but whether they couldn't have left even more of that tightening to a time in the future, given the need to actually loosen fiscal policy to help support struggling households at the moment.
Wouter Den Haan's picture Wouter Den Haan London School of Economics Undesirable Not confident
Well chosen tax increases are sensible. After all, UK tax rates are not that high. But yet another round of austerity is likely to negatively affect productivity (e.g., because of insufficient NHS funding) and economic growth.
Roger Farmer's picture Roger Farmer University of Warwick Undesirable Confident
The Truss plan went too far in one direction. The Sunak plan has overcompensated. Moderate deficits are sustainable long term and large deficits are possible in times of crisis. This is one such time.
Natalie Chen's picture Natalie Chen University of Warwick Absolutely necessary Confident
Lucio Sarno's picture Lucio Sarno Cambridge University Undesirable Confident
Costas Milas's picture Costas Milas University of Liverpool Absolutely necessary Confident
Linda Yueh's picture Linda Yueh London Business School Desirable Confident
Ethan Ilzetzki's picture Ethan Ilzetzki London School of Economics Desirable Not confident

Question 2

Participant Answer Confidence level Comment
Jumana Saleheen's picture Jumana Saleheen Vanguard Asset Management Neither faster nor slower Confident
I thought they got the balance right. History shows that economic growth is the key to sustainable public finances.
David Cobham's picture David Cobham Heriot Watt University Faster Confident
faster than the course implied by the mini-budget, not faster than what would have happened without the dire elements of that event.
Alessandra Bonfiglioli's picture Alessandra Bonf... Queen Mary University of London Neither faster nor slower Not confident
Nicholas Oulton's picture Nicholas Oulton London School of Economics Neither faster nor slower Confident
As many analysts have noted the planned reduction in the debt to GDP ratio is only scheduled to take effect at the end of the new 5 year horizon. Despite the obvious possibility that the government (or its successor) will renege on this commitment, markets seem unfazed. This may be because for investors it’s all about relative risks. The UK’s position is not obviously worse than some eurozone economies, not to mention Japan or even the US.
Sir Charles Bean's picture Sir Charles Bean London School of Economics Neither faster nor slower Confident
The present speed of planned consolidation strikes a reasonable balance between providing near-term support to the economy and getting the public finances onto a sustainable trajectory further out. But should economic conditions turn out better than expected, then the government would be well advised to bank the surprise as a faster pace of consolidation rather than using it as an excuse to spend more or tax less.
Ricardo Reis's picture Ricardo Reis London School of Economics No opinion or other Extremely confident
To have an opinion, I'd have to spend more time quantitatively weighing different factors at play
Martin Ellison's picture Martin Ellison University of Oxford Neither faster nor slower Not confident
The danger of tightening fiscal policy during a recession supports the back-loading of fiscal consolidation and an almost glacial paydown of the debt, but with the credibility of the UK government on the line it is important to demonstrate commitment to reducing the debt in a reasonable timeframe. Whether that commitment is credible is an open question – it is though clear that in all cases that the UK would be better off with a credible government.
Paul De Grauwe's picture Paul De Grauwe London School of Economics No opinion or other Not confident
Michael Wickens's picture Michael Wickens Cardiff Business School & University of York Substantially slower Confident
As explained, the debt-GDP ratio is already falling due negative real interest rates. Fiscal austerity just reduces growth and economic welfare. Despite the recent market tantrum, UK's the debt-GDP ratio is lower than, for example, the US and Germany, and the UK has never defaulted on its debt, so rationally the markets should not be concerned about a slow reduction in the UK's debt-GDP ratio.
Stephen Millard's picture Stephen Millard National Institute of Economic and Social Research Substantially slower Extremely confident
Again, the need at the moment is to loosen fiscal policy so as to help struggling households deal with the cost-of-living crisis.
Natalie Chen's picture Natalie Chen University of Warwick No opinion or other Confident
Lucio Sarno's picture Lucio Sarno Cambridge University Neither faster nor slower Confident
Costas Milas's picture Costas Milas University of Liverpool Neither faster nor slower Confident
Linda Yueh's picture Linda Yueh London Business School Neither faster nor slower Confident
Ethan Ilzetzki's picture Ethan Ilzetzki London School of Economics Neither faster nor slower Not confident

Question 3

Participant Answer Confidence level Comment
Jumana Saleheen's picture Jumana Saleheen Vanguard Asset Management Got the tax-spending mix about right Confident
The current government had a tough job.They had to walk the tightrope between (a) convincing markets they were fiscally prudent and (b) not hurt growth excessively through austerity at s time of rapid monetary policy tightening. They managed to get away by loosening fiscal policy very slightly in the next two years. After that point it becomes contractionary. I was impressed. I thought they did a good job at providing short-term stimulus to the economy and convincing markets of their medium-term fiscal orthodoxy.
David Cobham's picture David Cobham Heriot Watt University Should have relied more on tax increases Confident
But tax increases on the better-off used to finance some public spending increases on the NHS and other public services, and some increases in public sector wages: the latter is a serious problem which will have to be addressed and can't be just brushed under the carpet, not least because of the implications for growth (as well as equality and, dare I say it, political stability).
Alessandra Bonfiglioli's picture Alessandra Bonf... Queen Mary University of London Should have relied more on tax increases Confident
Nicholas Oulton's picture Nicholas Oulton London School of Economics No opinion or other Confident
Truss and Kwarteng's budget was heavily criticised for highly optimistic statements about growth without setting out any serious policies to achieve those targets. Hunt's budget contained virtually nothing on growth, except that some capital spending is to be reined back. It's not clear this is much of an improvement. In fact, the new fiscal framework fails to distinguish between capital and current spending, surely a retrograde step (back to the old PSBR?).
Sir Charles Bean's picture Sir Charles Bean London School of Economics Should have relied more on tax increases Confident
The departmental spending plans require either a further reduction in the public sector pay relative to that of the private sector, which will create significant recruitment and retention problems, or amn unacceptable deterioration in the quantity and quality of public services delivered. Consequently, I think it is inevitable that they will eventually be raised somewhat. That said, I do think that such a path for departmental spending should at least have been part financed by indexing benefits - especially pensions - to pay rather than inflation at the present juncture. It is frankly immoral that pensioners, many of whom are relatively well off, are fully protected from the spike in the cost of living while those in work are seeing a very significant fall in their real incomes.
Ricardo Reis's picture Ricardo Reis London School of Economics Should have relied more on spending cuts Confident
Tax revenues/GDP already increased by 1.4% between 2020 and 2021 in the UK, versus only 0.5% in the OECD average.
Martin Ellison's picture Martin Ellison University of Oxford Should have relied more on tax increases Confident
It will be very difficult for the government to deliver many of the proposed cuts in government spending, as they relate to essential services that people expect to be provided. It is not possible to repress public sector wages without severe cuts in the quality of services provided across many government departments. With the credibility of cuts in question, I support tilting any desired fiscal consolidation towards more taxes. However, I think it should not be income taxes that bear the brunt of the adjustment. Instead, I would like to see better property taxes (it is crazy that council tax is based on 1991 valuations – we can surely do better) and environmental taxes (e.g. carbon taxes).
John VanReenen's picture John VanReenen London School of Economics Got the tax-spending mix about right Confident
The spending cuts after the election are not very credible.
Paul De Grauwe's picture Paul De Grauwe London School of Economics Should have relied more on tax increases Confident
Gino A. Gancia's picture Gino A. Gancia Queen Mary University of London Should have relied more on tax increases Confident
Michael Wickens's picture Michael Wickens Cardiff Business School & University of York No opinion or other Confident
As explained there was no need for either big spending or big tax cuts.
Stephen Millard's picture Stephen Millard National Institute of Economic and Social Research Should have relied more on tax increases Extremely confident
Public services have already been cut to the bone. We are going to have to realise as a nation that if we want better public services we need to pay for them through higher taxes.
Wouter Den Haan's picture Wouter Den Haan London School of Economics Should have relied more on tax increases Very confident
Roger Farmer's picture Roger Farmer University of Warwick No opinion or other Confident
Political choices kick in here in a big way. It's not just a question of tax increases of spending cuts. It matters a lot which taxes are increased and which expenditures are cut.
Natalie Chen's picture Natalie Chen University of Warwick Got the tax-spending mix about right Confident
Lucio Sarno's picture Lucio Sarno Cambridge University No opinion or other Not confident
Costas Milas's picture Costas Milas University of Liverpool Got the tax-spending mix about right Confident
Linda Yueh's picture Linda Yueh London Business School Got the tax-spending mix about right Confident
Ethan Ilzetzki's picture Ethan Ilzetzki London School of Economics Got the tax-spending mix about right Very confident