Fiscal policy and Brexit

The Institute of Fiscal Studies (IFS) has just published its annual ‘Green Budget‘. This is, in effect, a pre-Budget report (or a substitute for a government ‘Green Paper’) and is published ahead of the government’s actual Budget.

The Green Budget examines the state of the UK economy, likely economic developments and the implications for macroeconomic policy. This latest Green Budget is written in the context of Brexit and the growing likelihood of a hard Brexit (i.e. a no-deal Brexit). It argues that the outlook for the public finances has deteriorated substantially and that the economy is facing recession if the UK leaves the EU without a deal.

It predicts that:

Government borrowing is set to be over £50 billion next year (2.3% of national income), more than double what the OBR forecast in March. This results mainly from a combination of spending increases, a (welcome) change in the accounting treatment of student loans, a correction to corporation tax revenues and a weakening economy. Borrowing of this level would breach the 2% of national income ceiling imposed by the government’s own fiscal mandate, with which the Chancellor has said he is complying.

A no-deal Brexit would worsen this scenario. The IFS predicts that annual government borrowing would approach £100 billion or 4% of GDP. National debt (public-sector debt) would rise to around 90% of GDP, the highest for over 50 years. This would leave very little scope for the use of fiscal policy to combat the likely recession.

The Chancellor, Sajid Javid, pledged to increase public spending by £13.4bn for 2020/21 in September’s Spending Review. This was to meet the Prime Minister’s pledges on increased spending on police and schools. This should go some way to offset the dampening effect on aggregate demand of a no-deal Brexit. The government has also stated that it wishes to cut various taxes, such as increasing the threshold at which people start paying the 40% rate of income tax from £50 000 to £80 000. But even with a ‘substantial’ fiscal boost, the IFS expects little or no growth for the two years following Brexit.

But can fiscal policy be used over the longer term to offset the downward shock of Brexit, and especially a no-deal Brexit? The problem is that, if the government wishes to prevent government borrowing from soaring, it would then have to start reining in public spending again. Another period of austerity would be likely.

There are many uncertainties in the IFS predictions. The nature of Brexit is the obvious one: deal, no deal, a referendum and a remain outcome – these are all possibilities. But other major uncertainties include business and consumer sentiment. They also include the state of the global economy, which may see a decline in growth if trade wars increase or if monetary easing is ineffective (see the blog: Is looser monetary policy enough to stave off global recession?).

Articles

• No-deal Brexit would push UK debt to 50-year high, says think tank

BBC News, Faisal Islam (8/10/19)

• Public spending leaves no room for Budget tax cuts, Johnson warned

Financial Times, Chris Giles (8/10/19)

• Tories ‘cannot afford promised tax cuts’ says tax think tank

Daily Business (9/10/19)

• No-deal Brexit would push government debt to levels not seen since 1960s, experts warn

Independent, Gavin Cordon (8/10/19)

• No-deal Brexit would ‘push national debt to levels last seen in 60s’

The Guardian, Richard Partington (8/10/19)

IFS Report

• Government on course to break its fiscal mandate while almost matching Labour 2017 offer on total day-to-day public service spending next year

IFS Press Release, Carl Emmerson, Christine Farquharson and Paul Johnson (8/10/19)

• The IFS Green Budget: Full Report

Institute for Fiscal Studies, eds. Carl Emmerson, Christine Farquharson and Paul Johnson (8/10/19)

• The IFS Green Budget: Executive Summary

Institute for Fiscal Studies (8/10/19)

Data

• Public sector finances tables

Office for National Statistics (24/9/19)

• Public Finances Databank (Excel)

Office for Budget Responsibility (30/9/19)

Questions