In his blog, The bond roller coaster, John looks at the pricing of government bonds and details how, in recent times, governments wishing to borrow by issuing new bonds are having to offer higher coupon rates to attract investors. The interest rate hikes by central banks in response to global-wide inflationary pressures have therefore spilt over into bond markets. Though this evidences the ‘pass through’ of central bank interest rate increases to the general structure of interest rates, it does, however, pose significant costs for governments as they seek to finance future budgetary deficits or refinance existing debts coming up to maturity.
The Autumn Statement in the UK is scheduled to be made on 22 November. This, as well as providing an update on the economy and the public finances, is likely to include a number of fiscal proposals. It is thus timely to remind ourselves of the size of recent discretionary fiscal measures and their potential impact on the sustainability of the public finances. In this first of two blogs, we consider the former: the magnitude of recent discretionary fiscal policy changes.
First, it is important to define what we mean by discretionary fiscal policy. It refers to deliberate changes in government spending or taxation. This needs to be distinguished from the concept of automatic stabilisers, which relate to those parts of government budgets that automatically result in an increase (decrease) of spending or a decrease (increase) in tax payments when the economy slows (quickens).
The suitability of discretionary fiscal policy measures depends on the objectives they trying to fulfil. Discretionary measures can be implemented, for example, to affect levels of public-service provision, the distribution of income, levels of aggregate demand or to affect longer-term growth of aggregate supply. As we shall see in this blog, some of the large recent interventions have been conducted primarily to support and stabilise economic activity in the face of heightened economic volatility.
Discretionary fiscal measures in the UK are usually announced in annual Budget statements in the House of Commons. These are normally in March, but discretionary fiscal changes can be made in the Autumn Statement too. The Autumn Statement of October 2022, for example, took on significant importance as the new Chancellor of the Exchequer, Jeremy Hunt, tried to present a ‘safe pair hands’ following the fallout and market turbulence in response to the fiscal statement by the former Chancellor, Kwasi Kwarteng, on 23 September that year.
The fiscal impulse
The large-scale economic turbulence of recent years associated first with the global financial crisis of 2007–9 and then with the COVID-19 pandemic and the cost-of-living crisis, has seen governments respond with significant discretionary fiscal measures. During the COVID-19 pandemic, examples of fiscal interventions in the UK included the COVID-19 Business Interruption Loan Scheme (CBILS), grants for retail, hospitality and leisure businesses, the COVID-19 Job Retention Scheme (better known as the furlough scheme) and the Self-Employed Income Support Scheme.
The size of discretionary fiscal interventions can be measured by the fiscal impulse. This captures the magnitude of change in discretionary fiscal policy and thus the size of the stimulus. The concept is not to be confused with fiscal multipliers, which measure the impact of fiscal changes on economic outcomes, such as real national income and employment.
By measuring fiscal impulses, we can analyse the extent to which a country’s fiscal stance has tightened, loosened, or remained unchanged. In other words, we are attempting to capture discretionary fiscal policy changes that result in structural changes in the government budget and, therefore, in structural changes in spending and/or taxation.
To measure structural changes in the public-sector’s budgetary position, we calculate changes in structural budget balances.
A budget balance is simply the difference between receipts (largely taxation) and spending. A budget surplus occurs when receipts are greater than spending, while a deficit (sometimes referred to as net borrowing) occurs if spending is greater than receipts.
A structural budget balance cyclically-adjusts receipts and spending and hence adjusts for the position of the economy in the business cycle. In doing so, it has the effect of adjusting both receipts and spending for the effect of automatic stabilisers. Another way of thinking about this is to ask what the balance between receipts and spending would be if the economy were operating at its potential output. A deterioration in a structural budget balance infers a rise in the structural deficit or fall in the structural surplus. This indicates a loosening of the fiscal stance. An improvement in the structural budget balance, by contrast, indicates a tightening.
The size of UK fiscal impulses
A frequently-used measure of the fiscal impulse involves the change in the cyclically-adjusted public-sector primary deficit.
A primary deficit captures the extent to which the receipts of the public sector fall short of its spending, excluding its spending on debt interest payments. It essentially captures whether the public sector is able to afford its ‘new’ fiscal choices from its receipts; it excludes debt-servicing costs, which can be thought of as reflecting fiscal choices of the past. By using a cyclically-adjusted primary deficit we are able to isolate more accurately the size of discretionary policy changes. Chart 1 shows the UK’s actual and cyclically-adjusted primary deficit as a share of GDP since 1975, which have averaged 1.3 and 1.1 per cent of GDP respectively. (Click here for a PowerPoint of the chart.)
The size of the fiscal impulse is measured by the year-on-year percentage point change in the cyclically-adjusted public-sector primary deficit as a percentage of potential GDP. A larger deficit or a smaller surplus indicates a fiscal loosening (a positive fiscal impulse), while a smaller deficit or a larger surplus indicates a fiscal tightening (a negative fiscal impulse).
Chart 2 shows the magnitude of UK fiscal impulses since 1980. It captures very starkly the extent of the loosening of the fiscal stance in 2020 in response to the COVID-19 pandemic. (Click here for a PowerPoint of the chart.) In 2020 the cyclically-adjusted primary deficit to potential output ratio rose from 1.67 to 14.04 per cent. This represents a positive fiscal impulse of 12.4 per cent of GDP.
A tightening of fiscal policy followed the waning of the pandemic. 2021 saw a negative fiscal impulse of 10.1 per cent of GDP. Subsequent tightening was tempered by policy measures to limit the impact on the private sector of the cost-of-living crisis, including the Energy Price Guarantee and Energy Bills Support Scheme.
In comparison, the fiscal response to the global financial crisis led to a cumulative increase in the cyclically-adjusted primary deficit to potential GDP ratio from 2007 to 2009 of 5.0 percentage points. Hence, the financial crisis saw a positive fiscal impulse of 5 per cent of GDP. While smaller in comparison to the discretionary fiscal responses to the COVID-19 pandemic, it was, nonetheless, a sizeable loosening of the fiscal stance.
Sustainability and well-being of the public finances
The recent fiscal interventions have implications for the financial well-being of the public-sector. Not least, the financing of the positive fiscal impulses has led to a substantial growth in the accumulated size of the public-sector debt stock. At the end of 2006/7 the public-sector net debt stock was 35 per cent of GDP; at the end of the current financial year, 2023/24, it is expected to be 103 per cent.
As we saw at the outset, in an environment of rising interest rates, the increase in the public-sector debt to GDP ratio creates significant additional costs for government, a situation that is made more difficult for government not only by the current flatlining of economic activity, but by the low underlying rate of economic growth seen since the financial crisis. The combination of higher interest rates and lower economic growth has adverse implications for the sustainability of the public finances and the ability of the public sector to absorb the effects of future economic crises.
- Autumn Statement 2023: When is it and how will it affect me?
BBC News (16/11/23)
- What is the Autumn Statement?
House of Commons Library (13/11/23)
- Putting the fiscal toothpaste back into the tube: It’s time to normalise the euro area fiscal stance in 2024
VoxEU, Niels Thygesen, Roel Beetsma, Massimo Bordignon, Xavier Debrun, Mateusz Szczurek, Martin Larch, Matthias Busse, Mateja Gabrijelcic, Laszlo Jankovics and Janis Malzubris (30/6/23)
- Euro zone should tighten fiscal policy in 2024 to curb inflation, European Fiscal Board says
Reuters, Jan Strupczewski (28/6/23)
- Hutchins Center Fiscal Impact Measure: Federal, State and Local Fiscal Policy and the Economy
Brookings, Eli Asdourian, Louise Sheiner, and Lorae Stojanovic (27/10/23)
- IFS Green Budget
Institute for Fiscal Studies, Carl Emmerson, Paul Johnson and Ben Zaranko (eds) (October 2023)
- Explain what is meant by the following fiscal terms: (a) structural deficit; (b) automatic stabilisers; (c) discretionary fiscal policy; (d) primary deficit.
- What is the difference between current and capital public expenditures? Give some examples of each.
- Consider the following two examples of public expenditure: grants from government paid to the private sector for the installation of energy-efficient boilers, and welfare payments to unemployed people. How are these expenditures classified in the public finances and what fiscal objectives do you think they meet?
- Which of the following statements about the primary balance is FALSE?
(a) In the presence of debt interest payments a primary deficit will be smaller than a budget deficit.
(b) In the presence of debt interest payments a primary surplus will be smaller than a budget surplus.
(c) The primary balance differs from the budget balance by the size of debt interest payments.
(d) None of the above.
- Explain the difference between a fiscal impulse and a fiscal multiplier.
- Why is low economic growth likely to affect the sustainability of the public finances? What other factors could also matter?
During the pandemic, millions of people’s wages in the UK were paid by the government to prevent the closure of businesses and a surge in unemployment. The furlough scheme officially came to an end in September 2021. However, with the spread of the Omicron variant and the fear of further restrictions being put in place, there has been a call by many to re-introduce the furlough scheme.
The furlough scheme
The furlough scheme began when the government brought in, what was officially called the Coronavirus Job Retention Scheme (CJRS) in early 2020. This was when the pandemic first forced businesses across the country to close. The scheme worked by paying part of employees’ wages, preventing the need for businesses to make their staff redundant, therefore avoiding a rapid rise in unemployment along with the associated costs. It also avoided the financial and emotional costs of firing and then rehiring workers post pandemic. Under the scheme, furloughed workers received 80% of their wages, up to £2500 a month, if they couldn’t work because of the impact of coronavirus. Employees were able to maintain the security of employment and the payments helped furloughed workers pay their bills.
The scheme saw billions of pounds spent paying the wages of employees whose firms were forced to close temporarily. It could be argued that the expense of the scheme was a huge disadvantage. However, the alternative would have been for the government to pay unemployment-related benefits. Despite the furlough scheme being deemed necessary, it was not without its drawbacks for the structure of businesses. Rather than businesses adapting to changes in the economy and consumer demands, they could decide to claim the money and avoid the need to restructure. There was also concern about the length of the furlough scheme and the ability of businesses to bounce back post-pandemic.
Since the start of the scheme, the specifics of what was paid and who received it changed over time, especially once the economy started opening again. Initial steps were made to allow part-time return to work and the scheme started to wind down over the summer of 2021, with the government covering less of the wages and businesses covering more. From July, employers had to provide 10% of the wages of their furloughed staff, with the government paying the rest. This then increased to 20% in August with the CJRS coming to a complete end on 30 September 2021. At this point, there were around 1.6 million employees still receiving payment from the scheme.
Impact on Employment
With the end to the furlough scheme in September 2021, there were concerns that this would lead to a large number of redundancies. However, data indicate that has not happened and there is a record number of job vacancies. Official figures show that UK employment rose in October, confirming the strength of the labour market. The Office for National Statistics stated that the employment rate rose to 75.5% in the three months to October, up 0.2 percentage points on the previous quarter. This is believed to be driven by a rise in part-time work, which had dropped sharply during the pandemic. However, it is important to note that the strength in these numbers was prior to the emergence of the Omicron variant.
In November, the government had ruled out once again bankrolling people’s wages at enormous expense. However, the Chancellor is now under pressure to respond to the latest announcements around the ever-changing landscape of the pandemic. The fast-spreading mutation of the Covid-19 virus, Omicron, is posing a fresh threat to the economy.
On the 8 December, the Prime Minister announced new ‘Plan B’ Covid rules for England. As part of these new rules to limit the spread of Omicron, people are being asked to work from home again if possible and face masks are compulsory in most public places. Covid passes or a negative Covid test result are also needed to get into nightclubs and large venues.
Scotland and Wales have brought in further restrictions. Scotland’s First Minister, Nicola Sturgeon, has asked people to limit socialising to three households at a time in the run-up to Christmas. Shops and hospitality venues in Scotland must bring back physical distancing and screens. In Wales, nightclubs will close after 26 December and social distancing will be reintroduced in shops.
Although the hospitality industry and retail sector remain open, they are facing a slump in trade thanks to the new restrictions and worries among the general public. With the work-from-home guidance and advice from health officials that people should limit their social interactions, pubs and restaurants have seen widespread cancellations in the run-up to Christmas. Trade is suffering and these mass cancellations come at a time when these sectors were hoping for bumper trade after a dismal last couple of years.
In light of these concerns, ministers are now being urged to guarantee support in case businesses have to shut. Despite the indication that it would be highly unlikely that the UK would experience a full return to the restrictions seen at previous stages of the crisis, the International Monetary Fund has stated that the UK government should be drawing up contingency plans. The IMF has called for a mini-furlough scheme in the event that the Omicron variant forces the government to close parts of the economy. The idea is that the mini-furlough scheme would see a limited version of the multi-billion-pound job subsidy scheme being rolled out if firms are forced to close.
There are strong calls for there to be targeted support, which this mini-furlough scheme could offer. The Resolution Foundation argued in mid-December that a furlough scheme tied solely to the hospitality industry would help prevent job loses in an industry that is currently suffering once again. It calculated that the cost of a hospitality-only furlough scheme would be £1.4 billion a month if it were pitched at the original level of 80% of wage support. If a January to March sector-specific scheme were to be introduced it is estimated to cost around £5 billion, a small cost in comparison to £46 billion spent on furlough so far.
Any reintroduction of a furlough scheme would be a jolt for the government. This would mean a return to the 2020-style arguments around protecting livelihoods and businesses, a contrast to the recent messaging from the Treasury of restoring public finances. There is also concern about how this will all impact on current growth predictions and inflation concerns. The IMF expects the growth of the UK economy to be 6.8% in 2021 and 5% in 2022. However, the drawback from this is that the recovery would also be accompanied by rising inflation. It has been suggested, therefore, that interest rate increases from the Bank of England would be needed to keep inflation under control, while at the same time being not so great as to kill off growth.
It was widely expected that the Bank of England would again put off a rate hike in order to wait to see the economic impact of Plan B restrictions. However, on Thursday 16 December, interest rates were raised for the first time in more than three years. Despite the fears that Omicron could slow the economy by causing people to spend less, Bank Rate was raised from 0.1% to 0.25% . This came in the wake of data showing prices climbing at the fastest pace for 10 years.
Government finances would take another huge hit if the furlough scheme were revived. But a version of such a scheme is likely to be necessary to avert an unemployment crisis and the attendant costs.
However, in resisting further measures, the government has argued that it has already acted early to help control the virus’s spread by rapidly rolling out booster jabs, while avoiding unduly damaging economic and social restrictions.
The government also argues that some of the measures from the total £400 billion Covid support package since the start of the pandemic will continue to help businesses into Spring 2022. Such measures include government-backed loans for small- and medium-sized businesses until June 2022, a reduction in VAT from 20% to 12.5% until March 2022 and business rates relief for eligible retail, hospitality, and leisure businesses until March 2022. Talks are ongoing with hospitality and and other business organisations directly affected by Covid restrictions.
The British Chambers of Commerce has argued that current measures are not enough and has called for VAT on hospitality and tourism to be cut back to its emergency rate of 5% and for the 100% business rates relief for retailers to return. The CBI has also called for any unspent local authority grants to be spent now to help affected firms and that further help, including business rates relief, should be on the table if restrictions continue after the government’s 5 January review date. The IMF said that with strong policy support, the economy had proved resilient, but it stressed that a return of some of the measures that prevented mass unemployment and large-scale business failures might soon be needed.
Infections caused by the new Omicron variant are rising rapidly, doubling every two to three days. It is expected to become the dominant variant in the UK soon with health officials warning it may be the most significant threat since the start of the pandemic. However, it is not yet known what the full extent of the impact of this new variant on the NHS will be, leaving the severity of future restrictions uncertain.
But what is evident is that the course of the pandemic has changed and there is a growing case for the government to start planning for new support packages. Although a reintroduction of the furlough scheme was hoped not to be needed on the path out of the pandemic, a short detour may be required in the form of a mini-furlough scheme. The size and reach of any support put in place will depend upon any further restrictions on economic activity.
- Should the level of support for business return to the levels in place earlier in 2021?
- What measures could a government put in place to curtail the spread of the Omicron variant that have only a minimal impact on business and employment?
- Compare the UK measures to curtail the spread of the virus with those used in some other European countries.
- What are the arguments for and against (a) re-introducing the furlough scheme as it was earlier in 2021; (b) introducing a version restricted to the hospitality sector?
At a meeting of the G7 finance ministers in London from 4–5 June, it was agreed to adopt a minimum corporate tax rate of 15% and to take measures to prevent multinational companies using tax havens to avoid paying taxes. It was also agreed that part of the taxes paid should go to the countries where sales are made and not just to those where the companies are based.
This agreement is the first step on the road to a comprehensive global agreement. The next step is a meeting of the finance ministers and central bank governors of the G20 countries in Venice from 9 to 10 July. The G7 ministers hope that their agreement will be adopted by this larger group, which includes other major economies such as Russia, China, India, Brazil, Australia, South Korea and South Africa.
Later in July, the proposals will be put to a group of 139 countries and jurisdictions at a meeting co-ordinated by the OECD. It is hoped that this meeting will finalise an international agreement with precise details on corporate tax rules. It follows work by the OECD on reforming international taxation under its Framework on Base Erosion and Profit Shifting (BEPS).
These meetings follow growing concerns about the ability of multinational companies to avoid taxes by basing regional headquarters in low-tax countries, such as Luxembourg or Singapore, and declaring their profits there, despite having only a tiny proportion of their sales in these countries.
The desire to attract multinational profits has led to a prisoners’ dilemma situation, whereby countries have been competing against each other to offer lower taxes, even though it reduces global corporate tax revenues.
With many countries having seen a significant rise in government deficits as result of the COVID-19 pandemic and the support measures put in place, there has been a greater urgency to reach international agreement on corporate taxes. The G7 agreement, if implemented, will provide a significant increase in tax revenue.
Details of the G7 agreement
The agreement has two parts or ‘pillars’.
Pillar 1 allows countries to tax large multinationals earning global profits of more than 10% if these companies are not based there but earn revenues there. Countries will be given tax rights over at least 20% of the profits earned there which exceed the 10% margin. The level of profits determined for each country will be based on the proportion of revenues earned there.
Pillar 2 sets a minimum corporate tax rate of 15% for each of the seven countries, which call on other countries to adopt the same minimum. The hope is that the G20 countries will agree to this and then at the OECD meeting in July a global agreement will be reached. If a country chooses to charge a rate below 15%, then a top-up tax can be applied by the home country to bring the total rate up to the 15%.
It is possible that these proposals will be strengthened/amended at the G20 and OECD meetings. For example, the 15% minimum rate may be raised. Indeed, the USA had initially proposed a 25% rate and then 21%, and several EU countries such as France, have been pushing for a substantially higher rate.
The agreement was hailed as ‘historic’ by Rishi Sunak, the UK Chancellor of the Exchequer. This is true in that it is the first time there has been an international agreement on minimum corporate tax rates and locating part of tax liability according to sales. What is more, the rules may be strengthened at the G20 and/or OECD meetings.
There have been various criticisms of the agreement, however. The first is that 15% is too low and is well below the rates charged in many countries. As far as the UK is concerned, the IPPR think tank estimates that the deal will raise £7.9bn whereas a 25% rate would raise £14.7bn.
Another criticism is that the reallocation of some tax liabilities to countries where sales are made rather than where profits are booked applies only to profits in excess of 10%. This would therefore not affect companies, such as Amazon, with a model of large-scale low-margin sales and hence profits of less than 10%.
Also there is the criticism that a 20% reallocation is too low and would thus provide too little tax revenue to poor countries which may record large sales but where little or no profits are booked.
The UK was one of the more reluctant countries to sign up to a deal that would have a significant impact on tax havens in various British overseas territories and crown dependencies, such as the British Virgin islands, Bermuda, the Cayman Islands, the Channel Islands and Isle of Man. The agreement also calls into question whether the announced UK freeports can go ahead. Although these are largely concerned with waiving tariffs and other taxes on raw materials and parts imported into the freeport, which are then made into finished or semi-finished products within the freeport for export, they are still seen by many as not in the spirit of the G7 agreement.
What is more, the UK has been pushing for financial services to be exempted from Pillar 1 of the deal, which would otherwise see taxes partly diverted from the UK to other countries where such firms do business. For example, HSBC generates more than half its income from China and Standard Chartered operates mostly in Asia and Africa.
Update: July 2021
The G7 plan was agreed by the finance ministers of the G20 countries on July 11 in Venice. By that point, 130 of the 139 countries which are part of the Inclusive Framework of the OECD and which represent more than 90% of global GDP, had signed up to the plan and it was expected that there would be a global agreement reached at the OECD meeting later in the month. The other nine countries were Ireland, Hungary and Estonia in the EU and Kenya, Nigeria, Peru, Sri Lanka, Barbados and Saint Vincent and the Grenadines. Several of these countries use low corporate taxes to encourage inward investment and are seen as tax havens.
- G-7 nations reach historic deal on global tax reform
CNBC, Silvia Amaro, Joanna Tan and Emma Newburger (5/6/21)
- Rishi Sunak hails ‘historic’ breakthrough as G7 ministers agree global tech tax deal
The Telegraph, Lucy Burton and Edward Malnick (5/6/21)
- G7 backs Biden’s sweeping overhaul of global tax system
CNN, Tara John and Kevin Liptak (5/6/21)
- ‘Historic’ G7 deal to stop global corporate tax avoidance welcomed by tech giants Google and Facebook
Sky News, Ajay Nair (6/6/21)
- Finance Leaders Reach Global Tax Deal Aimed at Ending Profit Shifting
New York Times, Alan Rappeport (5/6/21)
- G7 strikes historic agreement on taxing multinationals
Financial Times, Chris Giles (5/6/21)
- G7 tax deal is ‘starting point’ on road to global reform
LAPM Journal, Chris Giles and Delphine Strauss (FT) (6/6/21)
- G7 tax deal doesn’t go far enough, campaigners say
BBC News (6/6/21)
- Rishi Sunak announces ‘historic agreement’ by G7 on tax reform
The Observer, Phillip Inman and Michael Savage (5/6/21)
- G7 deal is as much about balance of power as global tax reform
The Guardian, Richard Partington (6/6/21)
- Global G7 deal may let Amazon off hook on tax, say experts
The Guardian, Jasper Jolly (6/6/21)
- Explainer: G7 tax deal – what was agreed and what does it mean for Ireland?
The Irish Times, Cliff Taylor (5/6/21)
- G7 deal: UK is badly conflicted between offshore tax havens and Biden’s global tax drive
The Conversation, Atul K. Shah (4/6/21)
- G7 tax dodging deal ‘sets bar so low companies can just step over it’
Independent, Emily Goddard (6/6/21)
- UK pushes for City of London to be exempt from G7 tax plan
The Guardian, Phillip Inman and Richard Partington (9/6/21)
- The global pandemic, sustainable economic recovery, and international taxation
Independent Commission for the Reform of International Corporate Taxation (May 2020)
- G20 finance ministers back deal to tax companies
BBC News (11/7/21)
- How are multinationals currently able to avoid paying corporate taxes in many countries, even though their sales may be high there?
- If the deal is accepted at the OECD meeting in July, would it still be in the interests of low-tax countries to charge tax rates below the agreed minimum rate?
- Why was the UK reluctant to accept the 21% rate proposed by the Biden administration?
- Find out about the digital services tax that has been adopted by many countries, including EU countries and the UK, and why it will be abolished once a minimum corporate tax comes into force.
- Argue the case for and against taxing the whole of multinational profits in countries where they earn revenue in proportion to the company’s total global revenue. Would such a system benefit developing countries?
- Should financial services, such as those provided by City of London firms, be exempted from the deal?
Many developing countries are facing a renewed debt crisis. This is directly related to Covid-19, which is now sweeping across many poor countries in a new wave.
Between 2016 and 2020, debt service as a percentage of GDP rose from an average of 7.1% to 27.1% for South Asian countries, from 8.1% to 14.1% for Sub-Saharan African countries, from 13.1% to 42.3% for North African and Middle Eastern countries, and from 5.6% to 14.7% for East Asian and Pacific countries. These percentages are expected to climb again in 2021 by around 10% of GDP.
Incomes have fallen in developing countries with illness, lockdowns and business failures. This has been compounded by a fall in their exports as the world economy has contracted and by a 19% fall in aid in 2020. The fall in incomes has led to a decline in tax revenues and demands for increased government expenditure on healthcare and social support. Public-sector deficits have thus risen steeply.
And the problem is likely to get worse before it gets better. Vaccination roll-outs in most developing countries are slow, with only a tiny fraction of the population having received just one jab. With the economic damage already caused, growth is likely to be subdued for some time.
This has put developing countries in a ‘trilemma’, as the IMF calls it. Governments must balance the objectives of:
- meeting increased spending needs from the emergency and its aftermath;
- limiting the substantial increase in public debt;
- trying to contain rises in taxes.
Developing countries are faced with a difficult trade-off between these objectives, as addressing one objective is likely to come at the expense of the other two. For example, higher spending would require higher deficits and debt or higher taxes.
The poorest countries have little scope for increased domestic borrowing and have been forced to borrow on international markets. But such debt is costly. Although international interest rates are generally low, many developing countries have had to take on increasing levels of borrowing from private lenders at much higher rates of interest, substantially adding to the servicing costs of their debt.
International agencies and groups, such as the IMF, the World Bank, the United Nations and the G20, have all advocated increased help to tackle this debt crisis. The IMF has allocated $100bn in lending through the Rapid Financing Instrument (RFI) and the Rapid Credit Facility (RCF) and nearly $500m in debt service relief grants through the Catastrophe Containment and Relief Trust (CCRT). The World Bank is increasing operations to $160bn.
The IMF is also considering an increase in special drawing rights (SDRs) from the current level of 204.2bn ($293.3bn) to 452.6bn ($650bn) – a rise of 121.6%. This would be the first such expansion since 2009. It has received the support of both the G7 and the G20. SDRs are reserves created by the IMF whose value is a weighted average of five currencies – the US dollar (41.73%), the euro (30.93%), the Chinese yuan (10.92%), the Japanese yen (8.33%) and the pound sterling (8.09%).
Normally an increase in SDRs would be allocated to countries according their IMF quotas, which largely depend on the size of their GDP and their openness. Any new allocation under this formula would therefore go mainly to developed countries, with developing economies getting only around $60bn of the extra $357bn. It has thus been proposed that developed countries give much of their allocation to developing countries. These could then be used to cancel debts. This proposal has been backed by Janet Yellen, the US Secretary of the Treasury, who said she would “strongly encourage G20 members to channel excess SDRs in support of recovery efforts in low-income countries, alongside continued bilateral financing”.
The G20 countries, with the support of the IMF and World Bank, have committed to suspend debt service payments by eligible countries which request to participate in its Debt Service Suspension Initiative (DSSI). There are 73 eligible countries. The scheme, now extended to 31 December 2021, provides a suspension of debt-service payments owed to official bilateral creditors. In return, borrowers commit to use freed-up resources to increase social, health or economic spending in response to the crisis. As of April 2021, 45 countries had requested to participate, with savings totalling more than $10bn. The G20 has also called on private creditors to join the DSSI, but so far without success.
Despite these initiatives, the scale of debt relief (as opposed to extra or deferred lending) remains small in comparison to earlier initiatives. Under the Heavily Indebted Poor Countries initiative (HIPC, launched 1996) and the Multilateral Debt Relief Initiative (MDRI, launched 2005) more than $100bn of debt was cancelled.
Since the start of the pandemic, major developed countries have spent between $10 000 and $20 000 per head in stimulus and social support programmes. Sub-Saharan African countries on average are seeking only $365 per head in support.
Articles and blogs
- Imagine you are an economic advisor to a developing country attempting to rebuild the economy after the coronavirus pandemic. How would you advise it to proceed, given the ‘trilemma’ described above?
- How does the News24 article define ‘smart debt relief’. Do you agree with the definition and the means of achieving smart debt relief?
- To what extent is it in the interests of the developed world to provide additional debt relief to poor countries whose economies have been badly affected by the coronavirus pandemic?
- Research ‘debt-for-nature swaps’. To what extent can debt relief for countries affected by the coronavirus pandemic be linked to tackling climate change?
Rishi Sunak delivered his 2021 UK Budget on 3 March. It illustrates the delicate balancing act that governments in many countries face as the effects of the coronavirus pandemic persist and public-sector debt soars. He announced that he would continue supporting the economy through various forms of government expenditure and tax relief, but also announced tax rises over the medium term to begin addressing the massively increased public-sector debt.
Key measures of support for people and businesses include:
- An extension of the furlough scheme until the end of September, with employees continuing to be paid 80% of their wages for hours they cannot work, but with employers having to contribute 10% in July and 20% in August and September.
- Support for the self-employed also extended until September, with the scheme being widened to make 600 000 more self-employed people eligible.
- The temporary £20 increase to Universal Credit, introduced in April last year and due to end on 31 March this year, to be extended to the end of September.
- Stamp duty holiday on house purchases in England and Northern Ireland, under which there is no tax liability on sales of less than £500 000, extended from the end of March to the end of June.
- An additional £1.65bn to support the UK’s vaccination rollout.
- VAT rate for hospitality firms to be maintained at the reduced 5% rate until the end of September and then raised to 12.5% (rather than 20%) for a further six months.
- A range of grants for the arts, sport, shops , other businesses and apprenticeships.
- Business rates holiday for hospitality firms in England extended from the end of March to the end of June and then with a discount of 66% until April 2022.
- 130% of investment costs can be offset against tax – a new tax ‘super-deduction’.
- No tax rises on alcohol, tobacco or fuel.
- New UK Infrastructure Bank to be set up in Leeds with £12bn in capital to support £40bn worth of public and private projects.
- Increased grants for devolved nations and grants for 45 English towns.
It has surprised many commentators that there was no announcement of greater investment in the NHS or more money for social care beyond the £3bn for the NHS and £1bn for social care announced in the November Spending Review. The NHS England budget will fall from £148bn in 2020/21 to £139bn in 2021/22.
Effects on borrowing and GDP
The net effect of these measures for the two financial years 2020 to 2022 is forecast by the Treasury to be an additional £37.5bn of government expenditure and a £27.3bn reduction in tax revenue (see Table 2.1 in Budget 2021). This takes the total support since the start of the pandemic to £352bn across the two years.
According to the OBR, this will result in public-sector borrowing being 16.9% of GDP in 2020/21 (the highest since the Second World War) and 10.3% of GDP in 2021/22. Public-sector debt will be 107.4% of GDP in 2021/22, rising to 109.7% in 2023/24 and then falling to 103.8% in 2025/26.
Faced with this big increase in borrowing, the Chancellor also announced some measures to raise tax revenue beginning in two years’ time when, hopefully, the economy will have grown. Indeed, the OBR forecasts that GDP will grow by 4.0% in 2021 and 7.3% in 2022, with the growth rate then settling at around 1.7% from 2023 onwards. He announced that:
- Corporation tax on company profits over £250 000 will rise from 19% to 25% in April 2023. Rates for profits under £50 000 will remain at the current rate of 19%, with the rate rising in stages as profits rise above £50 000.
- Personal income tax thresholds will be frozen from 2022/23 to 2025/26 at £12 570 for the basic 20% marginal rate and at £50 270 for the 40% marginal rate. This will increase the average tax rate as people’s nominal incomes rise.
The policy of a fiscal boost now and a fiscal tightening later might pose political difficulties for the government as this does not fit with the electoral cycle. Normally, politicians like to pursue tighter policies in the early years of the government only to loosen policy with various giveaways as the next election approaches. With Rishi Sunak’s policies, the opposite is the case, with fiscal policy being tightened as the 2024 election approaches.
Another issue is the high degree of uncertainty in the forecasts on which he is basing his policies. If there is another wave of the coronavirus with a new strain resistant to the vaccines or if the scarring effects of the lockdowns are greater, then growth could stall. Or if inflation begins to rise and the Bank of England feels it must raise interest rates, then this would suppress growth. With lower growth, the public-sector deficit would be higher and the government would be faced with the dilemma of whether it should raise taxes, cut government expenditure or accept higher borrowing.
What is more, there are likely to be huge pressures on the government to increase public spending, not cut it by £4bn per year in the medium term as he plans. As Paul Johnson of the IFS states:
In reality, there will be pressures from all sorts of directions. The NHS is perhaps the most obvious. Further top-ups seem near-inevitable. Catching up on lost learning in schools, dealing with the backlog in our courts system, supporting public transport providers, and fixing our system for social care funding would all require additional spending. The Chancellor’s medium-term spending plans simply look implausibly low.
Articles and Briefings
- Budget 2021: Key points at-a-glance
BBC News (3/3/21)
- Budget 2021: Full round-up of what Chancellor Rishi Sunak has announced
MoneySavingExpert, Callum Mason (3/3/21)
- Budget 2021 at a glance: The key points from Chancellor Rishi Sunak’s speech
This is Money, Alex Sebastian (3/3/21)
- Budget 2021
- Rishi Sunak delivers spend now, tax later Budget to kickstart UK economy
Financial Times, Jim Pickard, Chris Giles and George Parker (3/3/21)
- Swifter and more sustained? What did we learn about the UK’s economic outlook from Rishi Sunak’s Budget?
Independent. Ben Chu (3/3/21)
- Spending fast, taxing slow: Briefing Note
Resolution Foundation, Torsten Bell, Mike Brewer, Nye Cominetti, Karl Handscomb, Kathleen Henehan, Lindsay Judge, Jack Leslie, Charlie McCurdy, Cara Pacitti, Hannah Slaughter, James Smith, Gregory Thwaites & Daniel Tomlinson (4/3/21)
- JRF Spring Budget 2021 analysis and briefing
Joseph Rowntree Foundation, Dave Innes and Katie Schmuecker (4/3/21)
- NHS, social care and most vulnerable ‘betrayed’ by Sunak’s budget
The Guardian, Robert Booth ,Patrick Butler and Denis Campbell (3/3/21)
- Spend now, pay later: Sunak flags major tax rises as Covid bill tops £400bn
The Guardian, Heather Stewart and Larry Elliott (3/3/21)
- Rishi Sunak digs in for battle against financial cost of Covid
The Guardian, Larry Elliott (3/3/21)
- Tax and spending experts say Sunak’s budget doesn’t add up
The Guardian, Larry Elliott and Heather Stewart (4/3/21)
- Budget 2021: Prepare for a dramatic rollercoaster ride after chancellor’s give-then-take budget
Sky News, Ed Conway (3/3/21)
Official documents and data
- Assess the wisdom of the timing of the changes in tax and government expenditure announced in the Budget.
- Universal credit was increased by £20 per week in April 2020 and is now due to fall back to its previous level in October 2021. Have the needs of people on Universal Credit increased during the pandemic and, if so, are they likely to return to their previous level in October?
- In the past, the government argued that reductions in the rate of corporation tax would increase tax revenue. The Chancellor now argues that increasing it from 19% to 25% will increase tax revenue. Examine the justification for this increase and the significance of relative profit tax rates between countries.
- Investigate the effects on the public finances of the pandemic and government fiscal policy in two other countries. How do the effects compare with those in the UK?
- The Joseph Rowntree Foundation looks at poverty in the UK and policies to tackle it. It set five tests for the Budget. Examine its Budget Analysis and consider whether these tests have been met.