Professor Sir Anton Muscatelli, Principal and Vice-Chancellor, University of Glasgow, and member of the Scottish Government’s Advisory Group on Economic Recovery
This Wednesday will see the Chancellor of the Exchequer outline his economic statement. It will set out the measures which the UK Government believes are needed to drive an economic recovery from the economic crisis caused by COVID-19.
What measures might be announced? Some ideas have been trailed in the press, ranging from a temporary VAT cut, to job creation schemes.
The stakes could not be higher.
The costs of stemming the impact of COVID-19 on the economy, through the furlough/Coronavirus Job Retention Scheme (CJRS) and other measures in terms of deferred taxation and business loans, have been estimated by the Office for Budget Responsibility (OBR) to cost the exchequer £132.6bn in terms of additional cash borrowing in 2020-21.
The OBR’s reference scenario assumes a V-shaped recovery, with GDP returning to its pre-crisis path in 2021. The Institute for Fiscal Studies (IFS) has developed [1] a number of potential alternative scenarios for the public finances, on the assumption of a less optimistic recovery. In the IFS central scenario, which is similar to the OECD June 2020 forecast, GDP only partially rebounds in 2021 before returning to its previous growth path in 2022-23. This produces a budget deficit just short of 16% of GDP (a peacetime record in modern times) in 2020-21, followed by persistent deficits of around 5% of GDP out to 2024-25. This causes the Debt to GDP ratio to exceed 100% by 2024-25. A second wave of COVID-19 (stemmed by a resumption of the furlough scheme and other measures) is estimated by the IFS to lead to a Debt to GDP of close to 120% in a more pessimistic scenario.
These are eyewatering numbers, but the key message from the IFS analysis is that, in the absence of an economic recovery, the implications for the public finances could be much greater. Hence the Chancellor will want to use the spending firepower he has to maximum effect on Wednesday.
Let’s look at some of the tax and spend instruments which have been mooted.
First, VAT is often seen as a useful instrument to quickly stimulate consumer spending. A temporary VAT cut, where the time horizon of the cut is announced up front, should ‘tilt’ future spending towards the present, as consumers take advantage of temporarily lower prices. The problem with a VAT cut is two-fold: it is very expensive in terms of tax forgone if applied right across all goods and services; and it’s stimulating demand across the board, even in sectors which have been less affected by the COVID-19 crisis. This suggests that the VAT cut should be carefully used, and deployed only if consumer demand fails to recover during the next few months. Indeed a more appropriate move might be to reduce VAT selectively on some sectors which have been badly hit by the crisis, such as food and accommodation.
Another possibility is to look at tax cuts which help both consumer spending and de-carbonisation. For instance, as part of its recovery package Germany announced a temporary increase in the incentives to purchase electric cars. Aligning tax reductions to allow the economy to adapt to the climate crisis could be a helpful way to combine a short-term spending stimulus with a long-run objective of greening the economy.
An argument against using tax reductions is that, given the uncertainty which COVID has caused for consumers, they could simply lead consumers to save more. Even the ‘high street voucher’ suggested by the Resolution Foundation in recent days is not immune from this problem as better-off consumers simply reduce their planned high-street spending levels (although it could work if targeted at consumers on low incomes).
This is why some economists have suggested focusing on additional direct spending by government, combined with sustaining employment beyond the end of the furlough/CJRS scheme. This could take various forms, from subsidies to businesses participating in youth employment or training programmes, to reductions in employee national insurance contributions (possibly conditional on companies not reducing their employment levels during 2020-21).
The additional spending could also be targeted locally. The Advisory Group on Economic Recovery for Scottish Government of which I was a member, the devolved governments across the UK and a number of English mayors have recently suggested a more decentralised approach to spending priorities. This would allow each region and nation to target sectors which have been particularly badly hit by the crisis.
The Chancellor faces some unenviable choices on Wednesday. Balancing the support for the demand and the supply side of the economy will be central to this. He has to balance the stimulus to sustaining consumer spending and hence demand, whilst preserving the economy’s supply-side capacity by protecting employment and the survival of those companies which have a sustainable future. This will be the key short-run trade-off.
Longer term there are other important challenges, such as the sustainability of the public finances, which in turn will depend on a resumption of productivity growth and economic growth. But for the recovery phase getting the economy restarted is the primary objective.
[1] The outlook for the public finances under the long shadow of COVID-19, IFS Briefing Note 295, June 2020, by Carl Emmerson, Ben Nabarro and Isabel Stockton
To cite this article: Muscatelli, Anton, The July ‘mini-budget’ – Engineering the economic recovery from COVID-19, Policy Scotland, 7 July 2020, https://policyscotland.gla.ac.uk/the-july-mini-budget-engineering-the-economic-recovery-from-covid-19
Image credit: Richard Johnson | iStockphoto
