UK borrowing numbers pave the way for tax cuts

Today’s public sector borrowing figures have come in significantly better than expected, opening up the possibility for the Chancellor, Jeremy Hunt, to announce further tax cuts in this year’s Budget (due 6th March) and which – most crucially – can be delivered without triggering a negative reaction in the gilt market.

Public sector net borrowing (excluding banks) in December was £7.8bn, sharply lower than the expected reading of £14.1bn and below the Office for Budget Responsibility’s (OBR) own forecast of £14.0bn. It means that over the first 8 months of the 2023/24 financial year, total government borrowing is now estimated to have been only £111.4bn, some £5bn less than the previous estimate of £116.4bn. The main reason for this better performance is the lower-than-expected pace of inflation, RPI slowing faster than was previously expected and which has reduced the government’s debt interest payments by approximately £5.5bn. Interest payments on UK index-linked gilts are calculated using the monthly change in the rate of RPI two months prior, and in October RPI rose by just 0.2%, much less than the 1.6% rise that had been expected by the OBR. Outside of this, most other government spending was largely in line with forecasts.

The consequence of this better performance almost certainly means that personal taxes will be cut in the forthcoming March Budget, as the ruling Conservative Party takes steps to maximise its chances of winning the next general election, an event that has to be held within the next 12 months but is generally expected to take place this Autumn. And the good news for the government is that the fiscal picture is looking increasingly rosy going forward, as expected falls in energy prices put further downwards pressure on RPI and reducing debt interest payments further. Some estimates suggest payments in the 2024/25 fiscal year could be reduced by as much as £12bn. All in all, the Chancellor has been given significant headroom to ease the tax burden without risking a negative reaction in the gilt market.

The key question, therefore, may be how the Chancellor chooses to 'spend' this windfall. Reducing the basic rate of income tax by 1p would cost the Exchequer £5.5bn. Alternatively, with much ire having been expressed over the decision taken by Hunt’s predecessor, Rishi Sunak, to freeze income tax allowances, raising the basic personal allowance by £500 would cost the Exchequer approximately £4.2bn and would have the added political bonus of not benefitting high earners. Alternatively, a decision may be taken to lower taxes on expenditure, such as the planned 5p increase in fuel duty in April expected to take effect on 23rd March.

In practice, Chancellor Hunt is unlikely to give away all of this ‘surplus’; if the purse strings are relaxed too much then pressure will be put on the Bank of England to reduce the potential for interest rate cuts this year as it reacts to neutralise the inflationary impact of this fiscal loosening. This would undoubtedly push up mortgage rates again and leave the government facing the ire of homeowners, something it will be desperate to avoid in an election year. But the pressure from his own party to return a meaningful amount will be significant. What decision is finally taken will be unveiled at the Budget - but it will likely be political considerations rather than pure economic ones that ultimately determine how much of tax-payers money the Chancellor decides to give back to them.