Autumn 2020 spending review

Chris Smith

The House of Lords is due to debate the spending review on 3 December 2020.

What is the 2020 spending review?

Spending reviews set out the Government’s long-term plan for some of its expenditure. They usually take place every two to four years.

At the March 2020 budget, the Chancellor announced a new spending review that would cover day-to-day spending from 2021/22 to 2023/24 and would report in July 2020. However, given the uncertainty created by the coronavirus pandemic, this spending review (‘SR20’) was delayed, and restricted to only the financial year 2021/22. The review was accompanied by the latest economic forecasts from the Office for Budget Responsibility (OBR).

Overall spending

SR20 set core day-to-day departmental expenditure, excluding responses to coronavirus, at £384 billion for 2021/22. Along with increases in 2020/21, this represents a 3.8% real terms increase per year compared to 2019/20.

Capital spending was set at £100 billion for 2021/22, a £27 billion real terms increase from 2019/20.

Components of spending

Departmental spending excluding coronavirus

SR20 set out how core day-to-day departmental spending, excluding measures in response to coronavirus, would rise by £14.8 billion in cash terms between 2020/21 and 2021/22. It said that this increase was £9.6 billion less than had previously been announced in the March 2020 budget, “reflecting changed circumstances”.

The settlement varied between departments. The Department for Environment, Food and Rural Affairs received the largest increase in funding between 2020/21 and 2021/22. Its core budget rose by 45%, largely due to taking on responsibility for farm support following Brexit. The Foreign, Commonwealth and Development Office saw the largest fall, of 15%. This was due to a decision to reduce overseas aid spending from 0.7% to 0.5% of gross national income. The Foreign Secretary, Dominic Raab, said the Government would legislate to achieve the reduction but would aim to return to 0.7% “when the fiscal situation permits”.

Although SR20 only covered one year’s spending in detail, it also set out plans for overall government spending for years beyond 2021/22. It suggested real terms increases in day-to-day spending of 2.1% per year between 2021/22 and 2025/26. Again, the increases for each year in cash terms are lower than those set out in the March budget. However, SR20 maintained the planned real terms increases in central government investment spending outlined in the budget.

Around 59% of total day-to-day departmental spending is protected by existing multi-year settlements. This includes funding for the NHS, schools in England and defence. Outside the protected areas, spending by other government departments is projected to be broadly flat in real per capita terms between 2021/22 and 2022/23.

Coronavirus response

Since March 2020, the Government has committed £280 billion to a package of support measures in response to coronavirus. Of this, £113 billion is for public services such as the NHS, local government, transport and employment support. The remainder includes support for businesses, such as the furlough scheme and support grants, plus higher welfare payments and deferred taxes. The OBR said that, despite the high cost of these schemes, they were beneficial, as they “prevented an even more dramatic fall in output and attenuated the likely longer-term adverse effects of the pandemic […] and the Government’s furlough scheme has prevented a larger rise in unemployment”.

For 2021/22, the Government has budgeted an extra £55 billion for public services in response to coronavirus. In later years, it has assumed that no additional funds are needed.

Debt interest payments

Despite the sharp increase in government debt during the pandemic, total interest payments on it are expected to fall. This is due to further falls in interest rates and the way that the Bank of England’s quantitative easing scheme acts to reduce debt costs. The OBR said that debt interest spending as a percentage of government revenue will fall from 3.5% in 2019/20 to a post-war low of 1.7% in 2021/22.

The OBR stated that the falls in interest payments mean that the debt incurred because of the pandemic “has not undermined the sustainability of the public finances”. However, it has made the fiscal position more vulnerable to increases in interest rates. For example, the OBR said that debt interest costs would now increase by £12 billion for a one percentage point rise in short-term rates—twice the amount in March 2020.

Capital spending

SR20 provided more details on the Government’s plans for infrastructure and investment spending. These included:

A national infrastructure strategy (NIS) to promote economic recovery and levelling up, and to meet the UK’s net zero emissions target by 2050. It includes commitments on transport, broadband, hospitals, schools and prisons.
A national infrastructure bank, as part of the NIS, to “catalyse private investment in infrastructure projects”.
Allocations for specific projects, such as rail and road upgrades, flood defences and affordable homes.
A levelling up fund, in addition to the previously announced shared prosperity fund.
Changes to how decisions on major investment programmes are made, through the ‘green book’. These changes seek to align investment decisions more closely with the Government’s strategic objectives, such as levelling up.

Public sector pay, national living wage and employment support

SR20 announced a pay freeze for all public sector workers except NHS workers and those earning less than £24,000, who would each receive a £250 increase.

The Government stated that it would increase the national living wage for those aged 23 and over by 2.2%, up from £8.72 to £8.91 per hour, from April 2021.

SR20 also set out additional funding of £3.7 billion in 2021/22 to support the labour market; for example, though a new restart programme to support the unemployed in finding work.

Taxation

SR20 did not contain any major announcements of changes to central government taxation policy. However, it did permit local authorities to increase council taxes by up to 5%. The OBR said that it assumed “most councils take advantage of this flexibility”.

Economic forecasts

Alongside SR20, the OBR published revised forecasts for the UK economy.

The OBR said that its forecasts were subject to “huge uncertainty” as a result of the pandemic and its economic consequences. As a result of the uncertainty, the OBR forecasts showed both a central case and two other scenarios:

In the central case, public health restrictions cease in spring 2021, and the economy returns to pre-virus levels of activity at the end of 2022.
In the upside scenario, the virus is brought under control more quickly and the recovery is more rapid, returning to pre-virus levels at the end of 2021.
In the downside scenario, activity only returns to pre-virus levels at the end of 2024.

The OBR also noted further uncertainty around the future trading relationship with the EU, as discussions were ongoing at the time it prepared the forecasts. Its main analyses assumed a smooth transition to a “typical” free trade deal with the EU. However, it also modelled the effects of a no-deal scenario for Brexit.

Economic growth

The OBR said that the economy (measured by gross domestic product (GDP)) would shrink by 11.3% in 2020, the largest fall since 1709. In the upside scenario this figure would be 10.6%, and in the downside 12.0%.

In the central scenario, economic growth was 5.5% in 2021 and 6.6% in 2022, before returning to a more usual trend rate of 1.8% by 2025.

In a no-deal scenario, the OBR said GDP would fall by an additional 2% in 2021.

The OBR discussed the concept of scarring. It defined this as the permanent loss of capacity in the economy resulting from the pandemic. It said that in the upside virus scenario, and with a smooth transition to a free trade deal with the EU, there would be no such long-term effects, so GDP would eventually return to its pre-pandemic path. However, in other scenarios the levels of scarring could be:

3% of GDP in the central scenario;
6% of GDP in the downside scenario; and
an additional 1.5% of GDP if there was a disruptive no-deal Brexit.

Public sector deficit

The public sector deficit is the difference between public sector spending and income in each year. In its central scenario, the OBR forecast that government borrowing in 2020/21 would be £394 billion, compared to £56 billion in 2019/20. This represents 19% of GDP, the highest level since 1944/45. Forecast borrowing in future years also rose.

In its upside scenario, the OBR said the 2020/21 deficit would be £353 billion (17% of GDP), and in its downside scenario it would be £440 billion (22% of GDP). It stated that a no-deal scenario would add a further £12 billion (0.7% of GDP) to borrowing in 2021/22.

Public sector debt

The public sector debt is the total stock of borrowing resulting from past deficits, to the extent that they have not yet been repaid. The OBR said that the increase in borrowing in 2020/21 would lead to overall debt of £2.3 trillion. This would represent 105% of GDP, the highest figure since 1959/60.

In its central scenario, debt remained above 100% of GDP for the entire forecast, peaking at 109% in 2023/24. In the upside, the ratio would peak at 99% and fall back to 91%. In the downside, it would rise to 123% by 2025/26.

Fiscal rules

The OBR reported on the likelihood of the Government meeting its fiscal rules. The rules aim to restrict spending and taxation policy by setting targets for key indicators such as the deficit and debt.

The existing fiscal rules were set down in legislation in 2017. The 2019 Conservative Party manifesto proposed a new framework and promised a formal review. However, this was put on hold as a result of the pandemic.

The OBR assessed the spending review against both the existing legislative targets and those in the 2019 manifesto, which it described as “materially looser”. Against the legislated rules, the OBR said all the borrowing and debt rules would be missed by “wide margins” in all scenarios. The welfare cap target would also be missed in the central and downside scenarios, but met in the upside scenario.

Against the manifesto targets, the picture was more mixed:

Current budget balance in the third year of the forecast would be met in the upside scenario, but missed in the central and downside scenarios.
Public sector net investment to be no more than 3% of GDP on average would be met in the upside and central scenarios, but missed in the downside scenario (all margins were small).
Debt interest to be no more than 6% of government revenue would be met in all scenarios.

The OBR said that “even on the loosest conventional definition of balancing the books, a fiscal adjustment of £27 billion (1 percent of GDP) would be required to match day-to-day spending to receipts by the end of the five-year forecast period”.

Unemployment

The OBR expects a “significant” rise in unemployment when the furlough scheme is withdrawn in the spring. It suggests that the headline rate will increase to 7.5% in the central case, 5.1% in the upside scenario and 11.0% in the downside scenario.