Paul Johnson, Director of the Institute for Fiscal Studies, responds to The King's Fund's 21st quarterly monitoring report, and discusses the outlook for health and social care funding ahead of the Autumn Statement.
This presentation was recorded at our breakfast event on 16 November 2016.
Well thank you. From the sort of ‘specifics’ of the Royal Free, to something which is rather more general about the public finances. Just now as we were talking and Caroline and Richard were talking to each other about how grim things are in the NHS, they looked at me and said, so I hope you’re going to cheer us up, and they’ve obviously not heard me speak before.
Well I’m afraid I’m probably not going to, and when I think about the position of the public finances and I’m going to talk particularly about the Autumn Statement, which happens a week today, at which point I think we will find out a lot more than we do now about where, I think we can think of the new government, is going to go with the public finances. I should start by saying I’ve got less idea of the answer to that question than I’ve had at least since 2010 and probably before. I really don’t know even what sort of broad direction the new chancellor is going to go in.
So let me just say a few words about where we are, about how things have changed over the last nine months or so and about where we might end up going. So looking back to the Budget in March which was only nine months ago, though it feels like a lifetime considering what’s happened in the period. Since then, the then Chancellor, George Osborne, was planning to take us from where we are, which is a deficit of around £70 billion or so, to a surplus on the public finances in 2019/20 and subject to some strange fiddling of the figures which I won’t go into, he is broadly going to achieve that by imposing some reasonably significant additional spending cuts and some smaller tax rises. The spending cuts were not in cash terms, or indeed in real terms, going to be for the NHS, although increased spending from next year on for the NHS is very, very small indeed. It’s certainly very, very, very small relative to the sorts of pressures that you’ve just heard about and the sorts of levels of increase the NHS has had historically. The bad news from what you’ve just heard Richard and Caroline say, is that those spending cuts are really quite substantial still going forward for local government, and of course local government, as the providers of social care of which social care is by far the biggest part of local government budgets, that’s going to continue to have an effect there. So if you look at what local government has done, they have protected social care relative to all of the other things that they do, but because it’s almost half of what they do, they’ve certainly not been able to protect it completely. It’s still being cut by about 10% or so, 5-10% over the last five years. Other local government services by more like 20-30% and the pressures there are going to continue.
So George Osborne had in mind some modest tax increases, essentially not much at all in the way of spending increases on the NHS and some cuts elsewhere and that would’ve got him on, you know, if the economic forecasts have been broadly right, to something like a budget balance by 2019/20. Now last year, about this time last year, the government legislated three fiscal rules. One was to cap welfare spending at a particular level, one was to ensure that debt falls as a fraction of the national income every year and one was to get to that surplus in 2019/20. Well the first two of those are already bust and the third one has been abandoned so that’s a zero out of three within a year of something they actually legislated. I’m not quite sure who goes to prison as a result of that, but that leaves us, and one of the reasons why I’m so uncertain about what the new chancellor will do, that leaves us with no, at the moment, guiding rule as to what they’re trying to achieve, and I think we will find out next Wednesday what the new chancellor is trying to achieve.
So why have they abandoned the target to get to surplus in 2019/20? Well because they’re not going to reach it, and why aren’t they going to reach it? Well essentially because the economic forecast has deteriorated post June 23rd. So what are the new economic forecasts? Well broadly speaking, the Bank of England thinks that the economy will be about 2.5% smaller in 2020 than it would’ve been had we voted the other way on June 23rd. Now there’s obviously a lot of uncertainty about that and I should stress that we’re going into the next few years with huge uncertainty about where the economy is going, but we’ve already seen, as you know, a 15% devaluation in the exchange rate which will make us all worse off, the price level will be about 2.5% higher as a result of that. That makes us worse off. There will be uncertainty in terms of investment decisions that companies make in the short run. So we can assume that the economy will do at least a bit less well than it would’ve done in the absence of that vote.
So what’s the impact of that on the public finances? Well we’ll lose about £25 billion in tax revenue as a result of that. If we’re worse off we pay less tax, that’s the way things work. Our estimate is that if the chancellor does nothing next week, then we’ll be heading for a deficit of £15 to 20 billion, as opposed to a surplus of £10 billion in 2019/20. Now a deficit of that level is actually pretty small by historical standards, the problem is the debt at about 85% of national income will be highest it’s been since the early 1960s. So what’s the chancellor going to decide to do in that context of very serious spending pressures, deficit significantly higher than it was intended, and debt at very high levels, at least by recent historical standards. And that’s where I don’t know the answer.
Now he could decide that because there is a short-term shock to the economy following June 23rd, he’ll follow the Bank of England to ease the monetary policy in August, by easing fiscal policy to support the economy and that could mean some temporary tax cuts or some additional spending on infrastructure or possibly on the NHS and the deficit, which is significantly higher in 2019/20. The problem with that strategy is that even if there is a short-term impact on the economy, there is certainly a long-term impact on the economy if we come out of the Single Market and the Customs Union. So if you loosen fiscal policy now, you’re going to have to doubly retighten it later as growth that you were previously expecting doesn’t turn up. So he could decide to have a short-term fiscal stimulus but that will be postponing the pain as a result of our diminished economic outlook. He could decide to simply do nothing. He could exactly leave all of George Osborne’s plans in place and that will take us to this £15 to £20 billion deficit. He could decide to set some other set of fiscal rules entirely, and actually I think the funding for the Health Service and for all other public services over the next four or five years are going to be very significantly determined by the fiscal framework that the new chancellor decides to put in place, and as I say, I don’t know which direction that’s going to head in.
Just one final word. I mean one of the things which will clearly be at the top of his mind, both in the short run and in the long run, will be things that we’re talking about today. Spending on the Health Service is a very large fraction of public section and a growing fraction has been growing over the last 30/40/50 years and will grow over the next 20 or 30 years as a fraction of the total, both because of the way that demand for health works, and because of demographic change. Tackling that and thinking much more seriously about the long run as well as the short run, and I know we’re not focused on the long run today, is going to be part of the whole debate, or the whole political future of the country as well as of the NHS specifically.