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Please see below article received from Jupiter yesterday evening, which analyses whether the measures announced by Rishi Sunak in Budget 2021 will sustain the UK’s economic and financial market recovery in the years ahead.

In every downturn, the UK Government’s finances turn down sharply. Tax receipts fall as job losses, bankruptcies and subdued spending impact the three big sources of revenue for the Treasury – income tax, National Insurance and VAT. But Government spending must rise to cushion the impact of a recession, through unemployment benefits and welfare payments.

There is always a moment at the depths of a downturn when the Government’s budget deficit looks awful and the prospect of a return to more balanced books nigh impossible.

Clearly this pandemic has a rather different dynamic, as the Government measures to support the economy from complete collapse during extended lockdowns, has pushed their spending to levels unprecedented outside wartime. Roughly 75% of the increase in the budget deficit has arisen due to these support measures – about £200bn. Today’s extension of such support until September will only increase the scale of this spending, all funded through borrowing.

Whilst tax receipts have fallen during the pandemic, they have done so only modestly – testimony to the success of the support in limiting the rise in unemployment and bankruptcies thus far. Tax receipts as a percentage of GDP have remained roughly in line with their long run average of 37% of GDP.

Government spending, by contrast, has risen from its more usual level of 40% of GDP to 55% and rising. Hence the Chancellor’s desire to ‘level with the British people’ on the unsustainability of current levels of borrowing and spending by Government and the need to rebuild public finances in the future.

The risk of raising taxes too soon into the post-pandemic recovery is that it saps the strength of the recovery. I believe there is bound to be a surge in consumer spending as individuals and families enjoy their freedom from lockdown to shop, eat out and holiday. But it won’t be until well into 2022 before we know the full scale of the likely bankruptcies to come, the peak levels unemployment will reach – today’s more upbeat forecast notwithstanding – nor the longer-term psychological impact on consumers of the pandemic on spending and saving habits.

Crucially, though, the Chancellor needs to remember the lesson of all his predecessors in the depths of a recession. The cyclicality of Government finances means that as the economy recovers, automatically Government spending will fall and tax receipts will rise. The end to Government support measures and a resumption of consumer spending will boost VAT receipts just as the support cheques cease to be written; in this regard, I believe the transition measures announced today are to be welcomed.

Clearly though, one of the most significant of today’s announcements is the planned increase in Corporation Tax as of April 2023 from the current 19% to 25%. While this does indeed give businesses clarity, it is nevertheless a substantial increase, which will in time impact on companies’ ability to return profits to shareholders, and at variance with widely held expectations that such hikes would begin sooner and would be more gradual in their introduction.

Investors will be considering the impact of this pending rise and will be asking themselves to what extent it can be offset by the generous-sounding 130% “super deduction” on business investment. While this is, in my view, an innovative and progressive policy, taken together with the upcoming rise in Corporation Tax, it is likely to mean that the economic growth benefits resulting from the policy will be somewhat front loaded.

Meanwhile, the decision to maintain income tax, National Insurance and VAT at their current levels should provide some support consumer confidence and household budgets as the country emerges from the pandemic. Nevertheless, the Chancellor’s explicit announcements of upcoming fiscal drag – the result of not adjusting taxation thresholds to take account of future inflation – reflects the reality of the situation of the post-pandemic economy. Although this is undoubtedly a progressive policy, put simply, the higher inflation rises, the more the Treasury is likely to benefit. Over time, should we enter a more inflationary environment, in public finance terms this may well turn out to have been a prudent decision, given the impact of rising inflation on the cost of servicing our national debt.

Turning to the UK equity market, it was no surprise to see rising share prices among those businesses that should be beneficiaries of further support to the domestic economy, such as banks and leisure stocks, alongside housebuilders. The latter may well benefit from the extension of the stamp duty holiday and mortgage guarantee programme, as well as a more benign backdrop through the extension of Government support through the summer’s transition from lockdown and re-opening to the end of measures such as the furlough scheme.

Looking to the longer term, to my mind, the truly prudent but wise Chancellor will not risk the upturn by setting out a plan for increased taxation in the years ahead, but keep his powder dry to see just how radically Treasury finances improve over the coming year, without any action on his part whatsoever. While today’s Budget announcements appear well placed to support the transition to life after the pandemic over the next couple of years, it remains to be seen whether the “front-loading” of business incentives to spend now but be taxed later leads to a slowdown in growth thereafter which might not have been necessary.

We will continue to publish relevant content and news as the vaccine roll-out in the UK continues to expand and the light at the end of the tunnel brightens. Please therefore, check in again with us soon.

Stay safe.

Chloe

04/03/2021