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Due to the rollout of coronavirus vaccines, the pandemic in the UK is greatly improved, compared with last autumn. Most legal restrictions introduced to control the spread of the coronavirus have been lifted. However, there is still uncertainty about the path of the pandemic and the outlook for the economy and public finances.

The Spending Review 2021

The Spending Review will set out the Government’s spending plans for each government department for the next three financial years.

A spending “envelope” has already been set out, showing that overall spending is set to increase during the three years. Over time, the spending may change as plans at Spending Reviews are often revised both upwards and downwards in later years.

Spending envelope

Spending had already started to increase before the Covid-19 pandemic, following several years of mostly flat overall spending in real terms (and some departments having large cuts). We already know that spending in some areas (notably health and social care) will increase over the next few years, which may leave little opportunity for other departments to get spending increases.

Some commentators and media reports suggest that some departments will have further cuts. Several public services are experiencing pressures caused by the pandemic. For instance, schools may require funding to help students catch up on lost learning.

The Spending Review will also be an opportunity for the Government to set out long-term spending plans in specific areas, particularly local government (which has not had a multi-year finance settlement since 2016/17) and for its agenda on “levelling up”. It might also include details on the UK Shared Prosperity Fund, which is intended to replace EU structural funding.

Economic situation

Long term GDP growth

Due to a stronger-than-expected recovery earlier this year, as public health restrictions were lifted, it’s likely the OBR will revise its forecasts for growth in 2021. In March, it forecast GDP growth would be 4%. The average forecast among economists is now closer to 7%.

After the initial rebound, economic growth slowed over the course of summer 2021. The spread of the Delta variant and the large numbers of people having to self-isolate were thought to be behind the initial slowdown.

GDP relative to pre-pandemic level

More recently, disruptions to global supply chains and a shortage of labour in industries, such as Heavy Goods Vehicle drivers, pose risks to the economic outlook. Rising inflation, linked in part to the supply shortages and increasing energy prices, present an additional headwind for the economy heading into 2022.

The Bank of England forecasts annual consumer price inflation to rise above 4% by the end of the year, from its current rate of just above 3%. This is higher than the Bank’s 2% target. Some members of the Bank’s interest-rate setting committee have commented on the risks of persistently above-target inflation. This has led to speculation in financial markets that the Bank may soon raise interest rates from their current historic low of 0.1%.

Even when the immediate economic shock of the pandemic does eventually dissipate, the crisis may result in lasting damage – or ‘scarring’ – to the economy. Currently, the OBR’s estimates that the long-term effect of the pandemic will lead to GDP being 3% lower than it otherwise would have been. The Bank of England assumes a smaller impact of 1%. The OBR may update its estimates in its new set of forecasts released alongside the Budget.

Public finances

2020/21 was a year unprecedented in peacetime for the public finances. The Government spent huge sums addressing the pandemic and supporting households and businesses. Government borrowing – the difference between public spending and income raised from taxes and other sources – reached a peacetime record of £320 billion, equivalent to 14.9% of GDP. Government debt (which is the stock of past borrowing) has increased from around 80% of GDP to close to 96% of GDP, as of September 2021.

Public sector net borrowing, % GDP

Government spending is now falling as the public health emergency of the pandemic becomes less acute. Government revenues are increasing as the economy opens. Government borrowing will, therefore, be lower in 2021/22, but it will still be larger than in nearly all previous years of peacetime.

This year, borrowing is falling faster than the OBR forecasted in March 2021, largely thanks to the economy performing better than expected. It’s plausible that the OBR could lower its underlying forecast for borrowing in 2021/22 from £230 billion to less than £200 billion.

In year borrowing, £ billion

The Chancellor has also announced tax rises which will lower future borrowing. For instance, the main corporation tax rate will increase from April 2023. The thresholds at which people start paying income tax and the higher rate of income tax will be frozen from April 2022 to April 2026.

The level of effort required to get future borrowing close to pre-pandemic levels will largely depend on how much long-term economic damage the pandemic causes. If, in its October 2021 forecast, the OBR becomes more optimistic about the extent of long-term damage, its underlying forecast for future borrowing will come down.

The Chancellor may set out new targets to guide his management of the public finances at the Budget. Based on past comments, it’s likely that he will say that, in the medium term, the Government shouldn’t borrow to pay for day-to-day spending and that the debt-to-GDP ratio should be falling.

Cost of living pressures and who is most affected

Many household budgets are likely to be squeezed in the coming months.

The withdrawal of the £20 a week Universal Credit uplift, increases in personal taxes and the end of furlough scheme, will put pressure on incomes. At the same time, rising prices due to supply chain disruptions and increased energy costs will put pressure on household spending.

Many of the falls in income and increases in costs of living disproportionately affect low income households. Low income households are much more likely to receive Universal Credit, and low paid workers were more likely to be on furlough. Low income households also spend a larger proportion on essentials, so are more affected by price increases in energy, rent and groceries.

Further information

The Library will publish a summary of the Budget on the evening of 27 October. The Library briefing, The Budget and the annual Finance Bill discusses the way that Parliament debates the Budget and scrutinises the resulting Finance Bill. The next steps for Parliament, following the Budget, are summarised in section 6 of this briefing.

Ahead of the Budget, the Library will publish Economic Indicators, our analysis of the latest UK and international economic indicators. The latest data are also available on the Library’s UK economy dashboard.

The latest coronavirus research and analysis from the Commons Library and other parliamentary research services is available on our coronavirus hub.

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