Coronavirus (COVID-19): UK fiscal path – a new approach

The case for further fiscal stimulus

Phasing the withdrawal of the existing emergency support package will be crucial to minimise unemployment and protect and support firms whilst the economy transitions and markets and business places change to the new norms which are emerging. Scottish Government analysis shows that the Job Retention Scheme, alongside the other measures taken, is playing a key role in mitigating the impact of the shock on unemployment. While the unemployment rate could still reach 10% in Scotland over the course of this year, the rate could have peaked at 14% in the absence of the scheme. Our modelling also suggests that the UK Government's fiscal policy response to date could have prevented Scottish GDP falling by a further 7.5% in Q2. This highlights the importance of not unwinding the current support schemes too quickly.

Our proposal: Choose to use public money to protect jobs and livelihoods and continue sector-specific employment and business support into 2021

As we move into a new phase of the pandemic, it will be important to ensure that support packages remain available to those who are unable to work, either because they are shielding or because they are self‑isolating as a result of the test and protect approach. It may also prove impossible for certain sectors to resume economic activity in a way that is economically viable before the current employment support schemes are due to expire in October 2020. Sectors that may require further emergency support beyond October include, but may not be limited to, tourism and hospitality, arts and culture, oil and gas, childcare, and retail. These industries may also need support to help meet the increasing costs that will fall on employers from August onwards from the Job Retention Scheme.

Other countries have already signalled a more gradual removal of their comparable schemes. For example, France has already committed to extending its employment support scheme for up to two years for those unable to return to full-time employment, Germany has confirmed that its scheme will continue into 2021, and Spain and Italy are also considering sector-specific extensions.

The Job Retention Schemes represents one of the most costly elements of the emergency support package. The OBR estimates that the scheme costs around £9 billion per month (after tax) in its current form, with the UK Government paying 80% of the wages of furloughed workers until August and 60% by October. However, the costs of the scheme are likely to fall as more sectors of the economy are opening up and demand returns. Limiting the support to those sectors most in need would also reduce the costs substantially.

Overall, it will still be more cost-effective in the longer term to protect jobs and livelihoods through support schemes than through paying out for unemployment benefits. If the Job Retention Scheme is not extended until economic activity can safely resume, these jobs have not been saved but the British taxpayer has simply paid the wages of furloughed staff.

However, support should be targeted at those companies for whom the scheme secured their viability. Other means of support, such as grants or government backed loans and guarantees, should be considered where this is not the case but businesses remain financially viable in the longer term. Finally, there will be some business models which may no longer be viable due to changes in consumer behaviour and spending patterns. Rather than providing further employment support to these businesses, appropriate support should be provided to help individuals retrain and adapt their skills to find new employment.

Further stimulus to aid the economic recovery

In addition to phasing out the immediate emergency assistance, which helped households and firms through the economic lockdown by providing liquidity assistance, another set of measures will be required to encourage growth in demand as well as improving the supply of skills and infrastructure, with a view to grow the economy's productive capacity in the longer term.

Internationally, the focus of the fiscal response is also beginning to shift from emergency assistance to fiscal stimulus to kick-start the economy, with the European Commission announcing a €750 billion package to support the recovery over the next three years, around 1.8% of GDP. This will be on top of individual countries' stimulus packages, with Germany announcing a €130 billion support package, around 4% of GDP. This includes a VAT cut, direct funding to families, and a €50 billion climate change and innovation fund.

Such a stimulus package will require a fundamentally different approach from the support offered so far in the crisis which was focused on providing liquidity to businesses and households. A successful discretionary fiscal stimulus should be timely, targeted, temporary and transformative. IMF research also finds that tax cuts appear to be more successful in stimulating growth than spending increases.^[1] Timing will also be critical, as the fiscal stimulus would need to coincide with easing of lockdown restrictions to be effective. An ill-timed fiscal stimulus would risk having less of a positive economic impact if consumers cannot make use of tax incentives as shops remain closed or decide to save any increase in disposable income out of concerns about future job losses. This underlines the importance of avoiding a second spike in the virus as that would significantly undermine the impact of such stimulus measures.

Our proposal: Introduce a fiscal stimulus package worth 4% of UK GDP to kick-start the economy, reduce inequality and build an economy which has the broader wellbeing of the population at its heart

• Cut the standard rate of VAT to 15% for six months once current restrictions are lifted across the UK. Reduce VAT for the hospitality sector to 5%.
• Accelerate major investment in low‑carbon and digital infrastructure.
• Introduce a jobs guarantee scheme for young people increasing training.
• Create jobs through a significant reduction in firms' labour costs by cutting employers' National Insurance Contributions and removing the costs of the apprenticeship levy.

We have set out our ambition to deliver a fairer, net zero economy for Scotland in our Programme for Government, supported by our National Infrastructure Mission. The UK fiscal stimulus package needs to ensure that the environmental benefits that we have seen during the crisis are sustained as we renew and rebuild our economy to address the climate challenge.

As the UK Government decision to leave the EU means that the UK will be unable to benefit from the collective European response to the crisis, it is important that the UK makes up for this in its own policy response. We propose the UK Government follow the example set by Germany and adopt a further fiscal stimulus package of 4% of GDP, or around £80 billion. The need for urgent fiscal stimulus means that the short term stimulus will come primarily through the tax system and grants to businesses and households, which is the fastest way for government to provide fiscal stimulus, although consideration should also be given to short term green capital investment. From 2021-22, the balance of the stimulus will need to shift to focus on delivering the transition to a net zero economy with lower inequality and improved wellbeing.

A stimulus package of 4% of GDP would be able to afford to deliver:

• Support for consumers and businesses through tax cuts:
  • Cut the standard rate of VAT to 15% for six months once current restrictions are lifted across the UK. Reduce VAT for the hospitality sector to 5%. This would be one of the quickest ways to provide an additional spending boost to support the sectors of retail, hospitality, leisure and tourism that have been most impacted by the lockdown.
  • A cut in employers' National Insurance Contributions by 2p to reduce the cost of hiring staff and support the labour market recovery.
• Immediate additional public spending:
  • Financial support to low and middle income households through a one-off cash grant to stimulate consumption. For example, Germany's stimulus package offers a one-off €300 cash grant per child to each family, at a cost of around £3.8 billion. For better-off families, this is recouped through the tax system.
  • Increase government spending to support the economy whilst demand remains weak, particularly as consumers cannot be asked to immediately return to previous spending patterns.
  • Financial support to the key workers in all sectors who have contributed so much already in the fight against the pandemic.
• A public sector investment programme:
  • Investing in a Green New Deal for the UK, and ensure that as we rebuild the economy we also accelerate the transition to a net-zero world whilst lowering inequality and improving wellbeing.
  • Delivering the priorities of the Committee on Climate Change,^[2] creating low-carbon buildings and improving energy efficiency, and investing in the digital infrastructure we require to improve connectivity and reduce inequalities.
• Support for jobs:
  • An extension of the furlough scheme, or some other form of wage subsidy, for the hardest hit sectors.
  • A jobs guarantee for young people. It is already clear that the pandemic has a disproportionate impact on young people, who tend to work in sectors hardest hit by coronavirus, while graduates will find it harder to find a job in a recession.
  • Payments to employers that take on apprentices or young workers;
  • Abolish the apprenticeship levy and replace with direct funding. The levy costs businesses £3 billion annually, but in its current form is not fit for purpose and discourages companies to take on more apprentices.
• Additional funding for the Devolved Administrations:
  • The stimulus package must include additional Barnett consequentials for Scotland and the other Devolved Administrations to help us tailor our fiscal response to our individual circumstances.