Funding transition to net zero could cost UK less than pandemic, OBR says

Funding the UK’s transition to net zero emissions could cost the government less over 30 years than the pandemic has cost in just two, the Office for Budget Responsibility said on Tuesday.

Getting to net zero by 2050 would add 21 per cent of gross domestic product, or £469bn in today’s terms, to the UK’s public debt, if governments around the world took early action to reduce emissions, the fiscal watchdog said. Most of this would be due to the loss of revenue from fuel duty, with the gains from higher carbon taxes sufficient to cover public spending of about 0.4 per cent of GDP a year on net zero investments.

The OBR described this fiscal cost as “significant” but “not exceptional” — while warning that it could be much higher if governments delayed acting until 2030 and then had to cut emissions sharply. Unchecked climate change could take public debt to 289 per cent of GDP by the end of the century — compared with the post-pandemic peak of 108.6 per cent the OBR currently forecasts for 2023-24.

The growing frequency of extreme weather events is one reason the OBR believes advanced economies, the UK included, are more exposed to “potentially catastrophic risks” than in the past — with sporadic crises carrying lasting consequences for the public finances.

In its annual report on long-term fiscal risks, the OBR said it was too early to assess the permanent damage due to the pandemic, which would ultimately depend on the degree of economic “scarring”.

But it warned that Rishi Sunak, chancellor, could come under immediate pressure in this autumn’s spending review to find an extra £30bn over three years to meet the ongoing costs of the pandemic.

At present, departmental plans made no provision for virus-related spending beyond this financial year, but it could cost £10bn a year to run test and trace and revaccination programmes; clear backlogs in the health system; help children catch up with lost learning and plug a hole in fare revenues if passengers did not return to trains and buses.

The government could manage these pressures by cutting spending on pre-pandemic priorities, the OBR said, or it could increase total spending — and either raise taxes or “put at risk the chancellor’s aim of balancing the current budget and getting debt falling by the middle of the decade”.

Sunak said the report underlined “the importance of returning our public finances to a more sustainable path over the medium term” — confirming the “difficult choices” made at the last Budget.

The rapid increase in the UK’s stock of debt, combined with its shorter average maturity and high share of index-linked bonds, means the public finances have become far more vulnerable to any increase in inflation or interest rates. An increase of 1 percentage point in interest rates would increase the cost of debt service by more than 0.5 per cent of GDP within a year, the OBR said.

“In the 21st century, the government will struggle to either grow or inflate away its debt,” said Richard Hughes, the OBR chair. While previous chancellors had been able to wait for inflation to erode the stock of debt, he added, Sunak would be faced with “a much tougher set of choices that is really about tax and spending if he wants to get debt down”.