House of Commons - Budget 2011

Budget 2011 - Treasury Contents

3 The public finances

Changes within the budget

34. The overall fiscal impact of the policy decisions announced in the budget was very small. The net effect of the changes in each of the future five years was less than £0.5bn. To put this into context £0.5bn is less than 0.1% of the Government's total managed expenditure, which is expected to be £710bn in 2011-12. In the coming financial year, 2011-12, there is forecast to be a £10 million increase in spending compared to tax receipts.

Table 1: Summary of Budget policy decisions₁

Source: HM Treasury, Budget 2011, 23 March 2011, Table 1

35. Paul Johnson, the Director of the Institute for Fiscal Studies, told us "Most of what is happening over the next two years is not stuff that was announced in this Budget".[59] Following the Budget, in an IFS briefing, Mr Johnson had been even more clear, describing the Budget as a "fiscal non-event".

The new measures announced will, between them, have almost no impact on public spending, on borrowing or on total tax revenues.[60]

Mr Johnson told us:

In a sense, it was always going to be a bit of a non-event after the two huge events that we had last year—the Budget last June and the spending review in October were colossal. On one level, it would have been very surprising if we had had a very big set of changes in this Budget.[61]

Gillian Guy agreed that Budget had not been a major event. "We should remember that, in reality, the Budget is fiscally neutral, if not a non-event, as has been said."[62]

36. Although the net effect of the policy decisions in the budget was extremely limited there were 57 new Budget policy decisions.[63] The only changes which amounted to more than £1 billion in 2015-16, the end of the 5 year period, are as follows:

Changes which will result in a lower tax take

Further 1% decrease in Corporation tax rate.
Further increase in personal tax free allowance.
Reduction in fuel duty.

Changes which will result in a higher tax take

Switch default indexation for direct personal taxes to CPI.
Increase in supplementary charge on North Sea oil and gas producers.
Introduce carbon price floor.
A combination of ten policies to reduce tax avoidance and evasion.

The most significant of these changes in terms of tax revenue were the changes to fuel duty and to supplementary charges on North Sea oil & gas production. We discuss these changes and others in more detail later in the report.

37. In 2010 major decisions regarding public spending and tax were made in the Chancellor's Budget and Spending Review. It is therefore to be expected that the net fiscal effect of the policy changes announced in the 2011 Budget was minimal: to have done anything else would have contradicted one of the Chancellor of the Exchequer's stated objectives in the Budget.

Fiscal consolidation

38. The Red Book provided up to date information on fiscal consolidation plans over the forecast period to 2015-16. This clearly shows that most of the consolidation is yet to come.[64]

Figure 1: Total consolidation plans over the forecast period

Source: HM Treasury, Budget 2011, 23 March 2011, Table 1.1, p 10

This point was highlighted by Paul Johnson who told us that "At the moment there is a plan, but almost nothing has happened. Tax rises have happened and we have a bit of a spending cut this year, but most of it—nearly all of it—is over the next four years."[65] He pointed out that the spending cuts "have become more substantial because inflation is higher" and highlighted the potential political difficulty in seeing the spending cuts through.

If I were the Government, the thing that I would be most worried about, in terms of delivering what they said they are going to deliver, is how they are going to make those public spending cuts happen, particularly given the degree of political difficulty that's going to be involved in that.[66]

He considered there was a "substantial risk [...] that the spending cuts will prove too difficult to deliver" but noted that this was "clearly outside the OBR's remit to model."[67]

39. We asked the Chancellor about the risks involved and the likelihood that particular groups might feel unfairly treated due to the public spending cuts. He acknowledged that it would be a "challenge":

Obviously that is the great challenge and what I have tried to do is make sure that the burden is spread. I think the distribution tables, which is interesting this year did not get as much attention, show that it is pretty evenly distributed across the income deciles with the richest quintile paying the most.

He went on to explain:

I am certainly seeking to spread the burden fairly. If you look at who in the narrow sense are the losers from the budget, the people who have to pay more tax, if you like, are people who have avoided tax, and there is a big tax avoidance package, polluters, oil companies, and indeed there has been an increase in the bank levy as well. So I have tried to take some decisions that would be broadly seen as fair.[68]

40. We asked Paul Johnson about the distributional impact of the changes in public spending and tax both in the Budget and in previous announcements. He provided a detailed explanation to us:

If you look at the totality of things that have been announced and that are being introduced during this Parliament, from May 2010 onwards, you clearly find that those who are hit hardest are those in the top 10%, and indeed the top 2%, of the income distribution. There's higher-rate tax and all that—it is not terribly surprising—and also the NI changes. If you look further down the distribution, you see a pattern where, proportionally, those towards the bottom are hit somewhat harder than those towards the middle. That's the range of things that have now been announced in Budgets and spending reviews. There has been an additional announcement on the universal credit. We can't model that in quite the same way as we can model everything else, but if you add that in, it does flatten off that distributional effect, because it is aimed at increasing the incomes of people right at the bottom, and it takes a bit away from people towards the middle of the distribution.

41. In this Red Book, as in the last, the Treasury has included a considerable amount of additional analysis of the distributional impact of the Budget measures, in response to our requests. We are grateful for the Chancellor's responsiveness. This has become a regular feature of the Budget documents.

42. We note that the majority of the consolidation has yet to begin. In the coming year, for example, the total consolidation will increase over fourfold to £41bn in 2011-12 from £9.4bn in 2010-11. The consolidation of spending is £5.5bn in 2010-11 and £22bn by 2011-12. One concern expressed to us was that these future spending cuts may prove too difficult to implement. We agree with the Chancellor that it will be important to strive 'to spread the burden fairly' as the consolidation begins in earnest. Being seen to do so is important.

Meeting the fiscal mandate

43. The OBR's Economic and Fiscal outlook publication gives a clear explanation of the fiscal mandate and supplementary target that the Government has set itself.

In the June 2010 Budget, the Government set itself two medium-term fiscal targets for the current parliament: the fiscal mandate and a supplementary target. The OBR assesses whether the Government has a greater than 50 per cent probability of hitting these targets under existing policy.

The Charter for Budget Responsibility defines the fiscal mandate as "a forward looking target to achieve cyclically-adjusted current balance by the end of the rolling, five-year forecast period". For the purposes of the current Outlook, this means that total public sector receipts need to exceed total public sector spending (minus spending on net investment) in 2015-16, after adjusting for the impact on receipts and spending of any remaining spare capacity in the economy.

The Charter says that the supplementary target requires "public sector net debt as a percentage of GDP to be falling at a fixed date of 2015-16, ensuring the public finances are restored to a sustainable path." The target refers to the measure of public sector net debt (PSND) which excludes the temporary effects of financial interventions.[69]

44. We asked Paul Johnson about the fiscal mandate and how it differed from the 'Golden Rule' of the previous government. He told us that both were useful in providing a constraint:

One thing I would add—and this applies both to the golden rule and the fiscal mandate—is that one should not underestimate the power of having some fiscal rule. In a sense, any fiscal rule is not going to be precisely the right one. There is an element of judgment about what the rule is. What is important is that it imposes some level of constraint. Both the golden rule and the fiscal mandate will impose some constraint. There are problems, especially when that constraint is determined by things that happened many years ago.[70]

He also explained what he thought were the strengths and weaknesses of the fiscal mandate:

The advantage of the fiscal mandate relative to the golden rule is that it is explicitly forward-looking, so you can't build up that credit from things that happened in the past—that seems to be a clear advantage. There are two things that you might think about, especially with the way in which it is phrased. The description of how it is phrased is that you are looking for the current budget balance, cyclically adjusted, at the end of the five-year forecast cycle. In principle, that five-year point never arrives because the mandate changes each year. We will have to wait to see how the Government interpret that, which is itself a potential weakness.

A second factor, which is both a strength and a weakness, is that it seems appropriate to look at the structure of the cyclically adjusted balance, but it is never actually observed. Quite a lot of uncertainty and estimation goes into the cyclically adjusted balance as opposed to the actual balance. There is a similar problem with measuring the golden rule when you have to measure things over the cycle. All this depends on a very fine judgment about where the cycle is in the first place and what the structural deficit is in the second. In principle, that is the right thing to do, but in practice that makes it very hard to be sure.[71]

45. The OBR's Economic and Fiscal Outlook considered that "there is a better than 50 per cent chance of the Government achieving cyclically-adjusted current balance in 2015-16 and that it is therefore on course to achieve the fiscal mandate" and that "the Government has a greater than 50 per cent chance of achieving its supplementary target"[72]. However the OBR added that "the Government's margin for error in meeting the targets is slightly lower than in our November forecast"[73].

46. We asked some of our other witnesses about the fiscal mandate and whether or not they felt it would be met. Simon Hayes of Barclays Capital confirmed that their central forecast was that the fiscal mandate would not be met. Explaining in answer to our questions that "on our central view, the current deficit does not go into surplus." He went on to add:

In our pessimistic view, it is way below, and you will be talking about another £45 billion of tightening needed in order to meet the fiscal mandate. They were actually calculated jointly between us and the Institute for Fiscal Studies. This was work that we did as part of the Green Budget, so there are macroeconomic scenarios and then the IFS ran it through the public finance forecasts, so I think they are reasonably good quality projections are, as good as are typically produced.[74]

We pressed Mr Hayes to understand why the Barclays forecast differed from the OBR. He explained:

One is just the overall level of growth. We have a low growth forecast. We do have a lower trend growth assumption in there, and that gets increasingly important the further out you go. The third one is to do with the mix of demand as well. If demand is concentrated in domestic demand, consumption in particular is quite revenue-rich, whereas if your growth is coming from net exports, it is less so. The OBR's forecasts, as I think Roger was mentioning earlier, in terms of domestic consumption in particular, are stronger than we have in there.[75]

Professor Ray Barrell from NIESR added that the "OBR forecast does look rather optimistic in the end." Although he did also say that it was not worth worrying about too much:

We would expect the Government to be borrowing something like £55 billion in 2015-16, about twice as much as the OBR, or not quite twice as much. My comment on that is: it is best not to worry too much about that. The markets will not panic because, if it is slow growth that is producing that, the economy is still on track to reduce the debt stock.[76]

47. We asked Robert Chote about other forecasts which predicted that the fiscal mandate would not be met. He told us that he was "certainly not surprised that there is a wide range of different views on those issues". He went on to explain "that is exactly why we have the scenario analysis for things like the size of the output gap". He added that this scenario analysis was very useful for understanding where the risks lie in meeting the mandate.

All the forecasts, as the Chairman said, are bound to be wrong, but it is also a good way of showing where the errors are most likely to affect the judgement that you make about the eventual chances of meeting the mandate. There, it is the size of spare capacity, for example, more than the interest rates on Government debt. It is partly a reflection of that that we have relatively long maturity of debt, so that is not as important in the longer term, but it enables you to scale, somewhat, what you should be more or less worried about.[77]

48. The scenario and sensitivity analysis done by the OBR in trying to understand the risks surrounding the meeting of the fiscal mandate is welcome addition that will assist in explaining the thinking behind whether or not the fiscal mandate will be met. We welcome the fullness of the OBR Economic and Fiscal Report. It will be the task of the newly created and independent OBR rigorously to examine and explain progress in meeting the fiscal mandate and hence reinforce the fiscal plan's credibility.

Alternative strategies

49. We asked a number of witnesses about whether or not the Chancellor should have an alternative strategy prepared for use if the economic situation diverged significantly from the forecast. Paul Johnson told us:

Given that he had set out a course and given that, in our judgment, not a huge amount has changed—there is not a huge amount of new information—he probably should stay there at the moment. The question then becomes: what point and what new information would lead him to change course?[78]

Mr Johnson later provided more detail on when it might be appropriate to change course.

There are clearly things that could happen in the world that would lead you to want to change what you are going to do, or the time scale over which you are going to do it. There are two things that might happen. One is that growth forecasts go down just a bit, but in a way that means you are not going to meet the fiscal mandate. You may then decide that you want to tighten things further to make sure that you meet the fiscal mandate, or we may go into some kind of double-dip recession that relates to a significant additional problem with the economy.... It is very clear that there will be states in the world that could not possibly do what you are currently saying you are going to do.[79]

Mr Johnson considered it might be appropriate to spell out an alternative plan in advance: asked whether he himself would have a Plan B he told us. "I would have one, I wouldn't say exactly what it was, and I might tell people."[80]

50. Simon Hayes told us "I think that the necessity of a Plan B is pretty obvious to me". However he added that:

Having set out the plan, we are where we are. I think it is a more difficult judgment, because financial markets are concerned when there are shifts relative to where you are. I think they set a relatively high threshold for you changing your plan. From talking to investors, particularly overseas investors, who look at the UK economy and are very concerned about its medium-term prospects and tend to be more downbeat about growth prospects than domestic forecasters are, I would say a lot of this is factored in anyway and there is a broad expectation that, actually, growth may not be as strong as the OBR is forecasting, that the deficit is not going to come down as quickly as the Government is projecting. I think there is some wiggle room there to have some degree of leeway on the plan, at the very least in terms of timing, so you may stick to the plan in terms of your budget, or you smooth it through that you do a bit less this year and you plan to do a bit more next year. I do not think that those sorts of changes will be a problem.[81]

Stuart Green of HSBC told us "I broadly agree with those comments"[82] and later told us:

Just as it was imprecise in terms of knowing how much tightening was required, it is not certain how much slippage would prompt markets. At this stage in the cycle, it is important to stick to the course.[83]

51. Roger Bootle considered that markets would react differently depending on the reason for an increase in borrowing. He felt that "if borrowing [was] coming down less fast than the plan, because the economy has turned out to be weaker" then "the market would be comparatively forgiving". However he also believed that "what the market would be worried about, rightly in my view, is a political sea change, a loss of nerve".[84] Mr Bootle also considered that the reception of any 'Plan B' would depend on how well thought out and justified it was:

There is, therefore, potentially the scope for a well-enacted, well-justified Plan B to be accepted much more readily by the markets than something that seems to be stumbled into as a panic measure, is put together badly and seems to be taken as a rush for the exit.[85]

Jonathan Portes, Director of NIESR, told us that flexibility was important as he considered a "failure to change a plan in the face of changing circumstances is unlikely to increase market confidence". He added that:

My view of the previous confidence crises that I have had some involvement with—the ERM back with Andrew in 1992; Argentina in 2001—is that actually credibility and confidence is undermined by failure to change your plan to adopt your policy to changing circumstances. As Keynes said, "When the facts change, I change my mind. What do you do?"[86]

52. We asked some of the witnesses what alternative strategies and contingency plans could be used. Roger Bootle considered that there was "quite a strong political priority for this Government in sticking to its spending plans". He therefore felt "emergency tax cuts" would be an option. His other suggestions were:

Because there is still a distinction in the Government's thinking and in the numbers between current and capital spending, I would also have what I think is called in the jargon 'spade-ready' investment projects on the books, which could be enacted and put into operation, without therefore harming the objectives for the current budget deficit. Of course, there is, in the background, the possibility of more QE.[87]

Mr Portes felt that:

NIESR has been saying for some time—indeed, before I arrived at NIESR, so we have a clear and shared view on this—that we would have both delayed the fiscal consolidation and shifted the emphasis away from spending cuts to, if necessary, somewhat more in the way of tax rises, so we would both have pushed back from fiscal consolidation and shifted the emphasis somewhere.[88]

Mr Barrell gave further detail on this point in later questioning:

It is relatively clear, according to the IMF at least, that spending-led consolidations are more expensive than income tax-led consolidations; one could easily see a shift of plan to fewer spending cuts and higher income taxes that would both boost growth by, say, 0.25% and give you the same deficit target.[89]

53. Markets need to be confident that the Government is committed to its fiscal policy. A Government which talked of a Plan B as a substitute for that policy would prejudice that confidence. However, as we explored in our evidence, a responsible Chancellor is likely to have contingency plans to deal with a variety of scenarios where economic circumstances are fundamentally changing. Those plans should not be made public unless and until they are needed.

59 Q 96 Back

60 Paul Johnson, Opening remarks, post Budget 2011 briefing, The big news is the old news, 24 March 2011 Back

61 Q 144 Back

62 Q 154 Back

63 HM Treasury, Budget 2011, 23 March 2011, Table 2.1, p 42 Back

64 Ibid., Table 1.1, p 10 Back

65 Q 145 Back

66 Q 145 Back

67 Q 79 Back

68 Q 474 Back

69 Office for Budget Responsibility, Economic and Fiscal Outlook, 23 March 2011, p 154, para 5.4-5.6 Back

70 Q 90 Back