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 yearthe
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
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 itnearly all of itis
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 thatit
is not terribly surprisingand 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 addand this applies both
to the golden rule and the fiscal mandateis 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 pastthat
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 changedthere is
not a huge amount of new informationhe 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 withthe ERM back with Andrew
in 1992; Argentina in 2001is 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 timeindeed,
before I arrived at NIESR, so we have a clear and shared view
on thisthat 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
71
Q 91 Back
72
Office for Budget Responsibility, Economic and Fiscal Outlook,
23 March 2011, p 155, para 5.9-5.10 Back
73
Ibid., para 5.11 Back
74
Q 70 Back
75
Q 71 Back
76
Q 72 Back
77
Q 328 Back
78
Q 89 Back
79
Q 100 Back
80
Q 132 Back
81
Q 29 Back
82
Q 30 Back
83
Q 32 Back
84
Q 33 Back
85
Q 55 Back
86
Q 57 Back
87
Q 37 Back
88
Q 35 Back
89
Q 57 Back
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