House of Commons - Autumn Statement 2013

Autumn Statement 2013 - Treasury Contents

3 The public finances

The fiscal targets

19. The Government's fiscal mandate requires it to have as its objective a balanced cyclically-adjusted current budget by end of the rolling, five-year forecast period. Supplementing this mandate is a target for public sector net debt (PSND) as a percentage of GDP to be falling in 2015/16. Both of these targets are laid down in the Charter for Budget Responsibility, which "sets out the Government's commitment to managing fiscal policy in accordance with clear objectives and targets".[51] In the Economic and Fiscal Outlook (EFO) report accompanying each Budget and Autumn Statement, the OBR forecasts the likelihood of the Government's meeting these targets.

PERFORMANCE AGAINST THE FISCAL MANDATE

20. The cyclically-adjusted current budget (CACB) is defined by the OBR as "the amount the Government borrows to finance non-investment spending, adjusted for the state of the economy".[52] The Government's borrowing requirements for non-investment spending would generally be expected to be higher during periods in the economic cycle when the economy was operating below potential. Similarly, these borrowing requirements would be expected to be lower when the economy was operating above potential. The CACB is sometimes known as the 'structural current deficit', since it attempts to strip out the effect of the economic cycle to provide an estimate of the underlying or 'structural' level of borrowing.

21. At the time of Autumn Statement 2013, the OBR forecast that there was a "roughly 80 per cent chance" of the Government balancing the CACB and meeting its fiscal mandate in 2018/19, the final year of the five-year forecast period.[53] This marked an improvement in the Government's performance against the mandate since Budget 2013, when the OBR's judgement had projected a "roughly 70 per cent chance of achieving the fiscal mandate".[54] Table 2 highlights the changes over time in the OBR's forecast of the CACB.
Table 2: OBR projections of surplus on the CACB as a percentage of GDP

OBR Report date Forecast year

2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19

Jun-10 -4.8 -3.2 -1.9 -0.7 0.3 0.8

Nov-10 -4.7 -3.3 -1.8 -0.5 0.5 0.9

Mar-11 -4.6 -3.2 -2.0 -0.6 0.4 0.8

Nov-11 -4.5 -4.6 -3.9 -2.7 -1.6 -0.6 0.5

Mar-12 -4.4 -4.6 -4.2 -2.7 -1.5 -0.7 0.5

Dec-12 -4.3 -3.6 -2.2 -1.4 -0.8 0.4 0.9

Mar-13 -4.2 -4.0 -2.8 -1.7 -1.2 0.1 0.8

Dec-13 -3.6 -2.9 -2.0 -1.4 -0.2 0.7 1.6

Shaded cells = figures not provided. Bold figures are outturns; otherwise figures are forecasts.

Source: Office for Budget Responsibility, Economic and Fiscal Outlook report, June 2010; Office for Budget Responsibility, Economic and Fiscal Outlook report, November 2010; Office for Budget Responsibility, Economic and Fiscal Outlook report, March 2011; Office for Budget Responsibility, Economic and Fiscal Outlook report, November 2011; Office for Budget Responsibility, Economic and Fiscal Outlook report, March 2012; Office for Budget Responsibility, Economic and Fiscal Outlook report, December 2012; Office for Budget Responsibility, Economic and Fiscal Outlook report, March 2013; and Office for Budget Responsibility, Economic and Fiscal Outlook report, December 2013

22. The March 2013 forecast took 2017/18 as the target year, however, since at the time of the Budget this was the final year in the forecast horizon. Examining the projected surplus on the CACB for each individual year of the forecast period, the OBR projected no improvement relative to its Budget 2013 forecast. In contrast, projections for the surplus on the current budget without cyclical adjustment increased in each year of the December forecast relative to March, as shown in Table 3.Table 3: OBR projections of surplus on the current budget as a percentage of GDP

OBR Report date Forecast year

2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19

Mar-13 -6.0 -6.0 -5.2 -4.3 -3.5 -1.9 -0.9

Dec-13 -5.5 -4.5 -3.3 -2.5 -1.1 0.2 1.4

Shaded cells = figures not provided. Bold figures are outturns; otherwise figures are forecasts.

Source: Office for Budget Responsibility, Economic and Fiscal Outlook report, March 2013; and Office for Budget Responsibility, Economic and Fiscal Outlook report, December 2013

23. The fact that the projected surplus on the current budget increased while the balance on the CACB showed no improvement mirrored the OBR's judgement that "the upward revision to our economic growth forecast since March is cyclical rather than structural".[55] Robert Chote told us:

So in the OBR's view, the recent UK economic recovery has been beneficial to the current public finances, having boosted income from taxation and lowered the Government's borrowing requirements. But the recovery has come from economic activity beginning to make its way back to potential—a narrowing of the output gap—rather than any increase in the potential output of the economy.

24. As we noted in our report on Budget 2013, the measurement of the output gap is subject to considerable uncertainty. We concluded:

Charles Bean, Deputy Governor of the Bank of England (Monetary Policy) also told us that when determining how to "to describe the policy guidance", the output gap was treated with caution by the MPC as "we have no idea how big that is".[58]

25. The Committee has previously emphasised the considerable uncertainty in the measurement of the output gap and therefore the limit to its usefulness. The OBR's projection of the cyclically-adjusted current budget, which relies upon a forecast of the output gap, is therefore also highly uncertain. Despite these uncertainties, it nevertheless appears that a significant structural deficit has been the inheritance of the last decade, emphasising the need for further fiscal adjustment. Closing the structural deficit will require an improvement in economic performance.

PERFORMANCE AGAINST SUPPLEMENTARY DEBT TARGET

26. The OBR noted in its December 2013 EFO that the Government was "still on course to miss its supplementary target" for PSND to be falling as a percentage of GDP in 2015/16.[59] The OBR forecast that PSND would rise by 1.7 percent of GDP in 2015/16, and fall by a "statistically and fiscally insignificant margin" in 2016/17.[60]

27. The Government has been forecast to miss its supplementary target since the OBR's forecasts at the time of the 2012 Autumn Statement, owing to what it described as "cyclical" drag on the UK economy.[61] At that point, the Government said:

While choosing not to undertake additional consolidation in order to meet the target, however, the Government did not go as far as scrapping it:

28. In response, the Treasury Committee, in its report on Autumn Statement 2012, noted that the credibility of the target could be in doubt:

The possible failure to meet the supplementary target raises the question of the continuing credibility of that target. Successive governments have committed themselves to, but then failed to meet, their fiscal targets. For a fiscal target to be credible, it must be durable, and therefore not subject to frequent revision as circumstances change. It must also be capable of accommodating conditions different from those at the time the target was first formulated.

The Committee felt, however, that the target could retain its value, despite the projection that it would be missed:

29. In its subsequent report on Budget 2013, the Treasury Committee expressed agreement with the Government's decision to publish a new fiscal framework "only when the public finances are returning to a more stable position".[65] However, as the Treasury Committee noted in its report on Autumn Statement 2012, the timetable for the review of the target— to take place "once the exceptional rise in debt has been addressed"— was "vague".[66]

A NEW CHARTER FOR BUDGET RESPONSIBILITY

30. In Autumn Statement 2013, the Government announced a review of the Charter for Budget Responsibility, scheduled to take place in 2014. This review, the Government noted, would examine changes to the fiscal framework:

The Government will now begin a review of the current framework, reporting next year.

The review will consider several questions, including:

· What is the appropriate time horizon for the fiscal mandate once the structural current deficit is closer to balance?

The updated Charter would also be used to provide the Parliamentary framework for the Government's welfare reduction plans:

The government will establish [the] framework for the welfare cap as part of the Charter for Budget Responsibility [...]. The Charter will specify:

· the requirement for a cap

· the expectation on the government to bring forward a vote in the House of Commons when setting the level of the cap, if it wants to change the level of the cap, and if it breaches the cap

31. As set out in the Budget Responsibility and National Audit Act 2011, any modified Charter for Budget Responsibility would need to be approved by a resolution of the House of Commons before coming into effect.[69] In his Autumn Statement to the House on 5 December 2013, the Chancellor confirmed that the Government would ask Parliament to support the new Charter, which would be laid before it alongside the Autumn Statement 2014.[70]

32. The Treasury Committee has in the past recommended that any amendments to the fiscal framework also be subject to full public consultation. In its report on Autumn Statement 2012, the Committee said:

And in its report on Budget 2013, the Committee reiterated:

33. It is not yet clear what the outcome of the Government's review of the Charter for Budget Responsibility will be. It is reasonable to suppose that it may contain amendments to the fiscal mandate. This Committee has previously recommended that any new fiscal framework should be subject to full public consultation. The requirement for the updated Charter for Budget Responsibility, including any amended fiscal framework, to be approved by the House of Commons, falls some way short of this proposal. The Government should consult on any proposed changes to the fiscal framework as part of its review of the Charter for Budget Responsibility. Effective public consultation will improve the prospects of creating a framework for fiscal policy that will be more stable and resilient than those used in the past.

The future path of public spending

RING-FENCING

34. In Autumn Statement 2013, the Government confirmed that it would continue its policy of 'ring-fencing' certain departmental budgets. Expenditure on Health, schools and Official Development Assistance (ODA) would "be protected in line with the policy set out at Spending Round 2013". Other resource departmental expenditure limits (RDEL) would share additional cuts of £1.1bn in 2014/15 and £1bn in 2015/16.[73] Local government spending, HMRC and the Single Intelligence Account were also exempted from these new spending reductions, although the Chancellor told the Treasury Committee that:

35. Paul Johnson, Director of the Institute for Fiscal Studies (IFS) pointed out in addition the ring-fencing of pension benefits:

The Government outlined explicitly the protection of pensions following the Committee's evidence sessions, confirming its commitment to increase the size of the state pension by at least 2.5 percent per year in the next Parliament.[76]

36. The Treasury Committee has expressed its concern about ring-fencing. For example, in its report on Budget 2013, we said:

37. One of the consequences of ring-fencing is sharply to alter the overall composition of public spending. Paul Johnson told us:

Table 4: Changing composition of DEL

	Share of DEL (per cent)
Financial year	NHS	Schools	ODA	Other DEL
2010-11	26.4	9.8	2.2	61.6
2011-12	27.9	10.4	2.3	59.4
2012-13	29.2	10.9	2.4	57.5
2013-14	29.7	10.8	3.0	56.5
2014-15	30.3	11.0	3.1	55.6
2015-16	31.0	11.2	3.3	54.5
2016-17	32.0	11.6	3.5	52.9
2017-18	33.6	12.2	3.8	50.4
2018-19	34.6	12.5	4.0	48.9

Note: The DEL total is consistent with that used in the 2014 IFS Green Budget, and has been adjusted for various transfers between DEL and AME to derive a consistent series over time.

Source: IFS written evidence, PESA 2013, Autumn Statement 2013, Spending Review 2013, DfID statistics on Overseas Development Assistance spending.

The IFS noted in their written evidence that:

The IFS provided further evidence, see Table 4, showing the effect on the non-ring-fenced DELs if the current ring-fences were maintained, and the Government's planned levels of total public spending and current policy on Annually Managed Expenditure was followed.[80] The IFS told us however that "The Chancellor has mooted the possibility of an additional £12 billion of cuts to social security spending, which could be used to ease the cuts to DEL." Table 5 shows the effect on the unprotected DELs if the £12 billion reduction in social security spending were used to reduce the cuts to DELs, while maintaining the ring-fence.Table 5: Changing composition of DEL, assuming cuts to spending on unprotected areas in 2018-19 reduced by £12 billion

Financial year Share of DEL (per cent)

NHS Schools ODA Other DEL

2010-11 26.4 9.8 2.2 61.6

2018-19 33.3 12.1 3.8 50.8

Note: The DEL total assumes £12 billion is cut from social security spending by 2018-19 and allocated to unprotected departments.

Source: IFS written evidence, PESA 2013, Autumn Statement 2013, Spending Review 2013, DfID statistics on Overseas Development Assistance spending .

38. In 2012, the British Social Attitudes survey asked people what would be their "highest priority for extra [government] spending" against a list of possible options: 41.9% said health, 30.0% education and 0.5% overseas aid. When asked for their next preference, 31.5% said education, 29.4% health and 0.5% overseas aid.[81] The Chancellor explained that the Government's aim in ring-fencing certain departmental budgets was to reflect the public preference:

39. This assessment was echoed in part by Paul Johnson, who told the Committee:

Mr Johnson also noted, however, that there was inadequate public discussion about the trade-offs involved in choosing where to focus public spending:

WELFARE

40. The Autumn Statement 2013 confirmed that, in line with previous policy for fiscal consolidation, the Government's Total Managed Expenditure (TME) would continue to fall in 2016/17 and 2017/18 at the same real rate as over the current Parliament, bringing its level to 38.4 per cent of UK GDP by 2018/19.[85] TME includes both expenditure on public services and administration, and Annually Managed Expenditure (AME), which largely comprises social security and debt interest.

41. In its December 2013 EFO, the OBR forecast that, on the basis of current policy, "over the nine years from 2009/10 [...] government consumption of goods and services— a rough proxy for day-to-day spending on public services and administration— [will have fallen] to its smallest share of national income at least since 1948".[86] The Chancellor told us, however, that this projection relied on an "erroneous judgement about what the political system would do":

42. While he did not place specific numbers on the Government's plans, the Chancellor confirmed that "many billions of pounds of welfare savings are going to be required", and that:[88]

43. The IFS estimated that avoiding an acceleration in public service spending cuts would "require cuts in welfare (or other AME) spending of a further £12 billion a year by 2018-19".[90] Describing the effect of such reductions in welfare spending, Paul Johnson said:

44. Following the Committee's evidence sessions, in a speech on 6 January 2014, the Chancellor appeared to confirm the IFS figures, noting that "on the Treasury's current forecasts, £12 billion of further welfare cuts are needed in the first two years of next Parliament [...] to reduce the deficit without even faster cuts to government departments, or big tax rises on people".[92]

CONCLUSIONS

45. Ring-fencing, by definition, requires that the balance of public expenditure restraint and cuts be borne in the rest of public expenditure. Each successive year of public expenditure restraint results in an increase in ring-fenced spending as a proportion of the total. The smaller non-ring-fenced areas in turn have to bear a higher proportion of any savings in subsequent years. The IFS has shown that non-ring-fenced expenditure may fall from 61.6 per cent in 2010-11 to around 50 per cent in 2018-19 of total Departmental Expenditure Limits. Ring fencing also reduces the discipline on spending in these areas: the rigour of negotiations between the department and the Treasury on allocations will be weakened, since it is known in advance by both sides that this spending is protected.

46. The Chancellor says that the ring-fencing of health, schools and overseas aid budgets reflects public preferences. Protection of health and education spending, but not overseas aid, appears to reflect public preferences.

47. The Government should do what it can to ensure sufficiently informed public debate on the trade-offs inherent in ring-fencing and the allocation of spending cuts. Such a debate is especially important in a period of transformative spending reductions.

51 HM Treasury, Charter for Budget Responsibility, April 2011, pp 5,7 Back

52 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm 8748, December 2013, p7, para 1.11 Back

53 Office for Budget Responsibility, December 2013 Economic and Fiscal Outlook Briefing, p9 Back

54 Office for Budget Responsibility, March 2013 Economic and Fiscal Outlook Briefing, p9 Back

55 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm 8748, December 2013, p6, para 1.6 Back

56 Q63 Back

57 Treasury Committee, Ninth Report of Session 2012-13, Budget 2013, HC 1063, para 54 Back

58 Oral evidence to the Treasury Committee, Bank of England November 2013 Inflation Report, HC 825, Tuesday 26 November 2013, Q44 Back

59 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm 8748, p165, para 5.11 Back

60 Office for Budget Responsibility, Economic and Fiscal Outlook, Cm 8748, p165, para 5.11 Back

61 HM Treasury, Autumn Statement 2012, Cm 8480, December 2012, p30, para 1.64 Back

62 HM Treasury, Autumn Statement 2012, Cm 8480, December 2012, p30, para 1.65 Back