OBR Fiscal Sustainability Report 2013 - Treasury Contents


1  Fiscal Sustainability Report 2013


Introduction

1. The Office for Budget Responsibility (OBR) is required by the Budget Responsibility and National Audit Act 2011 to "prepare [...] an analysis of the sustainability of the public finances" each financial year.[1] To satisfy this statutory obligation the OBR produces an annual Fiscal Sustainability Report (FSR). The report provides long-term projections for the UK's public finances, and assesses whether the path for public sector debt is sustainable. The OBR does this by first looking at the fiscal impact of past government activity, as reflected in the assets and liabilities accumulated on the public sector's balance sheet.[2] It then estimates the fiscal impact of future government activity by making 50-year projections for different categories of revenue, expenditure and financial transactions.[3] Since the OBR's creation in 2010, three FSRs have been published.

2. The 2013 FSR says that the UK's public finances are on an "unsustainable" path.[4] Public Sector Net Debt (PSND) is projected to fall from 85 per cent of GDP in 2017-18 to 66 per cent of GDP in 2032-33. This fall is based on the projection of a period of above trend growth as the output gap closes.[5] PSND is then projected to rise over the subsequent 30 years, reaching 99 per cent of GDP by 2062-63. This increase is largely assumed to be the consequence of increased spending pressures that will accompany an ageing population. As the population ages, the Government is expected to spend a larger share of national income on pensions and health care.[6]

3. On the basis of these central projections, to return to a debt to GDP ratio of 40 per cent in 2062-63 the OBR says that the Government would need to implement "a permanent increase in taxes and/or cut in spending of 1.2 per cent of GDP (£19 billion in today's terms) in 2018-19 or a series of tax increases or spending cuts worth an additional 0.5 per cent of GDP (£7 billion) each decade".[7] This £19 billion spending reduction can be compared with the £40 billion per year consolidation announced in the 2010 Budget.[8]

4. On 14 January 2014 the Committee took evidence on the 2013 FSR from Robert Chote, Chairman of the OBR and Graham Parker and Professor Stephen Nickell, Members of the OBR. While the Committee has regularly heard evidence from the OBR on its twice yearly Economic and Fiscal Outlook publication, this was the first time that the Committee had heard evidence on one of the FSRs.

Intended purpose of the FSR

5. In his advice to the Chancellor on 12 July 2010, Sir Alan Budd, the interim Chairman of the OBR said that:

    the permanent OBR should continue to assess the scale of government liabilities and their fiscal and economic impact, through its own analysis and through commentary on relevant work produced across government and elsewhere, to increase transparency and inform fiscal policy.

    With this in mind we propose that the OBR be required to produce an annual report on the long-term sustainability of the public finances, using on- and off balance sheet information and forecasts. This should also include long-term fiscal projections for the public finances.[9]

At the time this proposal was made the Treasury Committee agreed with this recommendation. The Government accepted the recommendation as noted in paragraph 1 of this report, the subsequent Budget Responsibility and National Audit Act 2011 placed a duty on the OBR to produce an annual assessment of the fiscal sustainability of public finances.

Uncertainty

6. The OBR itself acknowledges the uncertainties inherent in 50 year projections. The 2013 FSR states:

    It is important to emphasise that the long-term outlook for public spending and revenues is subject to huge uncertainties. Even backward-looking balance sheet measures are clouded by difficulties of definition and measurement. The long-term figures presented here should be seen as illustrative broad-brush projections rather than precise forecasts.[10]

7. We asked Mr Chote whether forecasting over a 50 year period was subject to too much uncertainty for the results to be useful for policy makers. While not disputing the uncertainty, he argued that a 50 year projection period was a "fairly typical horizon for reports of this sort produced by other bodies in other countries".[11] When questioned about whether a 25 year horizon would be more useful, Mr Chote said that "if you are making decisions on pension ages then that is often taking place over a horizon longer than that [25 years], and it is probably worth looking at it over that horizon [50 years]."[12]

SENSITIVITY OF FSR ASSUMPTIONS

8. To illustrate the uncertainty of the OBR's long-term projections the FSR produces a number of sensitivity analyses. They show how the central projections would change if key assumptions such as demographic trends, whole economy and health sector productivity growth and interest rates were varied. For example, in the Report's central projections, productivity in the health sector is assumed to grow in line with the rest of the economy at 2.2 per cent.

9. The OBR's sensitivity analysis shows that if health sector productivity growth was 1 per cent as opposed to the central assumption of 2.2 per cent, which is plausible owing to the labour intensity of much healthcare provision, the Government would have to increase health spending by a further 1.9 per cent of GDP by 2062-63 to raise the output of the health sector in line with productivity in the rest of the economy. This would have a substantial effect on the public finances. The report's central projection shows PSND rising to 99 per cent of GDP in 2062-63, but varying the health sector productivity assumption in that way "would see PSND rise substantially faster, reaching 211 per cent of GDP by 2062-63".[13] The lower productivity path referred to above might be a result of political choices on public sector pay or health service structures, but might also be for reasons outside the control of government.

Usefulness of the FSR

10. We asked Mr Chote about his views of the usefulness of the FSR for the development of long-term fiscal policy. He replied that:

    In part, I think it is helpful to see how particular individual policy change—you may be uncertain about what the central projection is, but does a particular policy change move you in a more or less favourable direction from that central expectation in terms of a policy decision? If you are making a change in terms of pension policy or student financial support, is that likely to push you in a more or less favourable direction? I think it can also be useful in terms of setting medium-term fiscal plans into a broader context. You might take a different view of a medium-term fiscal consolidation programme if you thought that, in the longer term, you were likely to have to continue to go in the same direction for other reasons not related to filling a particular hole in the public finances or that things were going back in another direction.[14]

Mr Chote assumed that policy makers paid attention to the FSR's key messages:

    As always, policy makers know that we will be producing this report and that we will be looking at the potential impact that these things have, so I am sure that when they are considering policy as regards pension age, for example, they would take that into account.[15]

11. The OBR provided the Chancellor of the Exchequer with a draft set of FSR projections and conclusions prior to publication.[16] The OBR explained that this gave the Chancellor an "opportunity to decide whether he wished to make further policy decisions that we would be able to incorporate in the final version."[17] The Chancellor did not provide any additional policy decisions for FSR 2013.[18] This was also the case for the previous two reports.

12. Under the Budget Responsibility and National Audit Act 2011 the OBR "has complete discretion in the performance of its duty" of analysing the sustainability of public finances.[19] To assess the fiscal impact of past government activity, the OBR looks at assets and liabilities accumulated on the public sector's balance sheet. The OBR draws on two different measures of the public sector balance sheet: the National Accounts balance sheet and the 2011-12 Whole of Government Accounts (WGA). This gives the OBR the opportunity to highlight any important differences between the two measures. For example, unlike in the WGA, the National Accounts classify most PFI liabilities as off-balance sheet resulting in a lower PSND figure. The OBR has quantified the impact of excluding PFI liabilities:

    the total capital liabilities in WGA arising from Private Finance Initiative contracts were £36 billion, up from £32 billion a year earlier. Only £5 billion of these were on the public sector balance sheet in the National Accounts and therefore included in PSND [...]. If all investment undertaken through PFI had been undertaken through conventional debt finance, PSND would be around 2.1 per cent of GDP higher than currently measured.[20]

This assessment is a valuable component of the FSR as it provides voters with a clearer indication of the UK's debt position and how this is affected by using off-balance sheet financing such as PFI.

Frequency of the FSR

13. We asked Mr Chote whether the FSR needed to be produced annually rather than, for example, once every Parliament. Mr Chote did not insist on the need for an annual FSR, and expressed a preference for a two year frequency. This was because the OBR "only get new population projections every two years".[21] These population projections were provided by the ONS and were used extensively by the OBR to produce the FSR figures.[22] He went on to add:

    I would have thought that the two-year frequency of the population projections would be probably the one I would jump on. To do it less frequently than that, you would have policy changes during the course of the Parliament that I think you and other people would probably have questions about what impact that has for sustainability that you probably want answered more frequently than once every five years.[23]

The ONS population projections are, however, just one of a number of components that are used by the OBR to produce the central projections. Other important data sources include the ONS's labour market statistics and public service productivity estimates, WGA financial accounting data and HMRC's statistics on the distribution of taxpayers by type of employment and age group.[24]

Cost

14. We questioned Mr Chote on the size of the OBR's annual budget and the proportion spent on producing the FSR. He explained that the OBR's budget was £1.7 million, and in subsequent written evidence said that the total cost of producing the latest FSR was £199,000, 11 per cent of the OBR's budget.[25] This figure consisted of £193,000 for staff costs and related overheads and £5,000 for production costs such as printing. The average cost of producing each of the three FSRs has been £228,000. [26]

15. The OBR's written evidence said that "moving to a less-than-annual frequency would save the direct production costs, but there would be little scope for savings beyond that."[27] This implies that the only savings from not publishing it would be the marginal cost of production — on average £4,000 for each of the three FSRs.[28] However, the OBR's written evidence added that:

    We have one member of staff whose core focus is the production of the FSR, and another for whom it is a substantial part of their remit. We estimate the cost of the time that these two in particular spend on the FSR is in the region of £60,000 a year, but they also carry expertise in other areas that we draw on particularly during our period of peak workload in the forecast rounds running up to the Budgets and Autumn Statements.

The marginal cost of publishing the FSR is therefore at least the production costs plus these staff costs, since labour costs are variable, not fixed. There is therefore more scope for savings from not producing the FSR than the OBR concedes.


1   Budget Responsibility and National Audit Act 2011, section 4 (4) Back

2   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, para 2 Back

3   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, para 2 Back

4   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, para 3.76 Back

5   The output gap is the difference between the actual output of an economy and the output it could achieve when it is most efficient, or at full capacity.  Back

6   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, para 39 Back

7   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, para 5.16 Back

8   HM Treasury, Budget 2010, June 2010, p 2 Back

9   Interim OBR Letter to the Chancellor, paras 34 Back

10   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, p 1 Back

11   Q10 Back

12   Q11 Back

13   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, para 43 Back

14   Q18 Back

15   Q21 Back

16   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, p 1 Back

17   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, p 1 Back

18   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, p 1 Back

19   Budget Responsibility and National Audit Act 2011, section 5(1) Back

20   The Office for Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, para 14 Back

21   Q2 Back

22   The Office of Budget Responsibility, Fiscal Sustainability Report 2013, July 2013, para 3.7 Back

23   Q4 Back

24   The Office of Budget Responsibility, Fiscal sustainability report - data sources, July 2013 Back

25   Q5 Back

26   Letter from OBR dated 23 January 2014 Back

27   Letter from OBR dated 23 January 2014 Back

28   Letter from OBR dated 23 January 2014 Back


 
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Prepared 13 March 2014