4.In its November 2015 Economic and Fiscal Outlook, published alongside the Spending Review and Autumn Statement, the Office for Budget Responsibility (OBR) made changes to its forecast that revised down public sector net borrowing, thereby improving the outlook for the public finances.
Table 1: Changes to the underlying forecast for public sector net borrowing since July 2015 (excluding the effect of Government policy decisions in the Spending Review and Autumn Statement; £ billion)
Change in receipts
Change in public spending
Source: Office for Budget Responsibility, Economic and Fiscal Outlook—November 2015, presentation slides
The improvements arise predominantly from changes to its forecasts for future interest rates and monetary policy, and corrections and changes to the modelling of certain tax receipts.
5.Compared with the OBR’s July forecasts, debt interest spending is expected to be £6 billion lower by 2020–21. This is partly because the OBR lowered its forecast for interest rates, and partly because it has altered its assumption about the level that the Bank of England base rate would reach before the Bank began to reverse its quantitative easing programme. The OBR had previously assumed that assets (primarily government bonds) purchased by the Bank under the quantitative easing programme would start to be sold once the base rate reached 0.75 per cent (i.e. after the smallest possible rise from its current level of 0.5 per cent). In their latest forecast, the OBR assume that assets will not be sold until the base rate reaches two per cent, thereby pushing back the point at which the first sales take place beyond their five-year forecast horizon. Robert Chote, Chairman of the OBR, explained why this change improved the outlook for the public finances:
when the Government are undertaking QE, they are effectively financing some of their borrowing at bank rate, rather than at gilt rate. Gilt rate is low and has fallen, obviously. It has fallen again in this forecast, but Bank rate is lower. If you are essentially saying that you are not going to reverse QE, or the implication is that you do not start to reverse QE until later, you continue to be able to finance for longer more of the debt at the lower Bank rate, rather than at the higher gilt rate.
6.Mr Chote said that the assumption had been changed in response to guidance published by the Bank in the November 2015 Inflation Report, which stated that the Monetary Policy Committee (MPC) “is unlikely to reduce the stock of purchased assets from its current level of £375 billion until Bank Rate is around 2 per cent”. The Bank had previously issued guidance in May 2014 stating that:
The MPC [monetary policy committee] is likely to defer sales of assets at least until Bank Rate has reached a level from which it could be cut materially, were more stimulus to be required.
7.Mr Chote was asked whether the OBR’s prior assumption, that asset sales would begin when the base rate reached 0.75 per cent, was reasonable in the light of the May 2014 guidance. He said that:
Obviously the Bank of England would have seen that that was the assumption we were making. I cannot remember whether we formally asked them, but we had a brief discussion with them in advance of our forecast, which is a useful exchange of information anyway, on whether that was a sensible interpretation of the policy at the time. They did not have any problem with it then.
8.The Committee was surprised by the OBR’s interpretation of the Bank’s May 2014 guidance. That guidance stated that assets purchased under quantitative easing would not be sold until interest rates reached a level from which they “could be cut materially”. Such a rate might reasonably have been thought to be higher than the OBR’s assumption of 0.75 per cent. The OBR should in future share its assumptions on the future path of monetary policy with the Bank in advance of publishing its forecast, and discuss formally whether these are a reasonable reflection of the guidance issued by the MPC.
9.A correction to the model used to forecast VAT receipts resulted in an £11 billion cumulative improvement to the public finances over the forecast period. The error arose because VAT refunds to central government had previously been forecast on the basis of past trends. However, owing to public spending cuts, deductions relating to the government sector have not in fact risen as quickly as past trends would suggest, an error that Mr Chote said “only really emerged as, over time, we saw the central Government public expenditure cuts mounting”. The Economic and Fiscal Outlook states that “the model was insufficiently transparent to pick [the error] up sooner”.
10.As with other models used for forecasting tax revenue, the VAT model is “owned” by HMRC. Mr Parker said that it was OBR staff who identified the error during the preparation of the October 2015 Forecast Evaluation Report. Asked whether he had concerns about other “departmental” models used by the OBR, Mr Parker said “I am always concerned”. He added that “we have a programme of trying to look at individual models [but] there are restricted resources in HMRC, as well as in the OBR, about how much we can do at one time”. Mr Chote said that “it would be good to have the resources to do more scrutiny of the models outside the harvest period [i.e. outside the run-up to fiscal events]”.
11.A change to the model used to forecast Class 1 National Insurance Contributions resulted in a £6.6 billion cumulative improvement to the public finances over the forecast period. The previous model, created by the Government Actuary’s Department, has been replaced with a HMRC model aligned with that used to forecast PAYE receipts. The OBR justify the change on the grounds that the new model is more transparent, and gives us “more scope to scrutinise and implement key judgements, in particular regarding the average marginal tax rates that drive the receipts forecast”.
12.The OBR is right to review the models it uses, to seek improvements, and to be frank about mistakes made. Given their potential to alter materially the outlook for the public finances, these changes, improvements and corrections should be done well in advance of fiscal events, and their likely impact made clear at that point. This would help to avoid the mistaken impression that the OBR was fixing its forecasts to suit the Government.
13.Revisions to the OBR’s forecasts for the public finances were widely interpreted as providing the Chancellor with a £27 billion “windfall” over the coming five years. The Chancellor endorsed this interpretation in his speech to the House on the Spending Review and Autumn Statement (hereafter, simply “Autumn Statement”), and argued that the revisions in question were the result of an improving economic outlook:
First, the OBR expects tax receipts to be stronger. A sign that our economy is healthier than thought.
Second, debt interest payments are expected to be lower–reflecting the further fall in the rates we pay to our creditors.
Combine the effects of better tax receipts and lower debt interest, and overall the OBR calculate it means a £27 billion improvement in our public finances over the forecast period, compared to where we were at the Budget.
14.Chart 1 breaks down the £27 billion into its component parts and shows that the ‘windfall’ is driven predominantly by changes to lower debt interest payments (in turn driven by changes to the OBR’s interest rate and monetary policy assumptions), and modelling changes. Revisions to the OBR’s forecast for welfare spending (revised upwards), local authority expenditure (revised upwards) and average earnings (revised downwards), counteract the “improvement” from these sources.
Chart 1: changes to the OBR’s underlying forecast for public sector net borrowing, broken down by source of change, 2016–17 to 2020–21
November vs July 2015; figures exclude the impact of policy measures announced in the Autumn Statement; negative figures (green bars) indicate a reduction in net borrowing and positive figures (red bars) indicate an increase
Source: adapted from Office for Budget Responsibility, Economic and Fiscal Outlook—November 2015, presentation slides
15.The £27 billion figure refers to the cumulative improvement in the public finances over the five-year forecast period (2016–17 to 2020–21). The changes in each individual year are considerably smaller, and never exceed £8 billion. Paul Johnson, Director of the Institute for Fiscal Studies, advocated focussing on annual improvements, and described the £27 billion as a “silly number”. In evidence to the Committee, Rob Wood, Chief UK economist at Bank of America Merrill Lynch, said that the improvement was “relatively a small number compared to the tax take over that period”. Robert Chote cautioned against assuming that £27 billion would in fact materialise:
You only have to look at every previous autumn statement that we have done to see that sometimes those forecasts go in your favour; sometimes they go against. They normally move by larger amounts than this one has.
16.The improvements to the fiscal forecast were driven not by a fundamentally better economic outlook, as the Chancellor suggested, but by changes to the OBR’s modelling and assumptions. The OBR has altered its models and assumptions in a way that is favourable to the public finances on this occasion. It may subsequently alter them in an unfavourable way. Moreover, the focus on the £27 billion cumulative change over the five year forecast period distracts attention from the fact that the annual improvements were small, and certainly of a scale that could be revised away in the future. What was widely interpreted as a “windfall” may well prove illusory.
17.In his speech to the House of Commons on the Autumn Statement, the Chancellor reiterated the commitment made in his Summer Budget speech to move Britain to a “higher wage, lower welfare, lower tax society”.
18.The Summer Budget announced measures that, overall, increased the tax take, with tax rises reaching £15.9 billion by 2020–21—including rises in dividend taxation, insurance premium tax and vehicle excise duty—only partly offset by tax cuts of £9.4 billion by 2020–21, including a two percentage point reduction in the main corporation tax rate.
19.The Autumn Statement also saw the announcement of measures that will, overall, increase tax revenues. Combined with the measures announced in the Summer Budget, these will result in tax take being £14 billion higher by 2020–21 (and the cumulative tax take over the coming five years £50 billion higher). Together with the effect of revisions to its macroeconomic forecast, changes to taxation in the Summer Budget and Autumn Statement combined have caused the OBR to revise up its forecast for the ‘tax burden’, as measured by the tax-to-GDP ratio, from 33.3 per cent to 34.2 per cent in each year from 2016–17 to 2019–20.
20.Among other things, the Finance (No.2) Act 2015, passed after the Summer Budget, implemented the “triple tax lock” promised by the Government during the election campaign. This prevents income tax, VAT and national insurance contributions rising above their current (2015–16) levels during the course of the Parliament. Collectively, these taxes account for around three-quarters of central government tax receipts. Following the Summer Budget, Jonathan Portes, Principal Research Fellow at the National Institute of Economic and Social research, and Philip Booth, Programme Director at the Institute for Economic Affairs, gave evidence to the Committee that was critical of the tax lock. Mr Portes said:
the result [of the tax lock] is that since the Government did feel it needed to put up taxes, you end up, as under the previous Government, with stealth taxes; taxes that nobody, certainly not me, understands.
21.Mr Booth agreed, stating that “The very last thing we need to do is legislate to not increase taxes that are about as transparent as they come”. Paul Johnson argued that the case for a tax lock was weaker than the case for ringfencing government spending:
It feels to me there is a less obvious economic rationale for tying your hands on that than there is on the spending side. The spending side is a clear statement about what Government priorities are. Tying your hands on what you might do to the tax system three years hence, it is less easy to see a reason for that other than a purely political one.
22.The additional tax revenues expected over the coming five years consequently come from other sources, including:
23.Paul Johnson described the Autumn Statement as “a tax raising budget”. In evidence to the Committee, he said that “the [ … ] important thing he [the Chancellor] has done, though, certainly if you put the July budget and Autumn Statement together, is raise taxes, which has also allowed him to spend a bit more”.
24.Asked whether the measures in the Autumn Statement and Summer Budget were consistent with his goal of a low-tax economy, the Chancellor said they were “perfectly consistent”. He added that the apprenticeship levy was “not a normal or usual tax in that sense” because “you can receive the money back”. On the new council tax flexibilities, he said that:
It is [ … ] up to councils whether they want to make use of it. I suspect many will, but what we are doing is essentially changing an administrative bar on the council tax that currently exists and raising the cap, creating certain conditions around that about how the money is spent.
25.The Chancellor was also asked by the Committee whether the revenue-raising measures in the Summer Budget and Autumn Statement were “stealth taxes”. He said that “I do not see how you could describe council tax and an apprenticeship levy as a stealth tax, as they are pretty transparent and straightforward. Everyone understands what they are”. He went on to describe “stealth taxes” as “things that people did not realise were even taxes they had to pay and then not announcing them in budget speeches”.
26.The tax-burden, which was 33.0 per cent of GDP in 2014–15, will rise to 34.2 per cent by 2017–18. The Chancellor’s objective of moving to a “lower tax society” was not advanced by the measures contained in either the Summer Budget or the Autumn Statement. These will raise the tax burden faced by individuals and businesses, through new taxes, including the apprenticeship levy and the stamp duty surcharge, and the raising of less salient ones, including dividends and insurance premium taxes.
27.The need to raise further tax revenues is understandable, given the imperative to reduce public borrowing. The “tax lock”, which prevents rises in national insurance, income tax and VAT, appears to be leading the Treasury to find additional revenues in less conventional ways.
28.According to the Association of Chartered and Certified Accountants (ACCA), the most significant tax announcement of the Blue Book was the proposals for “Making Tax Digital”. This is a programme to move to a fully digital tax system that the Autumn Statement declared would “give individuals and businesses a more convenient real-time view of their tax affairs, providing them with greater certainty about the tax they owe”. All of the written submissions from tax bodies expressed concern over the proposals to make it mandatory for businesses to give HMRC quarterly updates and scepticism at the way that this would contribute to a cost saving for businesses of £400 million by the end of 2019/20 as well as considerable uncertainty as to how it will operate. In oral evidence, the OBR stated that the estimates of Government revenues from the Making Tax Digital programme (£920 million over the forecast period) were based on an HMRC survey of the types of errors made in tax returns. The Economic and Fiscal Outlook ascribes a high uncertainty rating to these figures.
29.A discussion paper issued by HMRC on 14 December 2015, also indicates that the Making Tax Digital programme may lead to tax being paid earlier. Under a section entitled “smaller, more regular payments”, it states:
For businesses and individuals, there are variable periods of time between the activity generating the tax liability and the payment date. These lags made sense in a paper-based world where it took time to gather the information to calculate liabilities. But in an increasingly digital world, taxpayers should not have to wait until after the end of their tax year or accounting period to understand how much tax is likely to be due, or to receive any repayments.
31.However, some elements of HMRC’s Making Tax Digital plans, most notably the quarterly reporting requirement for all businesses, may create additional burdens for taxpayers. HMRC’s discussion paper implies that it could even require them to pay tax before it is legally due. It is premature to make the case for these plans on the grounds of simplicity and convenience for taxpayers. The main benefits appear to arise largely from additional revenue to the Exchequer, partly at the expense of cash flow to businesses where they need to pay their tax earlier, and partly as a result of a reduction in errors. Much more consultation over the detail is required before this policy is implemented. Legitimate concerns of businesses about the burden that may be caused by this policy need to be addressed by HMRC and the Treasury.
32.At the end of the last Parliament, the Chancellor stated that he intended to cut the welfare bill by £12 billion by 2017–18. In the Summer Budget, welfare changes were announced that made savings of £12 billion, although not until 2019–20.
33.In the Autumn Statement, the Government announced a number of measures that will increase welfare spending over the coming five years, compared with what was planned in the Summer Budget. By far the most important of these is the decision to reverse two changes to tax credits announced in the Summer Budget. In particular, the income threshold above which tax credits start to be withdrawn, originally planned to fall to £3,850, will remain at £6,420, while the rate of withdrawal (the ‘taper rate’), planned in the Summer Budget to increase to 48 per cent, will remain at 41 per cent.
34.The Autumn Statement did not, however, reverse reductions to work allowances in universal credit (analogous to income thresholds under the tax credits system). These will fall to £4,765 for those without housing costs, to £2,304 for those with housing costs, and be removed altogether for non-disabled claimants without children. As claimants are expected to be ‘migrated’ from tax credits to universal credit over the forecast period, the effect of the policy ‘reversal’ in the Autumn Statement is to increase welfare spending in the near-term, but to reduce it towards the end of the forecast period. The revised commitment to achieve a £12 billion reduction in the welfare bill by 2019–20 will therefore continue to be met, on current forecasts.
35.In addition to policy changes, revisions to the OBR’s forecasts since July have also caused an increase in expected welfare spending. In particular, the OBR has revised its assumption about how long it will take DWP and its contractors to complete the reassessment of working-age disability living allowance claimants during the move to personal independence payments. As a consequence, spending on disability benefits has been revised up substantially.
36.The OBR also pushed back their forecast for the rollout of universal credit, the latest in a series of revisions that mean the number of claimants in 2016–17 is now expected to be five per cent of what was forecast in March 2013. This has had the effect of lowering welfare spending forecasts “because it postpones the costs associated with those that stand to gain from universal credit and also those that stand to receive transitional protection payments because they would lose from universal credit”.
37.In the 2014 Budget, the Government introduced controls over some elements of annually managed expenditure (AME) on welfare. Specifically, this ‘welfare cap’ requires forecast expenditure for each of the following five years to be within limits set by the Treasury. Details of the cap’s operation are set out in the Charter for Budget Responsibility, which requires the OBR to assess whether forecast welfare expenditure falls within the set limits.
38.If forecast spending exceeds the level of the cap, this need not mean that the cap is treated as having been breached. Whether it has in fact been breached depends on whether or not the changes to forecast spending that cause the cap to be exceeded arise from a discretionary policy change on the part of the Government. In the case of such changes, there is no leeway, and a breach occurs if forecast spending exceeds the cap. In the case of all other changes to forecast spending (e.g. a revision to the OBR’s labour market outlook), the cap is only breached if forecast spending exceeds the stated cap plus a 2 per cent “forecast margin”.
39.The OBR judges that the welfare cap will be breached in 2016–17, 2017–18 and 2018–19, largely due to policy changes, including the reversal of planned changes to tax credits. In 2019–20 and 2020–21, it judges that the cap will be observed. However, this is only by virtue of a change in how local authorities will be funded for the management of temporary accommodation, which shifts the classification of such spending from AME to DEL. Although the rules governing the welfare cap require it to be adjusted to reflect “fiscally neutral classification changes”, the Government made the case to the OBR that this change should not result in an adjustment because it “will allow and encourage local authorities to spend the money in different ways”. Dr Gemma Tetlow, Programme Director at the IFS, said:
He [the Chancellor] did not formally breach the cap, but the way he managed to do that was by reallocating an item of spending [support for temporary accommodation] out of welfare and moving it to local government spending, instead. [ … ] It just raises an issue that there are three ways of getting yourself within the cap. One is active policy change; one is forecasting changes that work in your favour; and the third is reclassification of items of spending. It raises the issue of the transparency of the distinctions between those things, and how they get used.
40.In the event of a breach, the Charter for Budget Responsibility requires the Government to debate a votable motion in the Commons. The motion must propose measures which bring spending back within the cap; seek approval for the level of the welfare cap margin to be increased; or explain why a breach of the cap is justified. A debate on a motion that the breach was “justified and that no further debate will be required in relation to [it]” was held on 16 December 2015, and the motion was agreed to.
41.The decision to reverse planned changes to tax credits has caused the Government to breach its welfare cap in each of the first three years of the forecast period. The Government are meeting the cap in the final two years of the forecast because the OBR agreed to certify the change to the funding of local authority temporary accommodation as an expenditure-cutting policy decision, rather than a fiscally neutral classification change. It is not clear that this measure will materially reduce welfare expenditure. The OBR should explain, in full, why it has certified this as a policy change. The OBR should also explain whether it believes the welfare cap to be vulnerable to ‘gaming’ by the Treasury, given the lack of clarity about what constitutes a policy measure, as opposed to a classification change.
42.The cuts to departmental budgets made in the Spending Review were less severe than many had expected. The forecasts made by the OBR in July 2015 implied that average cuts of 27% would have to be made to the resource spending of unprotected departments, and the Treasury itself invited departments to set out plans for reductions in their resource budgets of 25% and 40%, in real terms, by 2019–20. In the end, the average real-terms cut for unprotected departments was 18%. At an annual average of 1.1 per cent, the pace of real terms departmental cuts over the coming Parliament is expected to be slightly lower than the 1.6 per cent seen in the last Parliament.
43.Paul Johnson summarised why the Chancellor was able to moderate departmental spending cuts (and make an equally unexpected reversal to planned changes in tax credits, discussed in the previous section), while still keeping within the fiscal mandate to run a surplus by 2019–20:
[The Chancellor] has banked some changes in forecasts for lower debt interest payments and higher tax revenues. That was lucky. By adding some tax increases he has made some of his own luck.
44.Mr Johnson added that “this spending review is still one of the tightest in post war history”.
45.Chart 2 illustrates how plans for day-to-day spending on public services have changed. In March 2015, real-terms cuts were expected to peak at £42 billion; by contrast, the November 2015 forecasts show cuts reaching a peak of just £10 billion. Robert Chote said that “public services spending is on much less of a rollercoaster than in March and on a less bumpy ride even than in July”.
Chart 2: change in real-terms day-to-day spending on public services*, comparison of forecasts since March 2015
relative to 2015–16, £ billion
* defined as resource departmental expenditure limits
Source: Office for Budget Responsibility, Economic and Fiscal Outlook–November 2015, Cm 9153, Chart 1.8
46.The Coalition Government followed a policy of protecting, or ‘ring fencing’, certain elements of public expenditure. The new Government has continued with this policy, reaffirming in the Summer Budget some existing protections, including overseas aid and the ‘triple lock’ on the State Pension, and enhancing others: real-terms NHS spending is planned to rise by £10 billion between 2014–15 and 2020–21.
47.The Summer Budget also expanded the ring fence to include new areas of public expenditure: the Chancellor pledged to increase the budget for the Ministry of Defence by 0.5% per year in real terms until 2020–21 and to protect the counter-terrorism budget in real terms over the same period. Child benefit will also continue to be paid at the same level for all children.
48.As a consequence of this ‘ringfencing’, and the fact that the budgets of the devolved administrations fell outside its scope, the Spending Review covered just 23 per cent of departmental expenditure. As Chart 3 shows, the proportion of spending going to non-ringfenced areas will continue to decline over the review period.
Chart 3: departmental spending—proportion of total accounted for by selected departments
Sources: HM Treasury, Public Expenditure Statistical Analyses 2015, Chapter 1: departmental budgets tables, Cm 9122, July 2015; HM Treasury, Spending Review and Autumn Statement 2015, Cm 9162 (various tables)
49.In evidence following the Summer Budget, Paul Johnson commented on the implications of ringfencing for the shape of the state:
the consequences are that the shape of public spending, the shape of the state, will be very different in 2020 to what it was in 2010 and certainly from what it was in 2000 with much, much more going on, particularly health and pensions, and much less on most other parts of public spending. I think that is an important political debate, in a sense, about whether that is the right shape and that is a shape that will become more like that going forward under current policy as the population ages.
50.The previous Treasury Committee considered the effects of ring fencing in its Report on the 2014 Budget and concluded that it “weakens rigorous scrutiny of spending”. In its Report on the 2013 Budget, the Committee concluded that ringfencing “can lead to waste or worse and it can distort the balance of spending as a whole”.
51.The economists that the Committee heard from following the Summer Budget agreed that the ringfencing of public expenditure could cause problems, although Jonathan Portes said that it was unlikely to affect the trajectory of health spending:
The level of health spending projected for the next parliament is the bare minimum that any government would have had to do for perfectly good and sensible political reasons anyway.
52.Paul Johnson agreed:
[ … ] it is hard to believe that spending on health, for example, would have been a lot different under a world in which you did not have that ring fence.
53.When asked by the Committee about ringfencing, the Chancellor said that it amounted to “an expression of our political priorities, the priorities of the Government, to invest in our health service, invest in our schools and the like, and protect our country”. He acknowledged that ringfencing certain areas of public spending “obviously increase[s] pressures elsewhere in government, but government is ultimately about making those choices”.
54.Jonathan Portes made a similar point, noting that ringfencing was done for “political reasons”, while Philip Booth said it was done “to satisfy the demands of certain interest groups”.
55.The press release accompanying the Spending Review stated that it “sets out how £4 trillion of government money will be allocated over the next five years”. In fact, three-quarters of departmental expenditure and three-fifths of welfare spending was already locked in before the Spending Review process had even begun, by political commitments to protect certain areas of spending, and by block grants to devolved administrations, which are governed by the Barnett formula.
56.The proportion of spending that is ringfenced by commitments on the NHS, defence, international development, schools and pensioner benefits will continue to increase over the course of the Parliament, dramatically altering the shape of spending, and with it, the role of the state. The Committee agrees with the Chancellor that this ringfence is an “expression of… political priorities”. But these priorities should at least have been subject to discussion and fuller explanation in the Spending Review. Even if the Government’s spending priorities were left unaltered, the implications of maintaining protections for certain areas of spending could have been brought into clearer focus and the scrutiny of spending decisions in these areas improved.
57.The previous Government stated that it intended to follow a deficit reduction “rule of thumb” that would see 80 per cent of reductions arising from spending cuts and 20 per cent from revenue increases. Based on the OBR’s forecasts in March 2015, almost all the planned fiscal consolidation over the five-year forecast period (2015–16 to 2019–20) was expected to come from spending cuts. The July forecasts made at the Summer Budget saw a shift in the balance to 80:20 (looking at the period 2016–17 to 2020–21), while the latest (November) forecasts, indicate a further shift to 75:25 over the same period.
58.Compared to plans made in March, the Chancellor has used the July Budget and the Autumn Statement to rebalance the planned fiscal consolidation away from spending cuts and towards tax rises. In responding to this report, the Treasury should explain whether, in pursuing further fiscal consolidation, it is continuing with the policy of an 80:20 split between spending cuts and tax rises.
59.Alongside the Summer Budget, the Government published a draft Charter for Budget Responsibility, intended to replace the previous version, which was published with the Autumn Statement in December 2014 and approved by Parliament the following January. Before it was approved by the House of Commons, that draft Charter was superseded by another one, which contains the same fiscal targets but makes changes to the OBR’s duties following the Treasury-led review of its work. Approval of the latest Charter by the House of Commons took place on 14 October 2015.
60.The December 2014 Charter set out ‘aims’ for the cyclically adjusted current budget to be balanced by the end of the third year of the rolling forecast period, and for public sector net debt as a percentage of GDP to be falling in 2016–17.
61.The new Charter replaces these two aims with ‘targets’:-
a)A surplus on public sector net borrowing by 2019–20. Once a surplus has been achieved, the target requires that it must be maintained
b)Public sector net debt as a percentage of GDP to be falling in each year until 2019/20
62.The targets are to apply unless the OBR assesses as part of its economic and fiscal forecast that “there is a significant shock to the UK”. This is defined in the Charter as “real GDP growth of less than 1% on a rolling 4 quarter-on-4 quarter basis.
63.In its November 2015 Economic and Fiscal Outlook, the OBR forecasted that the Government would run a surplus of £10 billion in 2019/20, thereby meeting its target. The OBR went on to conclude that, while the Government was “more likely than not” to meet the target, based on past forecasting errors, there was a 45 per cent probability that it would be missed. It listed a number of circumstances under which the target would be missed, including:
64.Asked how the Government would respond to a future change in the forecast that led to the target being missed, Clare Lombardelli, Director of Strategy, Planning and Budget, said that a decision would be taken if and when that occurred: “The surplus is projected on the forecast that we have now. Should that forecast change, then the Government will make decisions about whether or not it needs to change policy in response to that”.
65.Economists from whom the Committee has heard have been critical of the surplus target, largely because its design does not properly account for changes to the state of the economy. Jonathan Portes explained that, if growth was below the OBR’s forecasts, but above the 1% threshold, then receipts would fall below expectations. In these circumstances, the Government would have to cut spending in order to retain a surplus, something he did not believe would happen:
What the Chancellor’s Charter for Budget Responsibility says is that if [ … ] growth is 1.25% for the next four years [ … ] then we will still hit the surplus and to do that we will make £35 billion-worth of extra spending cuts. That is simply not going to happen. We know it is not. [ … ] So in that sense the surplus target is simply not credible.
66.Philip Booth agreed, arguing that the target was “unworkable” and that “in the handbook of possible fiscal rules the Government is choosing a very, very, very bad one”. Michael Saunders, Chief UK economist at Citigroup said that “the cyclical adjustments should be there and done properly” and questioned the wisdom of using a fiscal target that included capital spending. Simon Kirby, Head of Macroeconomic Modelling and Forecasting at the National Institute for Economic and Social Research, said that “the current rule is dramatically inflexible”, a statement with which Rob Wood agreed. Paul Johnson agreed that the rule was “extremely inflexible” and said:
I would work with a more flexible rule, which says, supposing I want to get to budget surplus, “Look, world: what I want to do is get to budget surplus at some point within the next five to 10 years, according to how the economy pans out, without being anything like as precise.” The difficulty he [the Chancellor] clearly has is that the world wants more precision than that, but I am not sure the precision is worth very much—given the difficulties it might create.
67.The Chancellor has decided to use the revenue raised from tax increases, and the uncertain gains from the OBR’s modelling and forecasting changes, to alleviate reductions in departmental spending, and to reverse planned cuts to tax credits. The OBR forecasts that this can be done while still achieving the target of running an overall budget surplus by 2019/20.
68.This target, however, is highly inflexible, making the Chancellor’s plans to spend two-thirds of the “windfall” arising from the forecasting and modelling changes all the more uncertain. As Robert Chote said, “sometimes forecasts go in your favour; sometimes they go against”. The OBR currently ascribes a 45 per cent probability to the forecasts moving in a way that eliminates the surplus in 2019/20. Were this to occur, the Chancellor would have to raise taxes, cut spending or abandon the rule.
69.If the forecasts were to change in a way that led to an expected deficit in 2019–20, the Treasury may, therefore, need to revisit the departmental settlements agreed as part of the Spending Review. Departments will need to plan for this.
70.More generally, the surplus rule provides no flexibility to respond to changing economic circumstances. In his speech in Cardiff on 7 January 2016, the Chancellor highlighted the “dangerous cocktail” of risks emanating from abroad, including “stock market falls around the world, the slowdown in China, deep problems in Brazil and Russia” and a dramatic fall in commodity prices. The rule leaves the Government unable to use fiscal policy to respond either to such shocks abroad, or to a turn in the economic cycle at home, unless they happen to depress GDP growth below the arbitrary rate of one per cent. The Committee agrees with the economists from whom it has heard and it is not convinced that the surplus rule is credible in its current form.
1 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153
2 Office for Budget Responsibility, Economic and Fiscal Outlook - November 2015, presentation slides
3 Office for Budget Responsibility, Economic and Fiscal Outlook - November 2015, Chairman’s presentation
5 Bank of England, Inflation Report – November 2015, p34
6 Bank of England, Inflation Report – May 2014, p41
8 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Table 4.8
10 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Box 4.2
14 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Table 4.8
15 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Box 4.2
16 HC Deb, 25 November 2015, Col 1359
17 Remarks on the Today programme, BBC Radio 4, 26 November 2015
20 HC Deb, 8 July 2015, Col 321
21 Office for Budget Responsibility, Economic and Fiscal Outlook - November 2015, Chairman’s presentation
22 Office for Budget Responsibility, Economic and Fiscal Outlook – March 2015, Cm 9024, Table 4.4; Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Table 4.5
23 HMRC, Tax and NICs receipts: statistics tables, December 2015
27 Office for Budget Responsibility, Economic and Fiscal Outlook - November 2015, Chairman’s presentation
28 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Table A.1
29 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Para 1.8
30 Institute for Fiscal Studies, Autumn Statement 2015 briefing: Paul Johnson’s opening remarks, 26 November 2015
36 ACCA, December 2015 memorandum on the fundamental principles of tax policy and Autumn Statement 2015, para 13
37 HM Treasury, Spending Review and Autumn Statement 2015, Cm 9162, Para 1.288
38 CIOT, Treasury Committee Principles of Tax Policy and Autumn statement 2015, para 2.3; ICAEW Traffic Light Assessment Autumn Statement 2015, para 6.2; ACCA December 2015 memorandum on the fundamental principles of tax policy and Autumn Statement 2015, para 24
40 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Table A.1
41 HM Revenue & Customs, Making Tax Digital: Discussion paper on simpler payments, 14 December 2015, Para 11
42 HC Deb, 18 March 2015, Col 771
43 Office for Budget Responsibility, Economic and Fiscal Outlook – July 2015, Cm 9088, Para 1.7
44 HM Treasury, Spending Review and Autumn Statement 2015, Cm 9162, Para 1.122
45 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Table 4.23
46 HM Treasury, Spending Review and Autumn Statement 2015, Cm 9162, Para 1.127
47 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Table 4.23
48 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Chart 4.8
49 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Para A.28
50 HM Treasury, Budget 2014, para 1.76
51 HM Treasury, Charter for Budget Responsibility: autumn 2015 update, October 2015
52 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Para 5.24
53 Q288 and Q291
54 HC Deb, 16 December 2015, Col 1650
55 Institute for Fiscal Studies, The Outlook for the 2015 Spending Review, Briefing Note BN176, October 2015
56 HM Treasury, A country that lives within its means - Spending Review 2015, Para 1.12, July 2015
57 Institute for Fiscal Studies, Autumn Statement 2015 briefing: Paul Johnson’s opening remarks, 26 November 2015
58 Office for Budget Responsibility, Economic and Fiscal Outlook - November 2015, Chairman’s presentation
59 Institute for Fiscal Studies, Autumn Statement 2015 briefing: Paul Johnson’s opening remarks, 26 November 2015
60 HC Deb 8 July 2015 c337 (Financial Statement)
61 HM Treasury, Summer Budget 2015, para 1.139, p37
62 HM Treasury, Summer Budget 2015, para 1.78, p26
63 HM Treasury, Summer Budget 2015, para 1.81, p26
64 HM Treasury, Summer Budget 2015, para 1.148, p38
65 HM Treasury, Public Expenditure Statistical Analyses 2015, Chapter 1: departmental budgets tables, Cm 9122, July 2015
67 Treasury Committee, Thirteenth Report of Session 2013–14, Budget 2014, HC 1189, Para 89, p33
68 Treasury Committee, Ninth Report of Session 2012–13, Budget 2013, HC 1063, Para 137, p63
73 HC Deb, 22 June 2010, Col 169
74 HM Treasury, Charter for Budget Responsibility: Summer Budget 2015 update, July 2015
75 HM Treasury, Charter for Budget Responsibility: Autumn 2015 update, September 2015
76 HM Treasury review of the Office for Budget Responsibility, 3 September 2015
77 HM Treasury, Charter for Budget Responsibility: Autumn 2015 update, September 2015, paras 3.2 to 3.5
78 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Para 5.8
79 Office for Budget Responsibility, Economic and Fiscal Outlook – November 2015, Cm 9153, Para 5.38
81 Oral evidence on Summer Budget 2015, HC 315, Q16
82 Oral evidence on Summer Budget 2015, HC 315, Q19
83 Oral evidence on Summer Budget 2015, HC 315, Q22
Prepared 11 February 2016