Eliminating the deficit in this parliament?
Carl Emmerson
Presentation at David Hume Institute seminar,
King Khalid Building, Surgeon’s Hall, Edinburgh, 12 May 2016
© Institute for Fiscal Studies
Three fiscal targets
• Cap forecast welfare spending
– introduced to help Chancellors make unpopular benefit cuts rather than
allow spending to increase inappropriately
– November 2015: breached in 2016–17, 2017–18, 2018–19; met in
2019–20, 2020–21
– March 2016: breached in all five years
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Three fiscal targets
• Cap forecast welfare spending
• Reduce public sector net debt as a share of national income every
year until a surplus is achieved
– good reasons to want to reduce indebtedness of the public sector
– but as of November 2015 was only being achieved via asset sales
– March 2016 Budget forecast on course to be missed
– initial out-turn for 2015–16 suggests it has been missed
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Three fiscal targets
• Cap forecast welfare spending
• Reduce public sector net debt as a share of national income every
year until a surplus is achieved
• New fiscal mandate: achieve a headline surplus every year from
2019–20, unless growth drops below 1%
– still standing, for now…
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Financial year
© Institute for Fiscal Studies
Source: Office for Budget Responsibility.
2020–21
2015–16
2010–11
2005–06
2000–01
1995–96
1990–91
1985–86
1980–81
1975–76
1970–71
1965–66
1960–61
1955–56
12
10
8
6
4
2
0
-2
-4
-6
1948
1950
% of national income
Achieving and maintaining a budget surplus
would be a break from the past
Financial year
© Institute for Fiscal Studies
Source: Office for Budget Responsibility.
2020–21
2015–16
2010–11
2005–06
2000–01
1995–96
1990–91
1985–86
1980–81
1975–76
1970–71
1965–66
1960–61
1955–56
12
10
8
6
4
2
0
-2
-4
-6
1948
1950
% of national income
Achieving and maintaining a budget surplus
would be a break from the past
Should we run budget surpluses?
• Debt as a share of national income will fall if debt grows less quickly
than the economy
– little economic difference between a small budget surplus and a small
budget deficit
– as long as does not harm growth, smaller deficit / greater surplus
would lead to debt falling more quickly
• Several potentially good reasons to borrow
– investment spending
– output stabilisation
– adjust gradually to shocks
– forecast errors
– tax rate smoothing
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
The Chancellor’s fiscal mandate
• Achieve a headline surplus from 2019–20, unless at any point growth
over four quarters …
– … appears to have been below 1% in the last year
– … or is forecast to be below 1%
• Fiscal mandate is easy to understand and transparent
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
The 1% escape clause
4Q-on-4Q rolling growth rate (%)
8
6
4
2
0
-2
-4
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Notes and sources: see Figure 3.6 of The IFS Green Budget: February 2016.
Source: Office for National Statistics; Office for Budget Responsibility.
2020
2015
2010
2005
2000
1995
1990
1985
1980
1975
1970
1965
1960
1955
-6
Three problems with the fiscal mandate
• Unless we aim consistently for large budget surpluses, significant
chance sharp adjustments will be necessary
– greater than one-in-four chance that deficit in coming year more than
0.5% of national income greater than expected
• Rule might not allow government to respond to lower interest rates
with more investment spending
– optimal level of borrowing will almost certainly depend, at least in part,
on the interest rate
• 1% threshold arbitrary, and could increase politicisation of the OBR’s
growth forecasts
– history suggests growth not often around 1%, but the future might not
look like the past
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Size and timing of the fiscal response
Percentage of national income
12
By 2015–16 64% done,
36% to do
10
8
6
4
2
0
Financial year
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Source: http://budgetresponsibility.org.uk/data/
Source: Institute for Fiscal Studies.
Long run*
2020–21
2019–20
2018–19
2017–18
2016–17
2015–16
2014–15
2013–14
2012–13
2011–12
2010–11
2009–10
2008–09
-2
Size, timing and composition of the fiscal response
Percentage of national income
12
Other current spend Overall 19% tax rises,
Debt interest
81% spending cuts
10
Benefits
8
Investment
6
Tax increases
4
2
0
Financial year
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Source: http://budgetresponsibility.org.uk/data/
Source: Institute for Fiscal Studies.
Long run*
2020–21
2019–20
2018–19
2017–18
2016–17
2015–16
2014–15
2013–14
2012–13
2011–12
2010–11
2009–10
2008–09
-2
Eliminating the deficit?
Percentage of national income
55
Current receipts
Total Managed Expenditure
50
45
Forecast surplus of £10 billion
Forecast
surplus
of £10
billion
(0.5% of
national
income)
(0.5% of national income)
40
35
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Source: http://budgetresponsibility.org.uk/data/
Source: Office for Budget Responsibility.
2020–21
2019–20
2018–19
2017–18
2016–17
2015–16
2014–15
2013–14
2012–13
2011–12
2010–11
2009–10
2008–09
2007–08
2006–07
2005–06
2004–05
2003–04
2002–03
2001–02
2000–01
30
Eliminating the deficit in the UK, but not in
Scotland
• UK deficit forecast to be eliminated by 2019–20, largely as the result
of further tax rises and spending cuts (rather than strong growth)
• What about the gap between receipts and spending in Scotland?
• GERS suggests that in 2014–15 the “Scottish deficit” was a larger
share of the economy than that of the UK
• IFS projections, using the latest OBR forecasts, suggest the gap will
widen
– driven by weak outlook for North Sea revenues
© Institute for Fiscal Studies
Gap = 4.7% of
GDP, £7.2bn
10
UK
Scotland
2017–18
% of national income
12
2016–17
Gap between UK and Scotland deficit projected
to widen
Gap = 6.7% of
GDP, £12.8bn
8
6
4
2
0
Financial year
© Institute for Fiscal Studies
Source: Office for Budget Responsibility; GERS 2014–15; Phillips (2016).
2020–21
2019–20
2018–19
2015–16
2014–15
2013–14
-2
Eliminating the deficit in the UK, but not in
Scotland
• UK deficit forecast to be eliminated by 2019–20, largely as the result
of further tax rises and spending cuts (rather than strong growth)
• What about the gap between receipts and spending in Scotland?
• GERS suggests that in 2014–15 the “Scottish deficit” was a larger
share of the economy than that of the UK
• IFS projections, using the latest OBR forecasts, suggest the gap will
widen
– driven by weak outlook for North Sea revenues
• Under Full Fiscal Autonomy (or independence) this would matter a lot
• But Scotland not penalised for this under “no detriment” principle
enshrined into the Block Grant Adjustments at least until 2021–22
© Institute for Fiscal Studies
in Scotland on
slightly
bigger,
Impact of tax and benefitGains
reforms
incomes
as lose less from restrictions on
to pensions
among
2. Measures introduced betweencontributions
May 2015 and
April 2019
Change in net income (%)
those with incomes above £150k
2%
Losses in Scotland slightly
smaller,
as lose less from
0%
cuts to housing benefit
-2%
for private sector tenants
-4%
-6%
All
-8%
Pensioners
-10%
Working-age without children
-12%
Working-age with children
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Source:
and Hood (2016)
Source: Elming
http://budgetresponsibility.org.uk/data/
(http://www.ifs.org.uk/uploads/budgets/budget2016/budget2016_weah.pdf )
All
Richest
9
8
7
6
5
4
3
2
Poorest
-14%
Actual and projected change in incomes
Cumulative change in household
income
14%
12%
10%
8%
6%
4%
2%
0%
-2%
-4%
95
90
85
80
75
70
65
60
55
50
45
40
35
30
25
20
15
10
5
-6%
Percentile point
2015–16 to 2020–21
© Institute for Fiscal Studies
2007–08 to 2015–16
2007–08 to 2020–21
Source: Browne and Hood (2016) (http://www.ifs.org.uk/publications/8171)
Public spending to fall to a low level by historical
standards
% of national income
Pensioner benefits (RH)
Working age benefits (RH)
50
25
40
20
Lowest level for over 60 years,
except 1999–2000 and 2000–01
30
20
10
30
Spending on working age social security to
be at lowest level since 1990–91
10
5
0
1948
1951
1954
1957–58
1960–61
1963–64
1966–67
1969–70
1972–73
1975–76
1978–79
1981–82
1984–85
1987–88
1990–91
1993–94
1996–97
1999–00
2002–03
2005–06
2008–09
2011–12
2014–15
2017–18
2020–21
0
15
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Sources: Office for National Statistics; Office for Budget Responsibility.
% of national income
Total public spending (LH)
60
Implications for spending areas
• Current (non-investment) departmental spending facing real cuts
of 3.7% (£12bn) between 2015–16 and 2019–20
– NHS, aid, schools, defence protected
– RDEL outside of Dept of Health, Dept of International Development,
Ministry of Defence and schools: –12.8% (£17bn)
– cuts in Scotland slightly smaller
• Takes the real RDEL cut between 2010–11 and 2019–20 to 10.9%
– RDEL outside of DH, DfID, MoD and schools: –31.5% (£52bn)
• Public service pension revaluation essentially an additional £2bn
RDEL spending cut in 2019–20
– Increases the real RDEL cut since 2015–16 from 3.7% to 4.3%
• Departments also face pressures from: increased NICs (ending of
contracting out); increased minimum wage; apprenticeship levy
– population growing and ageing
© Institute for Fiscal Studies
Risks: underlying receipts
• Many risks around public finance forecasts
• Perhaps most obvious uncertainty around the underlying public
finances is over the size of the economy
– if GDP turned out to be 0.7% lower than forecast in 2019–20 this
would likely be sufficient to eliminate the forecast surplus
– forecasts assume that we stay in the European Union, leaving would
most likely reduce national income and weaken the public finances
• Other factors matter too: including composition and distribution
of GDP, asset prices, etc.
• For example employment and earnings directly affect receipts of
PAYE income tax and National Insurance receipts (£262bn)
– 1% more employment boosts revenues by about 1%; but 1% more
earnings boosts revenues by about 1½%
– mix of earnings/employment growth in last few years has been
unfavourable for the public finances
© Institute for Fiscal Studies
Risks: future policy changes on indexation
• Indexation of fuel duty rates
– forecasts assume rates will be increased in line with the RPI every April
– but rates have not increased in nominal terms since April 2011, and
were not increased in April 2016 despite low oil price
– cash freeze would reduce revenues by £2½ billion in 2020–21
• Some other thresholds are frozen in cash terms which might not
prove sustainable
– 40% more additional rate taxpayers since April 2010 due to £150,000
threshold being frozen
– 50% increase projected over next five years in numbers losing some or
all of their child benefit due to the £50,000 threshold being frozen
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Risks: future income tax cuts
• Conservative Party manifesto
– personal allowance of £12,500 and a higher-rate threshold of £50,000
by April 2020
– note: UEL is currently linked to the higher-rate threshold
– standard indexation would increase these to £12,060 and £47,200,
increasing them to £12,500 and £50,000 would cost around £3 billion
– remember that 43% of adults have incomes too low to pay income tax
• SNP manifesto
– increase personal allowance by a further £250 to £12,750; freeze the
higher-rate threshold next April, inflation increases (at most) thereafter
– SNP estimate that this would boost revenues by a cumulative £1.2
billion over the parliament
– as the higher-rate threshold in Scotland would be below the UK-wide
UEL those in Scotland earning between £46k and £50k would face a
combined income tax + employee NICs tax rate of 52%
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Gains and losses under Conservative and SNP
plans for income tax and NICs
Gain / loss (£ per year, 2020 prices)
Change in income tax and employee National Insurance contributions
800
600
400
200
0
-200
-400
-600
£0
£25,000
£50,000
£75,000
£100,000
Taxable income
2020–21 Conservative
© Institute for Fiscal Studies
£125,000
2020–21 SNP
Note: assumes all income from employment, no pension contributions.
£150,000
Risks: spending
• Public service spending
– will continued squeeze on public service spending be delivered?
© Institute for Fiscal Studies
30%
Raw mean difference
Projection based on 1% pay award for four years from 2016–17
25%
20%
15%
10%
5%
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Notes and sources: see Figure 6.4 of The IFS Green Budget: February 2016.
2020–21
2018–19
2016–17
2014–15
2012–13
2010–11
2008–09
2006–07
2004–05
2002–03
2000–01
1998–99
1996–97
0%
1994–95
Estimated gap between public and
private sector hourly pay
Squeezing public spending by holding down
public sector wages
Risks: spending
• Public service spending
– will continued squeeze on public service spending be delivered?
• Social security spending
– further 4-year freeze in benefit rates will reduce levels significantly in
real terms: has not been attempted in last 30 years
– further delays in transition from Disability Living Allowance to
Personal Independence Payments would increase spending
© Institute for Fiscal Studies
Revisions to expected costs of disability benefits
18
March 2013
March 2014
March 2015
March 2016 pre-measures
March 2016
17
£ billion
16
15
14
13
12
11
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Source: Office for Budget Responsibility
2020–21
2019–20
2018–19
2017–18
2016–17
2015–16
2014–15
2013–14
2012–13
2011–12
2010–11
2009–10
10
Risks: spending
• Public service spending
– will continued squeeze on public service spending be delivered?
• Social security spending
– further 4-year freeze in benefit rates will reduce levels significantly in
real terms: has not been attempted in last 30 years
– further delays in transition from Disability Living Allowance to
Personal Independence Payments would increase spending
• Debt interest spending
– 1ppt increase (reduction) in gilt and short rates (from April 2016)
would increase (reduce) spending in 2019–20 by around £8 billion
– 1ppt increase (fall) in RPI inflation (from April 2016) would increase
(reduce) spending in 2019–20 by around £5 billion
© Institute for Fiscal Studies
Summary
• Two of the three fiscal targets set for this parliament already missed
• Achieving and maintaining a budget surplus difficult and
commitment to do so in 2019–20 risky
• Scotland’s relative fiscal position forecast to deteriorate
• Continued fiscal tightening:
– tax and benefit reforms to leave lower income working age households
worse off
– further cuts to spending on many public services
• Many risks remain
– will economy grow as the OBR expects?
– will further tax and benefit giveaways follow?
– will planned cuts to public service spending prove deliverable?
©
©Institute
Institutefor
forFiscal
FiscalStudies
Studies
Eliminating the deficit in this parliament?
Carl Emmerson
Presentation at David Hume Institute seminar,
King Khalid Building, Surgeon’s Hall, Edinburgh, 12 May 2016
© Institute for Fiscal Studies