1. Summary
An audit of the public finances
The January 2002 IFS forecast suggests that the current budget surplus in
2001–02 will be £14.0 billion compared with the £11.1 billion forecast by the
Treasury. We forecast a surplus on public sector net borrowing (PSNB) in
2001–02 of £1.6 billion compared with the £1.4 billion deficit forecast in the
November 2001 Pre-Budget Report. In the medium term, the January 2002
IFS forecast is that receipts will be at a similar level to the November 2001
Pre-Budget Report forecast though public spending will be higher.
The government could decide to reduce the level of caution contained in its
fiscal projections. If it did this, then it could finance its new measures (such as
the new tax credits) from increased borrowing, increase spending in 2004–05
and 2005–06 in line with national income and still meet its fiscal rules without
the need to increase taxes in the Budget. Such a strategy would mean that an
unexpected change in government revenues or spending could lead to the
fiscal rules being breached in the future.
Alternatively, the government could decide to budget for a medium-term
current budget surplus of around 0.7% of GDP. This is what the Chancellor
did in the March 2000 Budget and the March 2001 Budget. To restore the
degree of caution to this level and to finance the costs of the new measures
would require the Chancellor to announce new spending cuts or tax increases
of around £5 billion.
This assumes as a baseline that public spending in 2004–05 and 2005–06
grows in line with national income. In its last two Spending Reviews, the
government decided to increase public spending as a share of national income.
Increases in capital spending can be financed by increases in borrowing
without breaching the fiscal rules. Increases in current spending as a share of
national income require the Chancellor either to reduce the caution in his
forecasts or to ensure that tax revenues rise. If the government were to
increase current spending by 2¾% a year, then this would require around an
additional £1 billion each year in borrowing or tax revenues. Therefore to
increase current spending at 2¾% a year in real terms in 2004–05 and 2005–
06, to finance the new measures and to restore the amount of caution in its
plans to the March 2001 Budget level would necessitate new tax increases of
around £7 billion in the Budget. This comprises the £5 billion for restoring
caution, paying for the new measures and keeping spending constant as a
share of national income and an extra £1 billion for each year of increasing
current public spending at 2¾%.
Improving public services?
UK spending on health and schools is relatively low by international
standards. But current increases in health and education spending are
historically large, and are planned to continue at least until March 2004. If
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Green Budget, January 2002
continued substantial spending increases in the health and education budgets
are deemed necessary beyond 2003–04, then one option would be to try to
fund them from savings out of other departments. But this does not look easy
– it seems unlikely that falling unemployment will continue to provide
significant savings on social security, and the claims of many other spending
departments – for example, transport and defence – might be seen as relatively
strong at the moment. It seems likely, therefore, that continued large increases
in health and education spending beyond 2003–04 would need finance from
either increased borrowing or taxation.
Alongside increased public expenditure, the government sees reform of public
services as an important means of improving their quality. In particular, it
hopes that it can find new ways to involve the private sector and so increase
efficiency. Our overview suggests that the arguments for greater private sector
involvement are likely to be strongest in cases where the public sector is
confident in its own ability to anticipate its needs over a long time horizon.
Conversely, the arguments against tying the State into a long-term deal with
the private sector seem most compelling when there is significant uncertainty
about exactly what type of services we will want in the future.
Options for increasing tax
Restoring the level of caution in the public finance forecasts seen in the last
two Budgets and paying for measures under consultation (such as the new tax
credits) would require the Chancellor to raise taxes by around £5 billion.
There may also be a need to fund any increases in public expenditure being
planned for Spending Review 2002. Possible sources of significant extra
revenue in the 2002 Budget are National Insurance and VAT. But the decision
to rule out increases in income tax rates might seem disadvantageous should
the government want to raise significant revenue. For the pledge limits the
potential to increase the single biggest tax, and it does so more severely now
than it did in Labour’s first term, as many of the means used to increase
income tax revenue without changing the rates are now exhausted. It might
also seem disingenuous if income tax rate rises are simulated using National
Insurance. Indeed, the National Insurance option might seem less
distributionally appealing than income tax: National Insurance increases leave
untouched the unearned income of the wealthy and would hit moderately high
earners harder.
Personal tax reforms:
the child tax credit and the working tax credit
The government has promised to announce the rates of two new tax credits –
the child tax credit and the working tax credit – in Budget 2002. These credits
will be introduced in 2003–04, and are likely to have a full-year cost of £2–3
billion a year. In addition, after a worrying lack of public discussion and
openness, many of the operational details may be announced in the Budget.
These details will determine whether the people who the credits are aimed at
understand them and choose to claim them.
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Summary
We explore some options for the initial rates and total exchequer cost. As the
child tax credit is the most direct mechanism the government will have to meet
its child poverty targets, we show by how much the new tax credits could
reduce child poverty. We also discuss what operational details need to be
announced in the Budget and whether the credits will succeed as a new form
of means test.
Tax policy and companies
The government intends to introduce a further R&D tax credit open to larger
firms in Budget 2002. Following the Pre-Budget Report, it issued a further
consultation document on the final design of the credit. Although incremental
credits can be more cost-effective than volume-based credits in terms of
generating additional R&D, they can also introduce considerable complexity
and uncertainty. The government looks likely to opt for a volume-based credit
with relatively low compliance and administrative costs.
The 2001 Pre-Budget Report outlined proposals to pilot new initiatives to
improve the acquisition of basic skills and level 2 qualifications among
employees. This represents a further proposed reform to the provision of postschool education and training, following the introduction and subsequent
withdrawal of Individual Learning Accounts. Few doubt that there is some
role for government in the provision of training. But the government should
clearly identify, and consider evidence on the magnitude of, the market
failures that it is trying to tackle, and develop a policy that addresses these
issues. It is not clear that the current proposals have followed this route. The
piloting of the scheme, with plans for an evaluation of its effectiveness, is
therefore welcome.
Developments in asset-based welfare policy
At the time of the Pre-Budget Report, the Treasury published a consultation
document discussing two proposed asset-based welfare policies – the Saving
Gateway and the Child Trust Fund. These are intended to ‘extend the benefits
of saving and asset-ownership more widely’. The latest round of consultation
on asset-based welfare policies focuses on detailed design issues: on how pilot
versions of the Saving Gateway can be used to test practical elements of the
design of a nationwide policy and on how to organise the market for a
nationwide Child Trust Fund. It seems very likely that the policies will be
rolled out nationally, and it has been argued that they will form a good
complement to existing welfare policies. Increased spending on traditional
forms of welfare provision or State-provided services would also complement
existing provision. It is not clear that spending on matched savings accounts
(the Saving Gateway) represents a better way of supporting lower-income
families than would increasing benefit expenditures or funding more financial
education. Equally, it is not clear that children will be better supported by
being provided with an asset that matures at age 18 (the Child Trust Fund)
rather than by targeted increases in financial support to their families or by
targeted education spending.
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Green Budget, January 2002
A graduate tax for the UK?
The recent interest in a graduate tax continues a long-running, but unresolved,
debate about student finance in the UK. It is unclear whether there is to be a
formal consultation on the issue or whether concrete proposals will appear.
We examine the potential impact of a graduate tax scheme. Graduates tend to
be better off than the average, and to come from families with above-average
incomes. A graduate tax operating through increases in basic and higher rates
of income tax would have progressive effects. But fundamental questions
about whether it would be appropriate to use such a vehicle as a means of
funding higher education remain unanswered, as do many issues about the
design and implementation of such a tax.
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