The public finances
Robert Chote
Carl Emmerson
Christine Frayne
Outline
• Fiscal policy framework
• the fiscal rules
• assessment over the economic cycle
• potential reform to the fiscal policy framework
• Green Budget forecasts
• short and medium-term fiscal projections
• risks
• budget judgement
© Institute for Fiscal Studies 2005
The Chancellor’s fiscal rules
• ‘Golden rule’
• only borrow to invest
• judged over the economic cycle
• Sustainable investment rule
• net debt below 40% of national income
© Institute for Fiscal Studies 2005
Meeting the golden rule?
Percentage of national income
2.5
£19.6bn
Actual
£20.5bn
2.0
HM Treasury December 2004 Pre-Budget
Report forecast
1.5
£9.4bn
1.0
0.5
0.0
-0.5
–£6.9bn
-1.0
-1.5
–£12.5bn
–£13.9bn
-2.0
–£20.7bn
-2.5
1999–2000 2000–01
© Institute for Fiscal Studies 2005
2001–02
2002–03 2003–04
Financial year
2004–05
2005–06
Recent forecasting errors
Percentage of national income
2.5
Treasury estimates of current budget surplus
Previous year’s Budget
In-year Pre-Budget Report
Actual
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
1999–2000
© Institute for Fiscal Studies 2005
2000–01
2001–02
2002–03
Financial year
2003–04
2004–05
Probability of meeting golden rule
Will the golden rule be met? (1)
100%
80%
60%
50/50 chance
1yr remaining
2yrs remaining
3yrs remaining
4yrs remaining
40%
20%
0%
-0.5-0.4-0.3-0.2-0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4
Expected average CB surplus over cycle (% of GDP)
© Institute for Fiscal Studies 2005
Probability of meeting golden rule
Will the golden rule be met? (1)
100%
80%
Budget 2002
60%
50/50 chance
1yr remaining
2yrs remaining
3yrs remaining
4yrs remaining
40%
20%
0%
-0.5-0.4-0.3-0.2-0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4
Expected average CB surplus over cycle (% of GDP)
© Institute for Fiscal Studies 2005
Probability of meeting golden rule
Will the golden rule be met? (1)
100%
Budget 2003
80%
Budget 2002
60%
50/50 chance
1yr remaining
2yrs remaining
3yrs remaining
4yrs remaining
40%
20%
0%
-0.5-0.4-0.3-0.2-0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4
Expected average CB surplus over cycle (% of GDP)
© Institute for Fiscal Studies 2005
Probability of meeting golden rule
Will the golden rule be met? (1)
100%
Budget 2003
80%
Budget 2002
Budget 2004
60%
50/50 chance
1yr remaining
2yrs remaining
3yrs remaining
4yrs remaining
40%
20%
0%
-0.5-0.4-0.3-0.2-0.1 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4
Expected average CB surplus over cycle (% of GDP)
© Institute for Fiscal Studies 2005
Probability of meeting golden rule
Will the golden rule be met? (2)
100%
50/50 chance
Forecasting error one-off
80%
Forecasting error persists
Pre-Budget
Report forecast
60%
40%
20%
0%
-3.0 -2.8 -2.6 -2.4 -2.2 -2.0 -1.8 -1.6 -1.4 -1.2 -1.0 -0.8 -0.6 -0.4 -0.2 0.0
Current budget surplus in 2004–05
© Institute for Fiscal Studies 2005
Stress testing the golden rule
Central case
Cautious case
Financial year
© Institute for Fiscal Studies 2005
09–10
08–09
07–08
06–07
05–06
04–05
Next cycle?
03–04
02–03
01–02
Current cycle?
00–01
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
-2.5
99–00
Percentage of national income
Cyclically adjusted current budget surplus,
as a share of national income
Stress testing the golden rule
Central case
Cautious case
Financial year
© Institute for Fiscal Studies 2005
09–10
08–09
07–08
06–07
05–06
04–05
03–04
02–03
01–02
Next cycle?
00–01
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
-2.5
99–00
Percentage of national income
Cyclically adjusted current budget surplus,
as a share of national income
The Chancellor’s fiscal rules
• ‘Golden rule’
• only borrow to invest
• judged over the economic cycle
• Sustainable investment rule
• net debt below 40% of national income
© Institute for Fiscal Studies 2005
Financial year
© Institute for Fiscal Studies 2005
09–10
08–09
07–08
06–07
05–06
04–05
03–04
02–03
01–02
00–01
99–00
98–99
97–98
96–97
95–96
94–95
93–94
50.0
45.0
40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0
Actual
40% ceiling
PBR 04
Budget 02
92–93
Percentage of national income
Meeting the investment rule?
60.0
50.0
Central
40.0
30.0
Ceiling
20.0
Financial year
© Institute for Fiscal Studies 2005
08–09
07–08
06–07
05–06
04–05
03–04
02–03
01–02
0.0
00–01
10.0
99–00
Percentage of national income
Will the investment rule be met?
60.0
20%
50.0
40.0
Central
30.0
20%
20.0
Ceiling
Financial year
© Institute for Fiscal Studies 2005
08–09
07–08
06–07
05–06
04–05
03–04
02–03
01–02
0.0
00–01
10.0
99–00
Percentage of national income
Will the investment rule be met?
60.0
40%
50.0
20%
40.0
Central
30.0
20%
40%
20.0
Ceiling
Financial year
© Institute for Fiscal Studies 2005
08–09
07–08
06–07
05–06
04–05
03–04
02–03
01–02
0.0
00–01
10.0
99–00
Percentage of national income
Will the investment rule be met?
60.0
60%
40%
20%
Central
20%
40%
60%
Ceiling
50.0
40.0
30.0
20.0
Financial year
© Institute for Fiscal Studies 2005
08–09
07–08
06–07
05–06
04–05
03–04
02–03
01–02
0.0
00–01
10.0
99–00
Percentage of national income
Will the investment rule be met?
60.0
80%
60%
40%
20%
Central
20%
40%
60%
80%
Ceiling
50.0
40.0
30.0
20.0
Financial year
© Institute for Fiscal Studies 2005
08–09
07–08
06–07
05–06
04–05
03–04
02–03
01–02
0.0
00–01
10.0
99–00
Percentage of national income
Will the investment rule be met?
Reforming the fiscal framework
• Golden rule
• intergenerational fairness
• asymmetric target
• retrospective v forward-looking measure
• Net debt rule
• off balance sheet activities
• 40% debt ceiling too high?
• 40% debt ceiling too low?
© Institute for Fiscal Studies 2005
Potential institutional reform
Fiscal policy delegation
Audited
assumptions
No
delegation
Rule
compliance
Status quo
© Institute for Fiscal Studies 2005
Budget
approval
Full tax
powers
Limited tax
powers
All fiscal
policy
Sets fiscal
rules
Outline
• Fiscal policy framework
• the fiscal rules
• assessment over the economic cycle
• potential reform to the fiscal policy framework
• Green Budget forecasts
• short and medium-term fiscal projections
• risks
• budget judgement
© Institute for Fiscal Studies 2005
Green budget forecasts
• Current economic cycle
• golden rule to be met or missed by a small margin
• sustainable investment rule to be met
• Next economic cycle
• golden rule more likely than not to be missed
• 50/50 chance of debt exceeding 40% in 2008–09
• Budget judgement
• to restore caution to the level sought in last Budget
would require a tax increase of at least £11bn
© Institute for Fiscal Studies 2005
Forecasts for 2004–05
£ billion
Current receipts
© Institute for Fiscal Studies 2005
PBR
Dec. 2004
GB
Jan. 2005
Difference
451.0
449.6
–1.4
Forecasts for 2004–05
£ billion
PBR
Dec. 2004
GB
Jan. 2005
Difference
Current receipts
451.0
449.6
–1.4
Current expenditure
463.5
465.5
+2.0
© Institute for Fiscal Studies 2005
Forecasts for 2004–05
£ billion
PBR
Dec. 2004
GB
Jan. 2005
Difference
Current receipts
451.0
449.6
–1.4
Current expenditure
463.5
465.5
+2.0
Current budget surplus
–12.5
–15.9
–3.4
© Institute for Fiscal Studies 2005
Forecasts for 2004–05
£ billion
PBR
Dec. 2004
GB
Jan. 2005
Difference
Current receipts
451.0
449.6
–1.4
Current expenditure
463.5
465.5
+2.0
Current budget surplus
–12.5
–15.9
–3.4
Net investment
21.7
18.5
–3.2
PSNB
34.2
34.4
+0.2
© Institute for Fiscal Studies 2005
Baseline assumptions
• Economy performs as Treasury expects
• Contingency reserve reset to usual levels
• Current spending to remain constant as a
share of national income beyond March 2008
• Corporation Tax receipts return to long-run
average share of national income
© Institute for Fiscal Studies 2005
Treasury forecast optimistic?
350
Corporate tax receipts
Stockmarket profits
300
Index, 1987 = 100
Morgan Stanley profits forecast
250
HM Treasury CT forecast
200
150
100
50
© Institute for Fiscal Studies 2005
Analysis by Graham Secker, Morgan Stanley Research
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
0
Percentage of national income
Receipts forecasts
42.0
Treasury December 2004 Pre-Budget Report forecast
41.0
Green Budget January 2005 forecast
40.0
39.0
38.0
37.0
36.0
35.0
99–00 00–01 01–02 02–03 03–04 04–05 05–06 06–07 07–08 08–09 09–10
Financial year
© Institute for Fiscal Studies 2005
Percentage of national income
Current spending forecasts
42.0
Treasury December 2004 Pre-Budget Report forecast
41.0
Green Budget January 2005 forecast
40.0
39.0
38.0
37.0
36.0
35.0
99–00 00–01 01–02 02–03 03–04 04–05 05–06 06–07 07–08 08–09 09–10
Financial year
© Institute for Fiscal Studies 2005
Meeting the golden rule?
Percentage of national income
3.0
Cyclically adjusted current budget balance
HM Treasury, Pre-Budget Report, December 2004
Green Budget, 'cautious' assumptions
Green Budget, Morgan Stanley central case
Green Budget, Morgan Stanley 'worse scenario'
2.0
1.0
0.0
-1.0
-2.0
-3.0
01–02
02–03
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03–04
04–05 05–06 06–07
Financial year
07–08
08–09
09–10
Budget judgement
Percentage of national income
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
Green Budget, 'cautious' scenario, current budget surplus
-2.5
2004–05
© Institute for Fiscal Studies 2005
2005–06
2006–07 2007–08
Financial year
2008–09
2009–10
Budget judgement
Percentage of national income
2.5
2.0
1.5
1. surplus of 0.0% in 2006–07 = £11bn
surplus of 0.3% in 2007–08 = £13bn
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
Green Budget, 'cautious' scenario, current budget surplus
-2.5
2004–05
© Institute for Fiscal Studies 2005
2005–06
2006–07 2007–08
Financial year
2008–09
2009–10
Budget judgement
Percentage of national income
2.5
2.0
2. surplus of 0.7% in 2009–10 = £12bn
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
Green Budget, 'cautious' scenario, current budget surplus
-2.5
2004–05
© Institute for Fiscal Studies 2005
2005–06
2006–07 2007–08
Financial year
2008–09
2009–10
Budget judgement
Percentage of national income
2.5
2.0
1.5
3. 50/50 chance over 7 year cycle
starting in 2006–07 = £5½bn
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
Green Budget, 'cautious' scenario, current budget surplus
-2.5
2004–05
© Institute for Fiscal Studies 2005
2005–06
2006–07 2007–08
Financial year
2008–09
2009–10
Budget judgement
Percentage of national income
2.5
2.0
1.5
1.0
0.5
3. 50/50 chance over 7 year cycle
starting in 2006–07 = £5½bn
4. 50/50 chance over 7 year cycle
starting in 2005–06 = £8bn
0.0
-0.5
-1.0
-1.5
-2.0
Green Budget, 'cautious' scenario, current budget surplus
-2.5
2004–05
© Institute for Fiscal Studies 2005
2005–06
2006–07 2007–08
Financial year
2008–09
2009–10
Impact on current budget surplus, % of
national income
Conservatives’ proposals
2.5
2.0
1.5
0.0%
0.2%
Proposed tax cut
0.5%
0.8%
1.1%
1.7%
2010–11
2011–12
Proposed spending cut
1.0
0.5
0.0
-0.5
2006–07
© Institute for Fiscal Studies 2005
2007–08
2008–09
2009–10
Financial year
Conclusion
• Over the current cycle
• golden rule should be met if cycle ends in 2004–05
• 33% chance of success if cycle ends in 2005–06
• Over the next cycle
• length of next cycle crucial, but
• at least £11bn tax increase for caution to be restored
to levels recently sought by the Chancellor
• smaller tax increases would be required if a 50/50
chance of success were acceptable
© Institute for Fiscal Studies 2005