IFS
The public finances
Christine Frayne
Institute for Fiscal Studies
www.ifs.org.uk
Public finances overview
• The framework within which public finance
decisions are made in the UK
• Go over numbers
• Illustrate theoretical issues
© Institute for Fiscal Studies, 2007
Public finances overview 2
• Politically the public finances are closely
watched
– Overall:
• Borrowing
• Debt
– Constituent parts:
• Receipts (tax revenues)
• Spending
• Why do we care about these?
© Institute for Fiscal Studies, 2007
Why do we care about the levels of
public finances figures?
• Revenues (taxes)
– Personal
– Macroeconomic
• Borrowing
– Indicator of sustainability
– Political economy
– Inflation
© Institute for Fiscal Studies, 2007
• Spending
– Services/redistribution
– Crowding out/efficiency
• Debt
– Sustainability
– Debt repayments
– Hedging of risks/ safe
borrowing
Constraints on borrowing and
debt
• UK: Code for fiscal stability and fiscal rules
• Common in other OECD countries
– Stability and growth pact
• Credibility
© Institute for Fiscal Studies, 2007
Determining fiscal policy – The
fiscal rules (1)
• The Golden Rule: the government will borrow
only to invest.
– Intergenerational equity
– Borrowing smaller or equal to capital spending
– Surplus on current budget
• By definition: Current budget = revenues – current spending
– Assessed over the economic cycle
• Backward looking versus forward looking
© Institute for Fiscal Studies, 2007
Determining fiscal policy – The
fiscal rules (2)
• Sustainable investment rule: Ratio of net public
sector debt to GDP set at “stable & prudent level”
- 40%.
– Sustainability
– Again assessed over the cycle for the moment
• Optimal?
– Crude capital/current split
– Level for debt
– No direct relationship between MC and MB
© Institute for Fiscal Studies, 2007
Meeting the golden rule?
Current budget surplus as a share of GDP, 1966-67 to 2005-06
10
8
6
Forecasts
% GDP
4
2
0
-2
-4
-6
-8
1966-67
1971-72
1976-77
1981-82
1986-87
1991-92
1996-97
2001-02
2006-07
© Institute for Fiscal Studies, 2007
Note: HM Treasury forecasts, excluding the windfall tax and associated spending
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
Actual
-3.0
-4.0
11–12
10–11
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
Pre-Budget Report 2006 forecast
96–97
Percentage of national income
Current budget balance
© Institute for Fiscal Studies, 2007
Source: HM Treasury
5.0
PBR 2006 cycle = 0.1% of GDP or +£8.4bn
4.0
3.0
2.0
1.0
0.0
-1.0
11–12
10–11
09–10
08–09
07–08
06–07
05–06
04–05
03–04
02–03
01–02
00–01
Pre-Budget Report 2006 forecast
99–00
-4.0
98–99
Actual
97–98
-2.0
-3.0
96–97
Percentage of national income
Current budget balance
© Institute for Fiscal Studies, 2007
Source: HM Treasury
A changing cycle?
2.0
% of potential output
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
Budget 05: 7 year cycle
-2.0
2010Q1
2009Q1
2008Q1
2007Q1
2006Q1
2005Q1
2004Q1
2003Q1
2002Q1
2001Q1
2000Q1
1999Q1
1998Q1
1997Q1
1996Q1
1995Q1
-2.5
© Institute for Fiscal Studies, 2007
Source: HM Treasury ; Morgan Stanley
A changing cycle?
2.0
PBR 05 and Budget 06: 12 year cycle
% of potential output
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
Budget 05: 7 year cycle
-2.0
2010Q1
2009Q1
2008Q1
2007Q1
2006Q1
2005Q1
2004Q1
2003Q1
2002Q1
2001Q1
2000Q1
1999Q1
1998Q1
1997Q1
1996Q1
1995Q1
-2.5
© Institute for Fiscal Studies, 2007
Source: HM Treasury ; Morgan Stanley
A changing cycle?
2.0
PBR 05 and Budget 06: 12 year cycle
1.0
0.5
0.0
-0.5
-1.0
-1.5
Budget 05: 7 year cycle
-2.0
2010Q1
2009Q1
2008Q1
2007Q1
2006Q1
2005Q1
2004Q1
2003Q1
2002Q1
2001Q1
1998Q1
1997Q1
1996Q1
1995Q1
1999Q1
PBR 06: 10 year cycle
-2.5
2000Q1
% of potential output
1.5
© Institute for Fiscal Studies, 2007
Source: HM Treasury ; Morgan Stanley
Meeting the sustainable
investment rule
Net debt (% GDP)
90
70
50
30
10
-10
Net debt
PSNB
PSNB (% GDP)
9
6
3
0
-30
-3
1970- 1975- 1980- 1985- 1990- 1995- 2000- 2005- 201011
06
01
96
91
86
81
76
71
© Institute for Fiscal Studies, 2007
Revenues and spending
45
44
Percentage of GDP
43
Receipts
44.5
Expenditure
42.5
41.9
42.6
42
41
40.8
40
39
40.4
39.7
39.6
38.8
38
37.3
37
36
37.2
37.1
36.0
35
91- 92- 93- 94- 95- 96- 97- 98- 99- 00- 01- 02- 03- 04- 05- 06- 07- 08- 09- 10- 1192 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Year
© Institute for Fiscal Studies, 2007
Note: HM Treasury forecasts, excluding the windfall tax and associated spending
Changes in the tax burden
• The Cycle
• Higher denominator
• Taxes more cyclical
• GDP growth
• Fiscal drag: progressivity of
tax system
• Direct intervention
• Discretionary measures
• Change in the tax base
© Institute for Fiscal Studies, 2007
• Shocks to tax base: e.g.
industry / North Sea Oil
Why have tax revenues gone up?
% of national income Cash equivalent (£bn)
Announcements
Conservative
+0.7
+10.0
Labour 1st term
–0.2
–3.0
Labour 2nd term
+1.0
+14.3
Labour 3rd term
+0.4
+6.2
All announcements
+2.0
+27.5
Total
+2.9
+40.5
© Institute for Fiscal Studies, 2007
Note: Increase between 1996–97 and 2007–08
Why have tax revenues gone up?
% of national income Cash equivalent (£bn)
Announcements
Conservative
+0.7
+10.0
Labour 1st term
–0.2
–3.0
Labour 2nd term
+1.0
+14.3
Labour 3rd term
+0.4
+6.2
All announcements
+2.0
+27.5
Fiscal drag
+2.2
+30.3
Total
+2.9
+40.5
© Institute for Fiscal Studies, 2007
Note: Increase between 1996–97 and 2007–08
Why have tax revenues gone up?
% of national income Cash equivalent (£bn)
Announcements
Conservative
+0.7
+10.0
Labour 1st term
–0.2
–3.0
Labour 2nd term
+1.0
+14.3
Labour 3rd term
+0.4
+6.2
All announcements
+2.0
+27.5
Fiscal drag
+2.2
+30.3
Economic cycle
+0.2
+2.9
Total
+2.9
+40.5
© Institute for Fiscal Studies, 2007
Note: Increase between 1996–97 and 2007–08
Why have tax revenues gone up?
% of national income Cash equivalent (£bn)
Announcements
Conservative
+0.7
+10.0
Labour 1st term
–0.2
–3.0
Labour 2nd term
+1.0
+14.3
Labour 3rd term
+0.4
+6.2
All announcements
+2.0
+27.5
Fiscal drag
+2.2
+30.3
Economic cycle
+0.2
+2.9
Other
–1.5
–20.1
Total
+2.9
+40.5
© Institute for Fiscal Studies, 2007
Note: Increase between 1996–97 and 2007–08
IFS
The public finances
Christine Frayne
Institute for Fiscal Studies
www.ifs.org.uk
Total Managed Expenditure
Capital/Current budgets planned separately
• Annually managed expenditure
– social security payments
– debt interest
– devolved parliaments
– autonomous local gov.
© Institute for Fiscal Studies, 2007
• Departmental Expenditure
Limits
– 3 year spending rounds:
CSR July 98, SR 2000, SR
2002, SR 2004 and CSR 07
expected for 2008-09, 08-10
and 10-11
– Already have ideas
50
48
46
44
42
40
38
36
34
32
30
Real increase (LH axis)
11–12
10–11
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
Level (RH axis)
Percentage of national
income
8
7
6
5
4
3
2
1
0
-1
-2
96–97
Percentage real increase
Total Managed Expenditure
Financial year
© Institute for Fiscal Studies, 2007
Source: HM Treasury
A challenging spending review?
Av. annual increase (%)
2007 CSR
© Institute for Fiscal Studies, 2007
Current
Capital
Total
+1.9?
+2.7
+2.0?
A challenging spending review?
Av. annual increase (%)
Current
Capital
Total
+1.9?
+2.7
+2.0?
April 1999 to March 2008
+3.6
+15.6
+4.0
April 1997 to March 1999
–0.3
+6.7
–0.2
2007 CSR
Labour
© Institute for Fiscal Studies, 2007
A challenging spending review?
Av. annual increase (%)
Current
Capital
Total
+1.9?
+2.7
+2.0?
April 1999 to March 2008
+3.6
+15.6
+4.0
April 1997 to March 1999
–0.3
+6.7
–0.2
+1.7
–4.9
+1.5
2007 CSR
Labour
Conservatives
April 1979 to March 1997
© Institute for Fiscal Studies, 2007
What might the trade-off be?
• Health spending
– Wanless Review recommended minimum 4.4%
annual growth in spending
• Education spending
– State school spending per pupil to match that in
the private sector in 2005–06
• Child poverty
– £4½ billion needed to meet 2010–11 target
© Institute for Fiscal Studies, 2007
What increases might we have?
Total Managed Expenditure
2.0
TME after refilling margin
1.8
Of which:
Home office
0.0
-5.0
9 smaller departments
-3.5
Department for Constitutional Affairs
Official Development Assistance
11.2
Debt interest
2.0
Social security and tax credits
1.6
Non NHS, non-education
NHS and education
-6 -5 -4 -3 -2 -1
0
1
2
3
4
5
6
7
8
9 10 11 12 13
Percentage real increase
© Institute for Fiscal Studies, 2007
Source: HM Treasury ; IFS
What increases might we have?
Total Managed Expenditure
2.0
TME after refilling margin
1.8
Of which:
Home office
0.0
-5.0
9 smaller departments
-3.5
Department for Constitutional Affairs
Official Development Assistance
11.2
Debt interest
2.0
Social security and tax credits
Non NHS, non-education
2.5
0.0
NHS and education
-6 -5 -4 -3 -2 -1
3.3
0
1
2
3
4
5
6
7
8
9 10 11 12 13
Percentage real increase
© Institute for Fiscal Studies, 2007
Source: HM Treasury ; IFS
IFS
The public finances
Christine Frayne
Institute for Fiscal Studies
www.ifs.org.uk