Options for the 2012 Budget
Carl Emmerson
Presentation at LSE Financial Markets Group,
Taxation Seminar series, London, 12th March 2012
© Institute for Fiscal Studies
Outline
• The fiscal repair job
• The fiscal forecasts
• Key budget issues
– child benefit withdrawal
– raising the personal allowance
– 50p tax rate
– mansion tax
– “tycoon tax”
– pensions tax relief
– devolution of corporation tax
• Conclusions
© Institute for Fiscal Studies
Weak short-term growth thought to reflect a
permanent problem
Comparison of forecasts for real GDP growth and trend GDP
Level of GDP
(Index, actual 2009–10 GDP = 100)
130
125
Actual GDP (Mar 2011)
Potential ("trend") GDP - March 2011
Actual GDP (Nov 2011)
120
115
110
105
Lower growth this year
and forecast for next year
100
2009–10
2010–11
2011–12
2012–13
2013–14
2014–15
2015–16
© Institute for Fiscal Studies
Notes and sources: see Figure 3.2 of The IFS Green Budget: February 2012.
2016–17
Weak short-term growth thought to reflect a
permanent problem
Comparison of forecasts for real GDP growth and trend GDP
Level of GDP
(Index, actual 2009–10 GDP = 100)
130
125
120
Actual GDP (Mar 2011)
Potential ("trend") GDP - March 2011
Actual GDP (Nov 2011)
Potential ("trend") GDP - November 2011
GDP
returns to
trend in
2017–18
3½% loss
of trend
output
115
110
105
Most of this expected to be a
permanent loss of output
100
2009–10
2010–11
2011–12
2012–13
2013–14
2014–15
2015–16
© Institute for Fiscal Studies
Notes and sources: see Figure 3.2 of The IFS Green Budget: February 2012.
2016–17
Weak short-term growth thought to reflect a
permanent problem
Comparison of forecasts for real GDP growth and trend GDP
Level of GDP
(Index, actual 2009–10 GDP = 100)
130
125
120
Actual GDP (Mar 2011)
Potential ("trend") GDP – March 2011
Actual GDP (Nov 2011)
Potential ("trend") GDP – November 2011
Potential ("trend") GDP – March 2008
9½% loss
of trend
output
3½% loss
of trend
output
115
110
105
100
2009–10
2010–11
2011–12
2012–13
2013–14
2014–15
2015–16
© Institute for Fiscal Studies
Notes and sources: see Figure 3.2 of The IFS Green Budget: February 2012.
2016–17
The hole in the public finances
Percentage of national income
55
Total spending (Budget 2008)
Total spending (no action)
Permanent
damage =
7.5% of GDP
(£114bn)
Receipts (Budget 2008)
Receipts (no action)
50
45
40
35
© Institute for Fiscal Studies
Notes and sources: see Figure 3.6 of The IFS Green Budget: February 2012.
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
1999–00
1998–99
1997–98
1996–97
30
The cure (March 2011):
6.6% national income consolidation over 6 years
March 2011: 5.8% national income (£91bn) hole in public finances
Percentage of national income
9
Other current spend
Debt interest
Benefits
Investment
Tax increases
8
7
6
5
75%
4
3
2
1
25%
0
2010–11 2011–12 2012–13 2013–14 2014–15 2015–16 2016–17
© Institute for Fiscal Studies
Notes and sources: see Figure 3.5 of The IFS Green Budget: February 2012.
The cure (November 2011):
Nov 2011: 7.5% national income (£114bn) hole in public finances
Percentage of national income
9
Other current spend
Debt interest
Benefits
Investment
Tax increases
8
7
6
5
4
3
2
1
0
2010–11 2011–12 2012–13 2013–14 2014–15 2015–16 2016–17
© Institute for Fiscal Studies
Notes and sources: see Figure 3.5 of The IFS Green Budget: February 2012.
The cure (November 2011):
8.1% national income consolidation over 7 years
Nov 2011: 7.5% national income (£114bn) hole in public finances
Percentage of national income
9
Other current spend
Debt interest
Benefits
Investment
Tax increases
8
7
6
5
80%
4
3
2
1
20%
0
2010–11 2011–12 2012–13 2013–14 2014–15 2015–16 2016–17
© Institute for Fiscal Studies
Notes and sources: see Figure 3.5 of The IFS Green Budget: February 2012.
% not implemented by Apr 2012
The pain to come
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
© Institute for Fiscal Studies
88%
88%
94%
75%
66%
27%
All fiscal
Tax
Total
Investment
tightening increases spending
cuts
cuts
Benefit
cuts
Other
current
spending
cuts
Source: Author’s calculations using Figure 3.5 of The IFS Green Budget: February 2012.
Spending and revenues brought back to precrisis levels
Percentage of national income
55
Total spending (Budget 2008)
Receipts (Budget 2008)
Receipts (no action)
Total spending (no action)
50
45
40
35
© Institute for Fiscal Studies
Notes and sources: see Figure 3.6 of The IFS Green Budget: February 2012.
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
1999–00
1998–99
1997–98
1996–97
30
Debt back on a more sustainable path
200
180
160
140
120
100
80
60
40
20
0
Debt: Budget 2008
Debt: No policy action
Debt: Current policy
Debt: Current policy – incl. estimated impact of ageing
1974–75
1977–78
1980–81
1983–84
1986–87
1989–90
1992–93
1995–96
1998–99
2001–02
2004–05
2007–08
2010–11
2013–14
2016–17
2019–20
2022–23
2025–26
2028–29
2031–32
2034–35
2037–38
2040–41
Percentage of national income
- but to remain above pre-crisis levels for a generation
© Institute for Fiscal Studies
Notes and sources: see Figure 3.3 of The IFS Green Budget: February 2012.
Can the tight spending plans be delivered?
• Such cuts to public service spending not done in the UK before
– never more than 2 consecutive years of cuts previously
– spending plans imply April 2010 to March 2017 will be the tightest 7
years for public service spending since WWII
• Only comparable international experience is Ireland in late 1980s
• On the other hand cuts follow a period of big spending increases
– 12 consecutive years of real increases (1998–99 to 2009–10)
– by 2016–17 total public service spending will be the same as in
2004–05 in real terms (2000–01 as a % of national income)
© Institute for Fiscal Studies
7-year
6-year squeeze on public service spending
16.2% cut
over 7 years
9.3% cut
over 7 years
10
5
0
ConLib
Historic
1980–81
Labour
1970–71
-5
7 year moving average
© Institute for Fiscal Studies
Note: Figure shows total public spending less spending on welfare
benefits and debt interest.
2015–16
2010–11
2005–06
2000–01
1995–96
1990–91
1985–86
1975–76
1965–66
1960–61
1955–56
-10
1950–51
Annual percentage real increase
15
Can the tight spending plans be delivered?
400
350
300
250
200
Public service
spending
150
100
50
1998–99
1999–00
2000–01
2001–02
2002–03
2003–04
2004–05
2005–06
2006–07
2007–08
2008–09
2009–10
2010–11
2011–12
2012–13
2013–14
2014–15
2015–16
2016–17
Real spending (1998-99 = 100)
- How tight will they feel?
© Institute for Fiscal Studies
Notes and sources: see Figure 3.12 of The IFS Green Budget: February 2012.
Can the tight spending plans be delivered?
400
ODA
350
Health
300
Transport
250
200
Public service
spending
150
Education
100
50
1998–99
1999–00
2000–01
2001–02
2002–03
2003–04
2004–05
2005–06
2006–07
2007–08
2008–09
2009–10
2010–11
2011–12
2012–13
2013–14
2014–15
2015–16
2016–17
Real spending (1998-99 = 100)
- How tight will they feel?
Public order
and safety
Defence
© Institute for Fiscal Studies
Notes and sources: see Figure 3.12 of The IFS Green Budget: February 2012.
Can the tight spending plans be delivered?
400
ODA
350
Health
300
Transport
250
200
Public service
spending
150
Education
100
50
1998–99
1999–00
2000–01
2001–02
2002–03
2003–04
2004–05
2005–06
2006–07
2007–08
2008–09
2009–10
2010–11
2011–12
2012–13
2013–14
2014–15
2015–16
2016–17
Real spending (1998-99 = 100)
- How tight will they feel?
Public order
and safety
Defence
© Institute for Fiscal Studies
Notes and sources: see Figure 3.12 of The IFS Green Budget: February 2012.
Can the tight spending plans be delivered?
400
ODA
350
Health
300
Transport
250
200
Public service
spending
150
Education
100
50
1998–99
1999–00
2000–01
2001–02
2002–03
2003–04
2004–05
2005–06
2006–07
2007–08
2008–09
2009–10
2010–11
2011–12
2012–13
2013–14
2014–15
2015–16
2016–17
Real spending (1998-99 = 100)
- How tight will they feel?
Public order
and safety
Defence
© Institute for Fiscal Studies
Notes and sources: see Figure 3.12 of The IFS Green Budget: February 2012.
This year’s public finances
• Current budget deficit and public sector net borrowing
– PSNB: £124.2 billion (8.2% of national income)
– CB deficit: £95.6 billion (6.3% of national income)
• £2.9 billion lower than forecast by the OBR
• Current spending: £3.3 billion lower than forecast by OBR
– expect underspend by central government departments
© Institute for Fiscal Studies
And over the medium term
• Current budget
– strengthens from 6.3% of national income deficit in 2011–12 to 0.4%
surplus by 2016–17
– 0.6ppt from increasing tax burden as share of national income
– 6.2ppt from lower spending as share of national income
• Public sector net borrowing
– falls from 8.2% of national income to 0.6% of national income
• Borrowing in 2016–17
– 0.6% of national income (£9 billion) lower than forecast by the OBR
– (compares to 1.6% of national income increase in OBR’s forecast for
underlying borrowing in 2016–17 between March and November
2011)
© Institute for Fiscal Studies
Budget judgement: medium-term
• Forecasts more optimistic than OBR
– but risks skewed to the downside
– and longer-term pressures of ageing population loom
• So no significant medium-term net giveaway in the March Budget
• Revenue-neutral changes to tax and benefit system should be
made that would boost economic growth
• Government should hold Spending Review by autumn 2013
– in light of evidence on impact of cuts over this SR period
– revise plans for 2014–15
– set out spending plans for 2015–16 and 2016–17
– (taking advantage of any fiscal good news then)
© Institute for Fiscal Studies
Budget judgement: short-term
• Some fiscal stimulus done in Autumn Statement 2011
– revenue neutral but slightly growth enhancing reallocation of
spending
– no attempt to offset short-term rise in borrowing resulting from
weaker economic outlook
© Institute for Fiscal Studies
Budget judgement: short-term
• Some fiscal stimulus done in Autumn Statement 2011
• Case for taking this significantly further stronger than a year ago
– short-term economic outlook has worsened
– risk of monetary policy being tighter in response is now much lower
• But still not clear cut
– £740 billion of new debt to be issued over next five years
– important that interest rates on government borrowing remain low
• Any stimulus measures should be: Timely, Targeted, Temporary
– temporary VAT cut; temporary cut to employers’ NICs
– investment spending boost
© Institute for Fiscal Studies
Particular policies
• Child benefit withdrawal
• Raising the personal allowance
• 50p tax rate
• Mansion tax
• “Tycoon tax”
• Pensions tax relief
• Devolution of corporation tax
© Institute for Fiscal Studies
Child benefit withdrawal
• Child benefit costs £12 billion a year
– worth £1,056 p.a. for first child, £697 for each subsequent one
• From January 2013, Government plans to remove from families
containing higher rate taxpayer
– HMT estimated saving of about £2.4 billion in 2013–14
– will affect about 1.5 million families (average annual loss of £1,570)
• Will lead to many administrative challenges
• Policy creates a cliff edge
– 170k families could increase net income by reducing taxable income
– 200k families could get lower net income after rise in taxable income
© Institute for Fiscal Studies
The cliff-edge, illustrated
Budget constraint for example one-earner family with two children, 2013-14
£40,000
No CB withdrawal
Net income, £ per year
Government proposal
£35,000
Higher net income in this
region than if just above
higher rate threshold
Lower net income in this
region than if just below
higher rate threshold
£30,000
Crossing higher rate
threshold triggers loss of
£1,753 per year in CB
£25,000
£35,000
£38,000
£41,000
£44,000
£47,000
Gross income, £ per year
© Institute for Fiscal Studies
Notes and sources: see Figure 11.1 of The IFS Green Budget: February 2012.
£50,000
Child benefit withdrawal
• Child benefit costs £12 billion a year
– worth £1,056 p.a. for first child, £697 for each subsequent one
• From January 2013, Government plans to remove from families
containing higher rate taxpayer
– HMT estimated saving of about £2.4 billion in 2013–14
– will affect about 1.5 million families (average annual loss of £1,570)
• Will lead to many administrative challenges
• Policy creates a cliff edge
– 170k families could increase net income by reducing taxable income
– 200k families could get lower net income after rise in taxable income
• And affects one earner couple much more than two earners
• These are major problems of efficiency and equity
– why not use the tax credit system?
© Institute for Fiscal Studies
Personal allowance
• Currently stands at £7,475, due to rise by £630 (£210 more than
inflation) in April 2012
• Nick Clegg has said that the coalition agreement’s aspiration to
increase it to £10,000 will be met before the next general election
Year £10,000 personal allowance
introduced
Annual cost to the Exchequer
2012–13
£8.9bn
2013–14
£7.7bn
2014–15
£6.5bn
2015–16
£5.3bn
• Could reduce cost to £3.3bn by reducing higher rate threshold
– would lead to 600,000 additional higher rate income taxpayers,
200,000 of whom would (effectively) lose child benefit
© Institute for Fiscal Studies
£700
1.4%
£600
1.2%
£500
1.0%
£400
0.8%
£300
0.6%
£200
0.4%
£100
0.2%
£0
0.0%
Poorest 2
3
4
5
6
7
8
9 Richest
Income decile group
Annual cash gain (left axis)
All
Gain as a % of income (right axis)
© Institute for Fiscal Studies
Source: Browne (2012) http://www.ifs.org.uk/publications/6045
Gain as % of net income
Average annual cash gain per family
Perhaps not as progressive as you might think
£700
1.4%
£600
1.2%
£500
1.0%
£400
0.8%
£300
0.6%
£200
0.4%
£100
0.2%
£0
0.0%
Poorest 2
3
4
5
6
7
8
9 Richest
Income decile group
Annual cash gain (left axis)
All
Gain as a % of income (right axis)
© Institute for Fiscal Studies
Source: Browne (2012) http://www.ifs.org.uk/publications/6045
Gain as % of net income
Average annual cash gain per family
Perhaps not as progressive as you might think
50p tax rate
• We really don’t know what effect it will have on revenues or on
behaviour
• Treasury’s current estimate that it will raise £2.6 billion already
assumes £4 billion lost to behaviour change
– and that is on optimistic side
• HMRC have been asked to report on revenue effects for this
budget
– they won’t yet be able to give a clear answer: change in receipts
between 2009–10 and 2010–11 might give a distorted view of the
long-run impact of the tax
• And of course it’s not just revenue that matters
© Institute for Fiscal Studies
A mansion tax?
• Not likely to raise significant sums
– Liberal Democrat manifesto proposed a 1% tax on the value of
homes in excess of £2m: they estimated this would raise £1.7bn
with 70,000 households affected so an average annual bill of £24k
– only 126,000 Band H households in England: taking the highest
value half and giving them an annual bill of £16k would only yield
£1bn a year
• Higher tax on expensive properties may make some sense
– council tax is still based on relative values in 1991 and is regressive
because payments rise less quickly than the value of the property
and the payments are capped
• But wider reform preferable
– Mirrlees Review proposed replacing SDLT and council tax with a
proportional domestic property tax based on up-to-date valuations
© Institute for Fiscal Studies
A tycoon tax?
• Aimed at those with very high incomes paying low amounts of
tax
– through taking income as capital gains and incorporation
• In 2009–10 16,000 individuals had income over £1 million
– they paid an average of £860,000 in income tax which is an average
rate of 34.8%
• Setting a minimum tax rate still requires the taxbase to be
defined
• If particular reliefs and allowances are deemed too generous
better to reform those directly
– analogous to the benefits cap
© Institute for Fiscal Studies
Restricting tax relief on private pension
contributions
• Private pension saving is relatively tax favoured for many
individuals
– in particular 25% of the fund can be taken as lump-sum tax free
• Annual limit on contributions is £50,000 (from April 2011) and
lifetime limit on fund is £1.5m (from April 2012)
• Speculation £50,000 limit might be reduced
– difficult to estimate revenue raised
– losers would be lifetime rich and others wanting to make large
contributions prior to retirement (self-employed selling their business)
• Pension relief is overly generous to wealthy individuals as up to
£375,000 can be taken free of income tax
• Better to reduce the lifetime limit rather than the annual allowance
– even better to limit generosity of tax-free lump sum
© Institute for Fiscal Studies
Devolution of corporation tax
• We expect a decision of devolution of corporation tax rate to
Northern Ireland in 2012
– if devolved, seems likely that Wales and (especially) Scotland would
want the option to follow suit
• Uncertainty over the size of the effect on investment and whether
sufficient to outweigh revenue losses (and associated spending
cuts)
• Certain to be large administration and compliance costs
• Implementing devolution would at best be a calculated risk, with
unknown long-term consequences for the UK tax system
© Institute for Fiscal Studies
Tax reform for growth
• Tax system remains complex and distortionary
• We can improve it in many ways which are good for welfare
– stamp duty on property, uniform VAT
• We can improve it to promote growth
– support work incentives for those we know are responsive (over 55s
and mothers of school age children)
– reform corporation tax so as to avoid taxing the “normal” return
– replace business rates with a business land value tax
– introduce congestion charging
– rationalise environmental taxes
• Requires a long term strategy
© Institute for Fiscal Studies
Summary
• Apparent hole in the public finances has increased by £114
billion (7.5% of national income) since the start of the financial
crisis
• Planned fiscal consolidation: 8.1% of national income (£123
billion) over the 7 years to 2016–17
– including spending cuts on an unprecedented scale
• Borrowing this year and in medium term may end up a little
below OBR forecasts
– but great uncertainty and downside risks limit room for manoeuvre
• Chancellor also needs to get the micro-economics of tax and
spending right
– a spending review by Autumn 2013 is needed
– as is a tax strategy
© Institute for Fiscal Studies
Options for the 2012 Budget
Carl Emmerson
Presentation at LSE Financial Markets Group,
Taxation Seminar, London, 12th March 2012
© Institute for Fiscal Studies