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The public finances and the age
of austerity
Robert Chote
Society of Business Economists, 23 June 2009
© Institute for Fiscal Studies
Outline
• The big picture
– How much have the public finances deteriorated and why?
– How big is the planned tightening and what will it achieve?
• The tightening in more detail
– How tight is the spending squeeze?
– How might the cake be cut?
– What contribution do tax increases make?
• Conclusions
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The problem: more borrowing, mostly structural
Public sector net borrowing in Budget 2009, excluding PBR and Budget policy
measures
Sources: HM Treasury; IFS calculations; figures may not add due to rounding.
© Institute for Fiscal Studies
The problem: more borrowing, mostly structural
Public sector net borrowing in Budget 2009, excluding PBR and Budget policy
measures
Sources: HM Treasury; IFS calculations; figures may not add due to rounding.
© Institute for Fiscal Studies
The problem: more borrowing, mostly structural
Public sector net borrowing in Budget 2009, excluding PBR and Budget policy
measures
Sources: HM Treasury; IFS calculations; figures may not add due to rounding.
© Institute for Fiscal Studies
Why has the structural deficit risen so much?
• Long-term productive potential of economy assumed 5% lower
– Increases structural deficit by roughly 3.5% of GDP (£50+ billion)
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A bust without a boom?
6
Out put gap as % of pot ent ial
4
2
0
-2
-4
-6
-8
-10
Budget 2009 output gap
Output gap: constant trend growth from 1997
-12
2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2
6H 58H 60H 62H 64H 66H 68H 70H 72H 74H 76H 78H 80H 82H 84H 86H 88H 90H 92H 94H 96H 98H 00H 02H 04H 06H 08H 10H 12H 14H
5
19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20
5
19 6H2
5
19 8H
6 2
19 0H2
6
19 2H
6 2
19 4H2
6
19 6H
6 2
19 8H2
7
19 0H
7 2
19 2H2
7
19 4H
7 2
19 6H2
7
19 8H
8 2
19 0H2
8
19 2H
8 2
19 4H2
8
19 6H
8 2
19 8H2
9
19 0H
9 2
19 2H2
9
19 4H
9 2
19 6H2
9
20 8H
0 2
20 0H2
0
20 2H
0 2
20 4H2
0
20 6H
0 2
20 8H2
1
20 0H
1 2
20 2H2
14
H
2
19
Out put gap as % of pot ent ial
A bust without a boom?
6
4
2
0
-2
-4
-6
-8
-10
Output gap: constant trend growth from 1997
Budget 2009 (showing lower trend)
-12
5
19 6H2
5
19 8H
6 2
19 0H2
6
19 2H
6 2
19 4H2
6
19 6H
6 2
19 8H2
7
19 0H
7 2
19 2H2
7
19 4H
7 2
19 6H2
7
19 8H
8 2
19 0H2
8
19 2H
8 2
19 4H2
8
19 6H
8 2
19 8H2
9
19 0H
9 2
19 2H2
9
19 4H
9 2
19 6H2
9
20 8H
0 2
20 0H2
0
20 2H
0 2
20 4H2
0
20 6H
0 2
20 8H2
1
20 0H
1 2
20 2H2
14
H
2
19
Out put gap as % of pot ent ial
A bust without a boom?
6
4
2
0
-2
-4
-6
-8
-10
Output gap: constant trend growth from 1997
Budget 2009 (showing lower trend)
-12
Why has the structural deficit risen so much?
• Long-term productive potential of economy assumed 5% lower
– Increases structural deficit by roughly 3.5% of GDP (£50+ billion)
• Long-term whole economy price level lower
– Reduces tax revenues in cash terms, but has less impact on spending
• Falls in long-term level of house prices and share prices
• Long-term fall in financial sector profitability
• Tax gap assumption locks in losses from higher VAT debts
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200
180
160
140
120
100
80
60
40
20
0
40% ceiling
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Note: Excludes unrealised losses on financial interventions.
Sources: HM Treasury; IFS calculations.
2040-41
2035-36
2030-31
2025-26
2020-21
2015-16
2010-11
2005-06
2000-01
1995-96
1990-91
1985-86
1980-81
No tightening
1975-76
Percentage of national income
Debt set to explode without fiscal tightening
The response: giveaway followed by takeaway
© Institute for Fiscal Studies
Sources: HM Treasury; IFS calculations.
200
180
160
140
120
100
80
60
40
20
0
40% ceiling
Budget forecast
IFS extrapolation
© Institute for Fiscal Studies
Note: Excludes unrealised losses on financial interventions.
Sources: HM Treasury; IFS calculations.
2040-41
2035-36
2030-31
2025-26
2020-21
2015-16
2010-11
2005-06
2000-01
1995-96
1990-91
1985-86
1980-81
No tightening
1975-76
Percentage of national income
Debt set to explode without fiscal tightening
Two parliaments of pain
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Sources: HM Treasury; IFS calculations.
Eventual cost of fiscal tightening per family
Total cost:
£90 billion a year in
today's money or
£2,840 per family
by 2017–18
As-yet
unannounced t ax
increases or
current spending
cut s, £1430
Announced t ax
increases, £300
Current spending
cut s, £690
Invest ment
spending cut s,
£425
Implications for public spending
• Remainder of Comprehensive Spending Review 2007
– 2010–11
• Spending Review 2010
– 2011–12 to 2013–14
• Beyond Spending Review 2010: the second
parliament
– 2014–15 to 2017–18
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CSR 2007: 2010–11
•
£5bn PBR “efficiency savings” now allocated
•
Biggest in cash terms
– £2.3bn from Department of Health
– £0.6bn from Department of Children, Schools and Families
•
Biggest as a share of total budget
– 3% from Transport
– 2.9% from Home Office
•
Real spending growth over three CSR2007 years now
– Current spending:
4.6%
– Investment spending:
5.4%
– Total spending:
4.6%
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Spending Review 2010: 2011–12 to 2013–14
• PBR 2008 plans
– Current spending: real growth of 1.2% a year
– Investment spending: real cuts of 2.6% a year
– Total spending: real growth of 1.1% a year
• Budget 2009 plans
– Current spending: real growth of 0.7% a year
– Investment spending: real cuts of 17.3% a year
• “move to 1¼ per cent of GDP in 2013–14” in Darling-speak
– Total spending: real cuts of 0.1% a year
• Lowest since 1996–97 to 1999–00
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How tight are these real spending plans?
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Cash spending has not fallen in any year since
1947
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Sources: HM Treasury; IFS calculations.
Impact on departmental spending on services
Average annualrealincrease
Average annual real increases 2011–12 to 2013–14
11
9
7
5
3
1
-0.1
-1
-3
Debtinterest
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Socialsecurity
O therAnnually M anaged Rem ainder: otherTotal
Expenditure
M anaged Expenditure
Impact on departmental spending on services
Average annualrealincrease
Average annual real increases 2011–12 to 2013–14
11
9
8.4
7
5
3
1
-1
-0.6
-3
Debtinterest
© Institute for Fiscal Studies
Socialsecurity
O therAnnually M anaged Rem ainder: otherTotal
Expenditure
M anaged Expenditure
Impact on departmental spending on services
Average annualrealincrease
Average annual real increases 2011–12 to 2013–14
11
9
8.4
7
5
3
1.7
1
-1
-1.6
-3
Debtinterest
© Institute for Fiscal Studies
Socialsecurity
O therAnnually M anaged Rem ainder: otherTotal
Expenditure
M anaged Expenditure
Impact on departmental spending on services
Average annualrealincrease
Average annual real increases 2011–12 to 2013–14
11
9
Weakest three
year growth
since 1977–78
to 1979–80
8.4
7
5
3
1.7
1
-1
-1.6
-3
Debtinterest
© Institute for Fiscal Studies
Socialsecurity
O therAnnually M anaged Rem ainder: otherTotal
Expenditure
M anaged Expenditure
Impact on departmental spending on services
Average annualrealincrease
Average annual real increases 2011–12 to 2013–14
11
9
8.4
7
5
3
1.7
1.9
1
-1
-3
Debtinterest
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Socialsecurity
-2.3
O therAnnually M anaged Rem ainder: otherTotal
Expenditure
M anaged Expenditure
Cutting the shrinking cake
• Budget implies real cut in DELs of 2.3% a year or 6.7% after 3
years
– Equivalent to £26 billion a year real cut comparing 2013–14 to 10–11
• Conservatives say they want to protect health and overseas aid,
by which we assume they mean no real cuts and hitting the UN
target
– Other DELs would have to fall 3.3% a year or 9.7% after 3 years
• Ed Balls says Labour would hope to avoid real cuts for schools too
– Other DELs would have to fall 4.7% a year or 13.5% after 3 years
• Either could also make benefits or tax credits less generous
Beyond SR2010: 2014–15 to 2017–18
• Treasury has pencilled in fiscal tightening of 3.2% of national
income or £45 billion in today’s money over these four years
• Will require some combination of tax increases and cuts in
spending as a share of national income eventually equivalent to
£1430 per family in today’s money
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Tax increases: attention focused on the rich
• PBR 2008
– Personal allowance to be withdrawn in two c.£6.5k bands (above
£100k and £140k), giving 60% marginal rates and raising £1.2bn
– Tax rate above £150k to be 45% in 2010–11, raising £1.6bn
• Budget 2009
– Personal allowance to be withdrawn in one c.£13k band (above
£100k) , raising £180m more than the PBR proposal
– Tax rate above £150k to be 50% from 2010-11, raising £800m more
than the PBR proposal
– Tax relief on pension contributions to be reduced gradually from
50% at £150k to 20% above £180k, raising £3.1bn
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Income tax schedule, 2011-12
70%
M arginal income tax rate
60%
50%
40%
30%
Before PBR 2008
20%
After PBR 2008
10%
After Budget 2009
0%
£0
£50,000
£100,000
Gross annual income
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£150,000
£200,000
Income tax relief on pension contributions, 2011
70%
Rate at which tax relief given
Before PBR 2008
After Budget 2009
60%
50%
40%
30%
20%
10%
0%
£0
£50,000
£100,000
Gross annual income
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£150,000
£200,000
Tax increases to date
• Attention focussed on the income tax increases for the rich:
total income tax and pension package to raise £7bn a year
• From relatively few, relatively well-off people
– Roughly 2% of adults (750k) have incomes above £100k
– Roughly 1% of adults (350k) have incomes above £150k
• But part of an £18bn total tax increase in the Budget and PBR
that affects much more of the population (NICs and fuel duties)
• Partially offset by £7bn tax cut in PBR, including rise in income
tax personal allowance and NI primary threshold (legacy of 10p
saga)
Conclusions
• HMT thinks fiscal deterioration mostly structural, not cyclical
– Timing and strength of recovery has little impact on necessary
tightening if HMT right about structural deficit; very hard to tell
• Tightening more on spending than tax over next parliament
– Tightest squeeze on public services since late 1970s
– Tax increases not confined to the rich
•
Scale, speed and composition of tightening still up for grabs
– Is economy strong enough to start tightening next year?
– Will markets force us to move more quickly?
– If so, will balance shift towards tax increases, even under the
Tories?
• Voters deserve honesty and proper debate before the election