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Tough choices ahead
Illustrating the choices and trade-offs in
the next spending review
Kayte Lawton and Amna Silim
September 2012
All major political parties face tough choices on tax
and spend over the next few years
• The Coalition’s 2010 spending review ends in 2014/15
• The government must publish its spending plans for 2015/16
before the 2015 general election – and may set out plans for
further ahead at the same time
• The state of the public finances and the UK economy, combined
with the Coalition’s fiscal targets, implies some very difficult
choices on tax and spend – for 2015/16 and beyond
• These are not just questions for the Coalition partners – Labour will
have to deal with them too if elected to government in 2015
• This presentation sets out the scale of the challenge facing all
political parties as they look ahead to the next spending review
Note: all figures in this presentation are taken from the Office for Budget Responsibility’s March 2012 Economic and Fiscal
Outlook unless otherwise stated and are based on the OBR’s medium-term growth forecasts
Context: the 2010 spending review, covering the years
2011/12 to 2014/15, was tough for most departments
Departmental spending
is being cut by an
average 2.3% in each
year of the spending
review
•
The NHS budget is flat
in real terms
•
Education is being cut
by less than 1% a year
in real terms
•
The Home Office and
capital spending are
experiencing particularly
large cuts
The Coalition has set out broad plans for the public
finances in 2015/16 and 2016/17
The Coalition has set out its plans for total public spending
and revenues for the two years after the current spending
review. These are intended to enable it to achieve its two
fiscal targets:
1. The cyclically-adjusted current budget moves into
surplus at the end of a rolling, five-year period – now set
for 2016/17
2. Public sector net debt falls as a share of GDP after
2015/16
But these figures rest on the OBR’s economic and
fiscal forecasts from March 2012
• The Coalition’s plans to 2016/17 rest on forecasts produced
by the Office for Budget Responsibility (OBR) in March 2012
• Since then, leading economists (including the Bank of
England, the IMF and the OECD) have revised down their
growth forecasts for the UK over the medium term
• The fiscal challenge set out in this presentation is therefore
likely to be larger than implied by the OBR’s March 2012
figures
• This has generate considerable speculation about the
likelihood of the chancellor meeting both his fiscal targets
• The OBR will produce new medium-term forecasts on
5 December
Implications for the public finances to 2016/17 of the
chancellor’s current plans
(% of GDP)
2011/12
2012/13
2013/14
2014/15
2015/16
2016/17
Structural deficit
-4.6
-4.2
-2.7
-1.5
-0.7
0.5
Total public
spending
45.8
43.4
43.6
42.2
40.5
39.0
Receipts
37.5
37.5
37.7
37.8
37.6
37.9
Public sector net
borrowing
8.3
5.8
5.9
4.3
2.8
1.1
Public sector net
debt
67.3
71.9
75.0
76.3
76.0
74.3
The Coalition plans imply that public spending will be
3.2% of GDP lower in 2016/17 compared to 2014/15
Public spending as % of GDP
50
•
Under current policy
assumptions, welfare
spending is forecast to be
only slightly smaller in
2016/17 compared to
2014/15
45
40
35
30
25
20
•
•
Debt interest payments
will be slightly higher
This means that the
Coalition’s fiscal targets
imply large cuts to
departmental spending (if
welfare policy remains
unchanged)
15
10
5
0
2010-11
2012-13
Departmental spending
Gross investment
Other
2014-15
2016-17
Benefits and pensions
Debt interest
‘Other’ spending includes public service pensions, locally-financed
expenditure, VAT refunds and the BBC
This implies a real-terms annual cut of 3.8% in
departmental spending in 2015/16 and 2016/17
This is larger than in the
current spending review,
where the average figure is
2.3%.
The chart opposite shows the
impact on departmental
spending in cash terms if
spending was cut evenly across
all departments:
•
NHS spending in 2016/17
would be almost £8bn less
than in 2014/15
•
Education would be cut by
almost £4bn
Protecting the NHS and international development
would require larger cuts in other department budgets
•
•
In the current spending
review, the NHS and
international development
(DFID) budgets have been
protected from cuts
Doing the same in the two
years after the current
spending would require cuts
of 6% a year in other
departments
Defence
NHS, DFID &
education
protected
Home Office
NHS & DFID
protected
Local government
Education
•
Protecting education
spending as well would
require cuts of 8% a year
elsewhere
-7
-6
-5
-4
-3
-2
-1
0
Spending cut in 2016/17 compared to 2014/15, in
today's prices (£bn)
The impact of protecting departmental spending
Annual real terms cut in spending,
2015/16 and 2016/17
No
departmental
protections
NHS & DFID
protected
NHS, DFID &
education
protected
Total departmental spending
3.8%
3.8%
3.8%
Departmental spending excluding
NHS and DFID
3.8%
6.0%
8.0%
Departmental spending cuts in 2016/17 relative
to 2014/15 in today’s prices
Total
£23bn
£23bn
£23bn
NHS
£7.8bn
-
-
Education
£3.8bn
£6.0bn
-
Defence
£1.7bn
£2.7bn
£3.7bn
Home Office
£0.5bn
£0.9bn
£1.2bn
What could these cuts mean in practice?
• Education: £1bn in the education budget pays for the equivalent of
approximately 22,000 teachers
• Home Office: £1bn in the Home Office budget is equivalent to
around 20,000 police officers
• Defence: £1bn in the defence budget is equivalent to around 22,000
service personnel – or a single Type 45 destroyer
The chancellor has said that welfare cuts of £10bn would
allow departmental spending to fall at a slower rate
•
•
Cutting departmental
spending by 2.3% a year
in 2015/16 and 2016/17
would continue the same
rate of cuts seen in the
current spending review
If total spending and
revenues remain as
planned in these two
years, welfare spending
would have to be cut by
£10bn in 2016/17
% change in departmental spending
1
0
No change to
welfare policy
implies 3.8% cut
to departmental
budgets
-1
-2
Departmental
spending cuts
of 2.3% imply
welfare cuts of
£10bn
-3
-4
-5
-29
-26
-22
-19
-16
-12
-9
-6
-2
Change in welfare spending 2016/17 (£bn)
2
The impact of £10bn welfare cuts in 2016/17 on
departmental spending
Annual real terms cut in
spending, 2015/16 and 2016/17
Total departmental spending
Departmental spending excluding NHS and DFID
No welfare cuts
£10bn welfare
cuts
3.8%
2.3%
6%
3.7%
Departmental spending cuts in
2016/17 relative to 2014/15 in
today’s prices
Total
£23bn
£14bn
Education (if NHS and DFID protected)
£6.0bn
£3.7bn
Defence (if NHS and DFID protected)
£2.7bn
£1.7bn
Home Office (if NHS and DFID protected)
£0.9bn
£0.5bn
How could a £10bn cut in the welfare budget be achieved?
Welfare spending in 2012/13
•
Ending the winter fuel
allowance would save
around £2bn a year
•
Freezing child benefit for
two years from 2014/15
would save around £500m
in 2016/17
•
Freezing all working-age
benefits for two years
from 2014/15 would save
around £4bn in 2016/17
Spending cuts account for 97% of current fiscal
consolidation plans for 2015/16 and 2016/17
If this was reduced to 70% and tax rises did more work, revenues
would have to be £20bn higher than planned in 2016/17
Current plans
3% tax
rises
A mansion tax could
raise £2bn – 10% of
the extra revenues
that would be
needed
97%
spending
cuts
Equivalent to an extra
4p on the basic rate of
income tax or VAT at
24%
Spending
cuts are
£20bn lower
Reversing cuts in capital spending would require
deeper cuts to departmental spending
•
•
Many economists believe it was
a mistake to cut capital
spending so dramatically in the
current spending review,
because of the impact on
growth
Reversing this cut by increasing
capital spending in 2016/17 by
£10 billion would require cuts in
departmental spending of 5.4%
in real terms in 2015/16 and
2016/17
Otherwise the Coalition would
miss its target to have debt
falling after 2014/15
1
Gross investment (£bn)
Real change in departmental
spending(%) 2015/16 and 2016/17
•
0
17
22
27
32
37
42
47
52
57
-1
Planned capital
spending in
2016/17 is
£47bn
-2
-3
-4
-5
-6
Extra £10bn
capital spending
means 5.4%
annual cuts in
department
spending
The impact of £10bn extra capital spending in 2016/17
on departmental spending
Annual real terms cut in spending,
2015/16 and 2016/17
Total departmental spending
Departmental spending excluding NHS and DFID
No extra capital
spending
£10bn extra capital
spending
3.8%
5.4%
6%
8.6%
Department spending cuts in 2016/17
compared to 2014/15, in today’s prices
Total
£23bn
£32bn
Education (if NHS and DFID protected)
£6.0bn
£8.5bn
Defence (if NHS and DFID protected)
£2.7bn
£3.8bn
Home Office (if NHS and DFID protected)
£0.9bn
£1.2bn
An alternative option would be to delay fiscal
consolidation by two years
• Shifting the goal of achieving a surplus on the structural
budget back to 2018/19 would generate an extra £20bn in
2016/17
• The government could use this £20bn to:
– Increase planned investment in capital projects
– Lower the planned cuts to departmental spending
without cutting welfare spending
– Temporarily cut taxes
Departmental spending cuts could be much lower than
planned, without cutting welfare spending
•
Departmental spending
cuts could be reduced to
0.9% a year in 2015/16
and 2016/17 without
cutting welfare spending
•
If NHS and DFID were
protected, there would
£4.6bn more available for
education spending in
2016/17 than under
current plans
But delaying fiscal consolidation by two years would
extend cuts beyond 2016/17 and increase debt slightly
• Real terms cuts in departmental spending (at 0.9% a
year) would continue for two more years than under
current plans
• Borrowing would be roughly twice as high in 2016/17, at
2.0% of GDP rather than with 1.1% under current plans
• Debt would be slightly higher in 2016/17, at 75.2% of
GDP rather than 74.3% under current plans
• Both of the Coalition’s fiscal targets would be missed
The impact of delaying fiscal consolidation by two
years on the public finances
(% of GDP)
2011/12
2012/13
2013/14
2014/15
2015/16
2016/17
Structural deficit
-4.6
-4.2
-2.7
-1.5
-1.0
-0.5
Total public
spending
45.8
43.4
43.6
42.2
40.7
39.9
Total receipts
37.5
37.5
37.7
37.8
37.6
37.9
Public sector
net borrowing
8.3
5.8
5.9
4.3
3.1
2.0
Public sector
net debt
67.3
71.9
75.0
76.3
76.3
75.2
Note: Assumes that additional resources in 2015/16 and 2016/17 are allocated to spending rather than tax cuts
Summary
• Without changes to tax or welfare policy, the Coalition’s fiscal plans to
2016/17 imply large cuts in departmental spending
• These would be larger in other departments if the NHS budget
continues to receive protection
• Departmental cuts would be smaller if welfare was also cut, but this is
difficult to achieve without dramatically reducing entitlements
• Departmental cuts would also be smaller if tax revenues were increased
but popular options like a mansion tax raise too little to have a
significant impact
• Raising capital spend would be good for growth but would require extra
borrowing or deeper cuts to departmental spending
• Delaying fiscal consolidation by two years would reduce the scale of
spending cuts to 2016/17 but borrowing and debt would be higher than
currently planned
Conclusion
• No major political party will be able to avoid tough
choices on tax and spend in the years ahead
• These challenges should be central to the public debate
in the run-up to the next spending review and 2015
general election
• This analysis rests on OBR economic and fiscal
forecasts published in March 2012 and which now look
optimistic