Download Prospects for the UK economy

How to pay for the crisis
Ray Barrell
February 2010
NIESR
National Institute
of Economic and
Social Research
The Budget Problem
• Government borrowing is likely to be more
than 10 percent of GDP for several years
• The Debt Stock may rise to 100% of GDP
• The structural deficit is 5-6% of GDP
• There is a permanent output scar of 3-5%
incomes from the financial crisis
– We have less to consume
– Our children will be poorer
• Retiring later allows us to consume more
now and burdens our children les
Raising the retirement age a year
• We assume that the retirement age is raised by
one effective year over 5 years.
– Those near retirement work 66% of normal hours so
its 1.5 years on the age of retirement
– This is anticipated and consumption reacts
immediately to higher expected lifetime incomes
• Factor inputs depend on assumptions
– Labour input rises over five years, and initially
unemployment is marginally higher
– Private sector capital adjusts fully
• Savings fall slowly, the current account stabilises
at a lower level
Extending working lives in the UK
National Institute NiGEM model results
3
2
1.5
1
0.5
GDP
Labour input
Total capital
35
20
33
20
31
20
29
20
27
20
25
20
23
20
21
20
19
20
17
20
15
20
13
20
11
20
09
0
20
percent diff from base
2.5
Government capital
How do we use the money
– With deficit
targets direct
tax rates fall
– Direct tax
rates fall more
if government
consumption
and
investment are
unchanged
35
20
33
20
31
20
29
20
27
20
25
20
23
20
21
20
19
20
17
20
15
20
13
20
20
20
09
-0.001
11
0
proportion of personal income
• Transfers
reduced, direct
and indirect tax
up
National Institute NiGEM model results
-0.002
-0.003
-0.004
-0.005
-0.006
-0.007
-0.008
-0.009
-0.01
Tax rate fixed until 2019, government consumption on base
Deficit on target, spending increasing
deficit on target, government consumption on base
Impacts of a one year increase in working
lives on income tax as a proportion of
total income with different spending
and borrowing assumptions
How to pay for the banking crisis
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
2036
Tax rate fixed until 2019, government consumption on base
Deficit on target, spending increasing
deficit on target, government consumption on base
Tax rate fixed, government consumption on base
2035
2034
2033
2032
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
-0.2
2010
diff from base - percent of GDP
1.8
2009
• We focus on impacts of a
one effective year increase
in working lives starting in
five years, implemented
slowly
– saving fall permanently
as they are less needed
– government spending
and income taxes are
kept on current plans
• Gains in net revenue mean
budget deficit is better by
1% of GDP after 12 years.
• After 30 years the debt
stock is reduced by 20% of
GDP
Employment and unemployment?
• Markets work slowly even
when forward looking but
policy can speed them up
Real producer wages react to
rises in unemployment in the UK
12
– About a million a quarter
flow through unemployment 10
– Real wages react to
8
unemployment
• Unemployment will initially
rise by up to third of the
increase in the labour
force
4
2
0
2009Q1
2008Q2
Unemployment rate (percentage points)
Real (producer price) wage (% change over a year previously)
2007Q3
-4
2006Q4
2006Q1
2005Q2
2004Q3
2003Q4
2003Q1
2002Q2
2001Q3
2000Q4
2000Q1
1999Q2
1998Q3
1997Q4
1997Q1
1996Q2
1995Q3
1994Q4
1994Q1
1993Q2
1992Q3
1991Q4
1991Q1
1990Q2
1989Q3
1988Q4
-2
1988Q1
– The increase will all be
absorbed in five years
– Policy and information can
speed adjustment
6
What are the net revenue gains?
• In 2008 terms a one percent of GDP budget improvement is almost
£15 billion
– Less borrowing means lower debt stocks and lower interest payments
– Tax receipts higher because of higher incomes and consumption
• Policies have to be in place to shift MIG, TWIRLY, heating and other
pension related payments
• Changes in allowances for wealthy pensioners may be wise
Sources of budget improvement in 2019 with fixed direct tax rates
0.25
proportions in 2019
0.2
0.15
0.1
0.05
0
Corporation
tax
Interest
payments
Indirect tax
Income tax
Transfers
Conclusions on working lives
• What happens with extended working lives
– Incomes will be higher
– Consumption will be higher
• Governments face options
– Taxes could be cut
– Debt could be reduced
• One year on effective working lives could reduce
government borrowing by 1% of GDP
• Pension systems need to be designed to permit
this to happen
• The pension problem is in part caused by
increases in life expectancy