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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 © 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 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) © Institute for Fiscal Studies 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 © Institute for Fiscal Studies 200 180 160 140 120 100 80 60 40 20 0 40% ceiling © 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 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 © Institute for Fiscal Studies 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 © Institute for Fiscal Studies 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% © Institute for Fiscal Studies 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 © Institute for Fiscal Studies How tight are these real spending plans? © Institute for Fiscal Studies Cash spending has not fallen in any year since 1947 © Institute for Fiscal Studies 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 © 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 -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 © Institute for Fiscal Studies 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 © Institute for Fiscal Studies 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 © Institute for Fiscal Studies 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 © Institute for Fiscal Studies £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 © Institute for Fiscal Studies £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