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1
Economy DriveProspects and priorities ahead of the Spring
BudgetPre-Budget Event
Matt Whittaker
February 2017
@MattWhittakerRF @resfoundation
2
THE PUBLIC FINANCE OUTLOOK
Some rare good news ahead
3
Borrowing has come in lower in the first ten months of 2016-17 than the OBR thought back in November
Implication is that PSNB will be
~£56bn in 2016-17, some
£12bn lower than the OBR
forecast at AS16
Improvement reflects revisions in the first half of
the year, methodological
changes and higher-than-
expected receipts in recent months
Source: ONS, Public Sector Finances
4
Looking across consistent six-year forecasts, the OBR
has presented revisions ranging
from a £78bn improvement at AS13 to a £119
billion deterioration at AS11
Subsequent policy measures have
been more likely to increase rather than lower the
borrowing forecast
Borrowing forecast revisions have averaged £45.5bn across the OBR’s first 14 fiscal outlooks
Source: RF modelling & OBR, Economic and fiscal outlook, various
5
Adding the potential £12bn improvement in
2016-17 to more modest gains in
subsequent years, we estimate an
overall forecast reduction of
£29bn in cumulative terms
Next week’s revision is likely to be more modest, but should provide the first reduction in the borrowing forecast for three years
Source: RF modelling & OBR, Economic and fiscal outlook, various
6
The AS16 projections implied
that PSNB would still be 0.7% of
GDP (or £17bn) in the first year of the
next parliament
The Chancellor introduced a loosely-defined “objective for fiscal policy” at Autumn Statement 2016
Source: RF modelling & OBR, Economic and fiscal outlook, various
7
With the output gap projected to
disappear by 2020-21, the cyclically-
adjusted net borrowing figures
are expected to broadly match
PSNB by the end of the forecast
horizon
Provided headroom of £27 billion in 2020-21 below
conceptual ceiling
And a more explicit, but loosely-fitting, “mandate for fiscal policy” that specified structural borrowing falling below 2% of GDP by 2020-21
Source: RF modelling & OBR, Economic and fiscal outlook, various
8
The implied revision is
significantly bigger in 2016-17 than in the other years of the forecast. This
reflects acknowledgement
of better-than-expected public
finance performance in the
current year but continued
expectations of a slowdown relative
to the pre-referendum picture
in future years
A modest improvement in the borrowing forecast would increase the level of fiscal headroom to £31 billion in 2020-21
Source: RF modelling & OBR, Economic and fiscal outlook, various
9
• A revision of £29 billion would still leave borrowing significantly higher than was forecast 12 months ago – and deficit above pre-crisis norm for three more years
• Continued economic and fiscal uncertainty cautions against any overreaction
• The Chancellor made the right call ‘looking through’ the £100 billion deterioration laid out by the OBR at Autumn Statement 2016, he should take a similarly cautious approach this time round
• But that’s not to say that he should do nothing: can reprioritise to deal with large structural problems
Despite the good news, the public finance position remains incredibly tough
10
GOING ON AN ECONOMY DRIVE
Rebalancing UK growth
11
Following previous downturns, GDP
per capita growth has subsequently
grown above trend in order to ‘catch
up’ some of the lost years
What goes down usually goes up
Source: ONS, National Accounts
12
Following previous downturns, GDP
per capita growth has subsequently
grown above trend in order to ‘catch
up’ some of the lost years
That rebound has been absent this
time around, leaving a
‘permanent hit’ to annualised GDP
per capita of £5,700
But this time round, the economic recovery has lacked any bounce
Source: ONS, National Accounts
13
In 2016, consumption
accounted for more than 100%
of overall growth in GDP per capita
And has been too reliant on private consumption growth
Source: ONS, National Accounts
14
Incomes have grown relatively
strongly in recent years, helped by
ultra-low inflation and employment
growth, but the ‘mini-boom’
appears to have ended
With a potential earnings squeeze
coming in 2017, growth might
depend on the saving ratio
dropping further into the negative
Which raises questions of sustainability in a period in which income growth is set to slow
Source: ONS, National Accounts
15
Fixed capital formation
(covering private and public sector investment) has
fallen from 23% of GDP in the mid-
1970s to just under 17% today
1 in 3 firms admit to under-investing in last five years, citing barriers including
uncertainty, access to finance and short-termism
The flipside of over-reliance on consumption is a structural decline in investment
Source: ONS, National Accounts
16
The latest outturn for productivity is
broadly in line with where the OBR
thought it would be in 2011 back at
Autumn Statement 2010
The OBR has now downgraded its assessment of
trend productivity growth – implying
a permanently lower trajectory
While productivity performance continues to disappoint
Source: OBR, Economic and fiscal outlook, various
17
Tax cuts are set to cost ~£45bn by 2021-
22, more than three times the size of the projected deficit that
year
The proportion of the population
paying income tax has fallen from 53% to 46% since 2007-
08
Lower NI receipts associated with self-
employment is set to cost HMT £6.7bn by
2020-21
UK tax policy is also ripe for reform, with the tax-base narrowing and failing to keep pace with changes in the labour market
Source: OBR, Economic and fiscal outlook, various
18
Income growth fitting this profile would
produce an unprecedented combination of
falling incomes in the bottom half and
rising inequality
Overall income growth was lower in the last
parliament, but inequality fell
Inequality increased more rapidly in the
1980s, but incomes rose
As things stand, incomes are set to fall in the bottom half of the distribution between 2016 and 2020, driving inequality higher
Source: RF modelling
19
Benefit modelling includes: reversal of UC work allowance and family element
cuts, removal of two-child cap; reversal of freeze in the value of working-age benefits in 2018-19 and 2019-20 (we assume 2017-
18 is already in place); and reversal of the
benefit cap and age-limitation on Housing
Benefit
Reversing the benefit cuts inherited from the last government would help to flatten the growth curve
Source: RF modelling
20
Securing the same pace of employment growth as in the last
parliament, combined with a fall in average housing costs, would
boost incomes – in quite a progressive
way
More difficult given existing high levels of
employment, but policy can help
Pushing the income growth curve up requires policies focused on driving employment and productivity growth
Source: RF modelling
21
Adding in stronger wage growth would produce an overall
income growth curve that gets closer to the
average annual growth recorded
during the late-1990s and early-2000s period of strong,
shared growth
Pushing the income growth curve up requires policies focused on driving employment and productivity growth
Source: RF modelling
22
• Despite expected improvement in public finance outlook, we shouldn’t expect any major giveaways – though quite likely to see some funds for social care
• But the Chancellor should reprioritise within his existing envelope to do more to support those on low to middle incomes, avoiding an unprecedented living standards squeeze
• He also has the opportunity to build on plans for reform of corporate governance and industrial strategy in order to tackle long-standing problems
• With two Budgets this year, there is a clear opportunity for setting strong sense of direction and purpose that will inform the rest of the parliament
The Chancellor can aim for a Budget that is both short on rabbits but high on radicalism