The Chancellor, George Osborne, used Thursday’s Autumn Statement to take political advantage from the economic truth that he has not met his original fiscal targets. Whereas at the beginning of the parliament he made much of his intention to eliminate the structural deficit, with the stock of debt falling, both in this parliament, now he emphasises how the “job is not yet done”, aligning himself with the “sacrifice and endeavour” of the British people in the progress made so far. Implicit in this approach is an exhortation to finish the job by returning the same team at the general election planned for May 2015.
In doing so he was helped in presentational terms by the Office of Budget Responsibility having got its forecasts wrong at the March 2013 budget. Back then, the OBR finally caught up with the mood that had existed in 2011-12 and downgraded their growth forecasts. But they had missed the moment – just when their forecasts were downgraded, the recovery arrived – and so they had to reverse them, enabling the Chancellor to announce significant improvements to the economic outlook even though the forecasts were actually similar to those that had existed only a year before. With other commentators, notably the Bank of England, being even more up-beat about the economy than the OBR’s revised forecasts, this is a trend that looks as if it will continue as the general election nears.
Yet, ever-mindful of opinion polls that applaud his ability to take tough decisions, the Chancellor’s Autumn Statement emphasised the need for continuing prudence, with announcements of an overall cap on most welfare payments, further departmental cuts and a new fiscal framework to be debated in parliament. In doing so he has scattered traps for the Labour party, tempting them to pledge greater generosity and so appear less fiscally disciplined in the run-up to the next election.
Ed Balls’s response for Labour saw him return to the so-far reasonably effective theme of living standards, accusing the government of making people worse off in 2015 than they were in 2010, and only being interested in making things better off for the already affluent “people on their [own] Christmas card list”. He will be reflecting on how well these lines worked in the face of the positive numbers presented by the Chancellor, who had also sought to neutralise Labour’s appeal by announcing cuts to energy prices, cancelling the planned fuel duty rise and pledging a real-terms freeze in average train fares. Only the general election will tell whether the public is more concerned about the overall economic environment, or the level of their household bills.
THE BIG NUMBERS
The Office of Budget Responsibility is not doing well in terms of the reliability of its forecasts; indeed their routinely published discussion papers exploring the reasons behind their errors are as important to analysts as the forecasts themselves.
Their latest Economic and Fiscal Output published on the same day as the Autumn Statement presents substantial revisions to their headline growth forecasts, with GDP growth revised up from 0.6% to 1.4% this year, rising to 2.4% in 2014. Crucially, they presume that the improvement is cyclical, rather than structural; that is, that it is simply a bringing forward of the expected turn in the business cycle through higher consumer confidence, rather than reflecting any underlying change to the productive potential of the economy. Hence they assume a slowing in 2014-15 to allow productivity levels to catch up and then drive a continuation of the recovery into 2016. The change in GDP forecasts since the 2012 Autumn Statement is shown in Figure 1 below.
Figure 1: GDP forecasts
Source: Office of Budget Responsibility
With faster-than-expected economic growth comes higher tax receipts and so an improvement in the government accounts. This works in two ways. First the government simply gets more receipts, and insofar as unemployment falls faster, pays out a little less in cyclical unemployment benefits, both of which put downward pressure on the deficit and so the levels of outstanding government debt. Second, if the economy is larger, the usual way of measuring debt, as a proportion of GDP, gets smaller simply because it is divided by a larger number. Both of these factors come into play in the most recent forecasts. The stock of debt that was previously expected to peak at 86% of GDP in 2017-18 is now expected to peak at 80% in 2015-16, far nearer the forecast in December 2012 than March 2013 as Figure 2 below shows. This improvement, however, is not sufficient to enable the government to meet its initial target to have it “falling” by the end of the parliament.
Figure 2: Government debt forecasts
With the OBR judging that its previous assessment of the proportion of the deficit that is structural rather than cyclical to be broadly correct there has not been a corresponding improvement in the cyclically-adjusted forecasts of the budget deficit, which if anything are now expected to move into surplus a little later than was previously thought, as Figure 3 below shows. However given that the coalition has set itself a rolling target for this measure, namely that the deficit should be eliminated within a five-year forecast period from the date of the forecast, it remains on target to be met.
Figure 3: Government deficit forecasts
Forecasts of employment levels have been adjusted upwards each time the OBR has made a forecast since they were established in 2010, and this time is no exception. The official forecasts now expect an extra 100,000 people in work in 2013 compared with the March forecast, and another 200,000 and rising in 2014 and beyond, as figure 4 below shows.
Figure 4: Employment forecasts
That Labour is onto something regarding living standards also comes through the macroeconomic data: despite the rise in employment, average earnings – defined as wages and salaries divided by employees – are not expected to rise and if anything to fall over the next few years. However if the OBR’s assumptions on productivity increases are revised in future, their forecasts of average earnings may also alter. Falling inflation will also ease the pressure on the cost of living: this week’s OBR forecasts revise inflation down a notch for both 2013 and 2014, as the table below shows.
2012 Autumn Statement,2.5,2.2, 2.0, 2.0
2013 March Budget,2.8,2.4, 2.1, 2.0
2013 Autumn Statement,2.6,2.3, 2.1, 2.0[/table]
MAIN POLICY ANNOUNCEMENTS
Aside from the official announcement of two previous policy commitments – free school meals in the first three years of primary school and transferable income tax allowance for married couples – the Chancellor’s main policy announcements can be grouped into three broad categories: fiscal prudence, neutralising the Labour party and combatting tax avoidance.
Overall, the announced changes, including the scoring of some minor changes implicit in June’s spending review, were described as “fiscally neutral across the period” with gains from administrative improvements and £4.2bn savings from departmental underspends and reductions in the reserve, spent on totemic policies designed to grab headlines.
With the OBR retaining its structural deficit forecasts despite the growth improvement, there is no ability for the government to relax its fiscal constraints. However there are also good political reasons to be tough.
Not only does being tough on public finances resonate well in the opinion polls, but also – as the FT columnist Janan Ganesh describes in his biography of George Osborne – the Chancellor believes it is not possible for an Opposition party to win a general election without matching the spending plans of the incumbent government. He is therefore determined to raise that bar as high as possible. The Autumn Statement provided two new traps for Labour, namely:
In addition, the Autumn Statement also announced a further rising of the state pension age and increased the opportunities to make additional voluntary state pension contributions.
Neutralising the Labour party
At his party conference speech in the autumn, the Labour leader Ed Miliband made a number of policy commitments that the Chancellor used the opportunity of the Autumn Statement to match or attempt to leapfrog. Most notable were announcements designed to alleviate the pressure on household finances. So, where Labour pledged to freeze energy bills through a different regulatory regime, the government pledged to cut £50 from bills by shifting environmental levies into general taxation, and also pledged to scrap planned fuel duty rises and freeze rail fares after inflation.
Where Labour pledged a compulsory jobs guarantee for young people and long-term unemployed paid for by an increased bank levy, the government also raised the bank levy and abolished employer national insurance contributions for basic rate taxpayers under 21, lifted the cap on higher education, expanded apprenticeships and introduced a new scheme for making unemployment benefits for young people contingent on basic maths and English training where standards were unacceptable.
Where Labour had promised a big increase in housebuilding, the Chancellor announced a £1bn loan scheme to unblock planned housing developments as well as other measures to liberalise the social housing market.
The government also matched Labour’s previously-announced plans to reduce planned increases in business rates, hinting at a possible review of the whole system, and taunted Labour by name-checking a previously prominent Labour supporter, Sir Ronnie Cohen, for his help putting together a package of support for social enterprises and tax relief for social impact bonds.
Combatting tax avoidance
The final broad heading of policy announcements are relatively technical and designed to make it harder to engage in tax planning particularly between different forms of self-employed and partnership trading. As part of this a first inroad was made into capital gains tax relief for private residences, ensuring that non-resident owners are not able to claim the relief on sale, and restricting the time period that the relief applies for if the property is no longer lived in prior to sale.
There were also specific measures designed to support particular industry sectors:
WINNERS AND LOSERS
The Treasury’s analysis of distributional impact by 2015-16 of its combined policy decisions since the 2010 election shows that when all the changes in tax, benefit and public spending are examined together by quintile across the income distribution, all groups are worse off. In cash terms the loss is greatest in the highest 20%, facing a loss of £2,300 per year by 2015-16 in 2010-11 prices (mainly from tax increases), but the lowest 20% is the next worst affected, with a cash loss of £880 in 2010-11 prices (mainly from cuts to tax credits and benefits). The second, third and fourth quintiles are worse off by £590, £300 and £170 respectively.
When the changes are looked at as a proportion of income, the combined effect of all policy decisions by 2015-16 is even starker: the top 20% has lost the equivalent of 4.2% of income, and the bottom 20 per cent by almost as much at 3.7% of income.
However the macroeconomic environment has not remained static at the same time. In particular, in the four years to 2011-12 (latest available data), the incomes of the bottom 20% (particularly the second decile) have risen the highest from other sources outside government. Similarly when the overall level of benefits, tax credits and public sector receipts is examined as a proportion of total household income a different picture also emerges: the broad relationship with the state has not altered from its generally progressive stance: support of all kind remains inversely proportional to income. Within this, the effect of the consolidation has been that the richest 20 per cent contribute slightly more and the poorest 20 per cent receive slightly less.
A full list of winners and losers from the announcements at this Autumn Statement is given in the annex.
THINGS TO WATCH
The next set of fiscal forecasts will come at Budget 2014, which could be as little as three months away. The money is on a further upgrade to the growth forecasts, but the key question is whether the OBR will also alter its assessment of the structural deficit. If it too is revised, for example if growth starts to come from greater-than-expected productivity-increasing business investment rather than consumer spending, that could enable the Chancellor to clock savings for pre-election giveaways whilst still looking as if the public finances are on track.
A key driver of the renewed political focus on the cost of living is the assertion by economists that real wages have been ‘decoupled’ from economic growth. As the economic recovery gathers pace, this assertion will be tested. A recent document from the Treasury has contradicted the consensus by arguing instead that employers are allocating the same proportion of profits to employees, but some of this is diverted to higher national insurance and the need to shore up defined-benefit pension schemes rather than wages. As profits rise, it may be that wages will start to rise too, taking some of the steam out of the cost-of-living argument.
The key driver of the next election will be how it all feels to householders: as the economy starts to motor and optimism returns, will they be more interested in having a prudent Chancellor who understands the need to continue paying off debts, or will they listen to a campaigning leader of the opposition who wants to fight battles to keep their cost of living down?
ANNEX: MAIN WINNERS AND LOSERS FROM CHANGES ANNOUNCED IN AUTUMN STATEMENT 2013
Drivers:planned increase in fuel duty in 2014 cancelled
Small businesses with property that has rateable value under £12,000: 12 month extension of doubling of small business rate relief (SBRR)
Businesses business rates increase in 2014-15 capped at 2%
Retail businesses: £1,000 discount for 2 years on business rates for occupied retail food and drink premises with rateable value of £50,000 or less
Retail businesses moving into properties that have been empty for a year or more: 18-month reoccupation business rates 50% relief
Small businesses entitled to SBRR that take on additional property: can retain SBRR for a year
Married couples and civil partners where neither partner is a higher or additional rate tax payer: can transfer £1000 of personal allowance
Employers of people under 21 paying basic rate tax (and people under 21 looking for work): abolition of national insurance contributions
Future apprentices: expansion of apprentice numbers
UK film industry: increase rate of film tax relief
Unemployed entrepreneurs: extension of New Enterprise Allowance
Firms owned indirectly by employees – income tax exemption on bonuses
Savers in employee share schemes: limits raised in SAYE and SIP schemes
New charities: simpler on-line registration system
Families and agents of deceased: on-line capability for inheritance tax affairs
People affected by benefit errors: measures to correct more quickly
People needing local authority affordable housing: £300m increase in loans available for local authorities to borrow to build
HGV fleet operators considering switching to cleaner road fuel natural gas: 10 year certainty of cheaper fuel duty.
Consumers of alcohol with related health issues: price floor assumes reduction of alcohol consumption
Local authorities: more flexibility to spend capital receipts
Shale gas industry and other onshore oil and gas projects: new onshore tax allowance
Standalone data centres: eligible for lower rates of climate change levy
Motorists: can pay vehicle excise duty by direct debit – cheaper for people who used to pay 6 monthly and now pay monthly
Exporters: New package of guarantees announced
Future students: cap on student numbers abolished
Householders: environmental taxes shifted from bills to general taxation
Banks: increase in rate of Bank Levy from 1 January 2014. Raises an additional £2.5bn over 5 years.
People who have used an avoidance scheme: need to pay penalty upfront prior to any appeal against the ruling in a ‘representative case’
People using employment intermediaries to facilitate false self-employment to avoid paying national insurance
Large multinationals using ‘total return swaps’ avoidance schemes where deductions are claimed for payments between group companies under derivative contracts which are linked to company profits.
People who invest using enhanced share buy-backs to claim income tax relief through venture capital trusts
Oil and gas drilling companies who deduct the costs of leasing oil and gas capital equipment from corporation tax liability: the amount is capped from April 2014
Wealthy individuals who avoid tax by manipulating the ‘compensating adjustment’ rules
Hedge funds and other alternative investment fund management sector using limited liability partnership rules to reduce higher rate income tax liabilities.
Non domiciled resident taxpayers using dual contract arrangements to artificially assign part of employment income to overseas employment contract to avoid UK tax
Companies obtaining foreign tax relief inappropriately through loan relationship rules
UK residents holding accounts in Overseas Territories to avoid tax liabilities: automatic exchange of information from 2016
Individuals disposing of residential property that used to be main private residence between 18 months and 3 years previously: tightening of capital gains tax exemption to 18 months prior to sale from 3 years
Non residents selling UK-owned property: end of capital gains tax relief
Alcohol wholesalers selling illicit product: new registration scheme
Benefit fraudsters: more resource for compliance teams
Firms selling cheap alcohol: price floor introduced
Employees with non-tax advantaged employee share schemes: small gains to exchequer from simplification measures
New JSA claimants: additional savings to government from 7-day waiting period for new claims.
People living abroad claiming winter fuel payments in warmer countries: now only eligible if county has an average winter temperature comparable or lower than South West England.
Conditionality claimants for JSA and Universal Credit: now need to verify claim annually
Measurement and evaluation