Conscious that his party scores highly on its ability to take tough decisions, the Chancellor used this week’s Budget to further elongate the timescale over which those tough decisions need to be made. His key message was that this is a long-term economic plan: any diversion from it – for example at a general election – would jeopardise the gains expected at the end. As we said following the Autumn Statement, he therefore continues to make a political virtue out of the economic reality that his economic recovery is late.
For example, a projected budget surplus in 2017-18 will only be achieved if the country “doesn’t lose its nerve” on spending “in a critical phase” and sticks to the “long term plan”. And his policy focus shifted towards structural economic reforms to “build resilience” and “consolidate” because “we have twenty years of catching-up to do”.
Whilst presented as a response to the recent recession, in reality many of the Chancellor’s announcements lay in traditional Conservative territory. Support for the regions and manufacturing through lowering the energy bills of energy-intensive businesses could also be interpreted as standing up to the green lobby; measures presented as designed to reward savers in order to increase economic resilience were warmly received by the middle classes seeking to build their tax-free personal wealth.
Labour’s response, designed to point out that the government had not met its initial deficit-reduction or growth targets, did not land many punches. However given the enormity of the proposed change in the pensions market, it may be that stronger lines of attack emerge as the full implications of the changes become clearer.
The Big Numbers
The macroeconomic forecasts published alongside the Budget by the independent Office of Budget Responsibility are broadly similar to those of the Autumn Statement four months ago: there has been no substantive change to their underlying assessment of the productive capacity of the economy.
So, although the GDP forecast has been revised upwards a notch, this is by bringing forward activity that was previously expected later in the cycle, as shown by the expected lower level of activity in 2017 and 2018 compared with previous forecasts in Figure 1 below. Nevertheless, the outlook for 2014 looks substantially stronger than was previously presumed to be the case: the OBR now projects growth of 2.7 per cent in 2014, driven primarily by faster (if volatile) levels of business investment and a slightly stronger contribution from net trade.
Figure 1: GDP growth forecasts 2013-14
The inflation outlook is similarly benign, taking the steam out of the real wages debate and permitting the Chancellor to stick his neck out in favour of a real-terms increase in the minimum wage. If anything, inflation next year is expected to be slightly lower than previously thought and there are no anticipated rises on the horizon, as Figure 2 below shows.
Figure 2: Inflation forecasts 2013-14
The employment forecasts have been revised upwards at every opportunity in the last three years, and this Budget was no exception, as figure 3 below shows. Employment is now expected to be around a million higher in 2016 than was anticipated at Budget 2012, a higher proportion of the labour force than in the US, as the Chancellor took pleasure in pointing out on Wednesday.
Figure 3: Employment forecasts 2013-14
The bringing forward of expected economic activity has, as in December 2013, had the effect of lowering the expected peak of the stock of government debt. (Although, as we pointed out at the time, this could also be interpreted as the failings of the March 2013 forecasts compared to those before and after: earlier OBR estimates were closer in line with the current expectations.) Nevertheless, it now seems likely that the stock of government debt will peak at under 80 per cent of GDP in around two years from now, in line with expectations at the time of the Autumn Statement of 2012 and although double the pre-recession levels, is nevertheless firmly in the centre of the pack of comparable industrialised countries. This remains a year later than the supplementary debt target set by the government in its 2010 emergency budget; but that is now old news.
Figure 4: Public Sector Net Debt forecasts 2013
Because the OBR has not altered its underlying assessment of the productive capacity of the economy, there is little change in the projections of the structural deficit. The deficit is projected to become a surplus in 2017-18, within the limit imposed by the 5-year rolling target set by the government’s fiscal framework, but two years later than was initially projected in 2010. It is worth noting, however, that both the Bank of England and a number of private sector forecasters, notably Goldman Sachs, presume that there is greater capacity in the economy than the OBR, which if correct would alter the calculations behind the cyclically-adjusted deficit in a way that would bring it into surplus sooner.
Figure 5: Deficit forecasts 2013-14
Key policy announcements
Pensions and savings
The largest long-term change is the proposed ending of the requirement to purchase an annuity on retirement. Instead, those past the state retirement age will be free to invest in any type of asset class, draw down as much or as little as they wish as retirement income and be taxed at their marginal rate. The rationale behind the change is to give people more choice in how to organise their finances in retirement, with an additional spur being a recent review by the Financial Conduct Authority suggesting that the current annuity market is not working as well as it could for consumers.
The details are being consulted on, including the associated implications for people in defined benefit schemes, the link to inheritance tax and the implications for the classes of security that pension companies are likely to invest in, with the government acknowledging that the behavioural effects on pensioners will not be fully understood for some time. Initial modelling by the Treasury, endorsed by the OBR, indicates however that the change will lead to a net increase in tax receipts in the early years suggesting that more people will draw down cash than was previously the case despite a reduction in the rates at which such income is taxed. Savers also benefit from a new tax-free band for income from savings, an increase to ISA limits and the merging of stocks and shares and cash ISAs into one tax-free investment wrapper set at £15,000 per year.
There was a key shift in policy direction related to energy-intensive manufacturing. Policies designed to mitigate the effect of the increase in the price of carbon were introduced, primarily capping the carbon price floor at £18 a tonne from 2016-17 as well as extending the compensation scheme for companies hit by the carbon price floor and EU emissions trading system. Separately, the entire North Sea Oil taxation regime is to be reviewed – potentially adding significant uncertainty until policy decisions are made – to consider how it can be optimised as the fields mature.
The other policy announcement of major long-term importance is the setting of the level of the cap on welfare spending. Designed as a trap for the Labour Party this has been set at a level of £119bn and forecast to retain its value in real terms. Cyclical benefits such as jobseekers allowance have been excluded as has the state pension. Any changes to the cap, or what lies within it, will be subject to a parliamentary vote with immediate effect.
The Budget’s other announcements were widely trailed: generous support in the tax system for childcare costs, a raising of the tax-free income tax allowance to £10,500 by 2015-16, more generous investment allowances for companies until 2015, payment up-front of disputed amounts under anti-avoidance measures, an extension of the equity loan scheme for the purchase of new build assets within the Help to Buy programme, and other measures to support house building in the London commuter belt. There were also populist reductions to bingo duty and another penny off the cost of a pint of beer.
Finally, the Budget documentation set out the Treasury’s view as to the background context of the debate on future fiscal rules explaining for example, that it would take a budget surplus of 1 per cent each year for the next thirty years to return the overall levels of government debt that existed before the recession, all else being equal. This is about framing the debate in the run-up to the 2015 election: the message being that if you want to build resilience, further action will need to be taken.
Winners and losers
Overall this budget was fiscally neutral, consistent with the government’s intention to show it was sticking with its long term plan.
Within this, the main winners in terms of the increased amount of government spending are:
This is paid for by:
A full list of spending and saving is displayed at Table 2.1 of the Treasury’s Red Book.
Things to watch
With the economic recovery indisputably under way, the biggest potential change to the economic forecasts before the 2015 election will now come from assessments of the underlying potential of the economy, which determines estimates of the proportion of the deficit that is structural, rather than cyclical. Estimates vary but it remains possible that the OBR could decide to make a substantial revision in the next year, which might make the debt and structural deficit figures look far better than currently forecast.
The detail of the proposed changes to pension policy still need to be worked out. With the City reeling from the enormity of the changes and the distributional effects unclear, it may be that the government has a long journey to embark on before the details of the policy are worked through. Key to this will be whether pensioners are considered more or less likely to save for the end of their lives if they have more opportunity to take cash out earlier. Some on the Labour side have also questioned the use of tax relief to save for a pension that can then be taken as a lump sum: it may be that this raises concerns around avoidance.
As the economy recovers, with inflation low, the extent to which the cost of living argument retains its traction is debatable: Labour is keen to ram home the unequal distribution of the spoils of the recovery but with employment and real wages likely to rise across the country this may have less resonance than previously.
The OBR forecasts presume that the savings ratio – the proportion of income that is saved rather than spent – will slowly fall. This will play into existing concerns about the sustainability of the housing market recovery particularly in London and the South East. There is not a bubble now, but it may be that the new Financial Policy Committee of the Bank of England feels it needs to take a pre-emptive step given recent economic history. Indeed, the Treasury made it clear to the FPC that it should feel empowered in this regard in its routine refresh of the Committee’s mandate as part of the Budget process.
Finally, towards the second half of the year, expect the policy debate to start turning towards the best fiscal targets for the next parliament, with George Osborne keen to find every opportunity to propose a framework that Labour will find it hard to match as the election gets ever-closer.
Measurement and evaluation