The Chancellor’s fourth Budget was, broadly speaking, fiscally and ideologically neutral: he neither looked as if he was accepting the Keynsian argument to spend more, nor the monetarist argument to retrench more in the light of the deterioration in public finances. He did however start the political run-in to 2015 with eye catching giveaways on fuel, beer, home ownership and childcare.
The British economy is still expected to recover over the next few years, albeit slowly and painstakingly from a position of profound weakness, but the expected rate at which this happens has once again been lowered. As a result, the stock of outstanding government debt will not now start falling until 2017-18, a full three years later than the government originally anticipated in its first budget of June 2010. Inflation will be a little higher this year than previously thought, putting further downward pressure on wage growth, but the number of people in employment is nevertheless expected to rise even more strongly than earlier anticipated.
The Chancellor made three main policy decisions in this year’s budget. The first was to alter the mandate of the Bank of England, not to change the inflation target but to give more information as to the likely future direction of monetary policy. This could prove a useful tool insofar as it can shape expectations, and so increase the chances of them becoming self-fulfilling.
The Chancellor’s second decision was to keep bearing down on local and central government budgets, in particular public sector pay, in order to increase the switch to infrastructure investment, a reduction in the main rate of corporation tax to 20 per cent, a raising of the personal income tax allowance to £10,000 by 2014 as well as a number of sector-specific tax incentives. His third big decision was to sanction two innovative off-balance sheet initiatives designed to spur the housing market and in particularly the construction sector. The government will now take a stake in new build purchases of up to 20 per cent in place of a household deposit, which the exchequer would only realise on sale; the Treasury will also get into the business of guaranteeing low-risk mortgages to enable loans to be offered where borrowers have insufficient deposits.
The Chancellor may also have made a fourth major decision to fundamentally alter the way in which benefits spending is managed in his changes to Annually Managed Expenditure – we will need to wait until the June Spending Review to see the detail.
In terms of presentation, this was a budget on the side of aspiration and people who want to get on in life. Help was offered with the costs of childcare particularly for second earners, and an increase in the discounts available to public sector housing tenants seeking to buy their homes. Labour, by contrast, highlighted the huge gulf between the government’s stated macroeconomic aims and what has actually happened, linking the recent downgrading by Moody’s of UK sovereign debt rating to a “downgraded government”. They also portrayed the support for working families in the budget as too little, too late compared with the cut to the top rate of tax that will benefit the highest earners from April this year.
The business reaction was broadly supportive, particularly in those sectors that stood to benefit from specific tax breaks. But given that this budget in effect fired the starting gun for the general election campaign, the final verdict will not come until 2015 when the public decides whether the slow recovery in the country’s economic situation is because of, or despite, the efforts of this government.
When the Office of Budget Responsibility produced its first independent forecasts shortly after it was established in the aftermath of the 2010 general election, it was at pains to point out the inherent uncertainties that were attached to them. However nobody predicted quite how drastically wrong they have been shown to be.
Then, the presumption was that an acceleration of government austerity would lead to a bounce-back in business investment, which would help to pay off government debt and free up resources by the end of the parliament. In practice, depressed confidence throughout the economy and abroad meant that there was nowhere for growth to come from; in June 2010 the official forecast expected growth by 2013 to be above trend at 2.7 per cent. At this budget, it was revised down yet again to a mere 0.6 per cent.
Opinions differ as to whether this progressive deterioration in the growth forecasts has been driven by the austerity measures introduced by the government. The OBR has factored in some effect into all of its projections since 2010 and their models show the most recent forecast downgrade to have been driven by a greater-than-expected fall in net trade. Others, including parts of the IMF, believe the actions of government have had a more negative effect on growth than is being officially admitted. There is nothing in this year’s budget that resolves this conundrum one way or the other.
Figure 1 below shows how the growth forecasts have varied over the course of this parliament to date. The forecasts were first substantially revised downwards in the Autumn Statement of 2011; the most recent shows that the annual growth rate for 2012 now appears to be just positive (revised to +0.2 per cent from -0.1 per cent) but that it will now take until 2014 for a growth rate of over 1 per cent. When it does emerge, however, it is still expected to be driven by increased business activity; that this is now in the realm of possible is evidenced by the recent upturn in stock market activity.
Figure 1: OBR growth forecasts since June 2010
(% change in real GDP)
GDP forecasts 2012-13: growth slips away
It is the progressive weakening of the overall macroeconomic position that has caused the government to miss one of its fiscal rules, namely that the stock of outstanding government debt should be falling by 2014-15. Initially, the government expected to meet it a year early; now the official forecast is two years late as figure 2 below shows. The fact that the graph line for the latest forecast is significantly above the others shows how far the debt situation has deteriorated in the less-than-four-months since the last official figures were produced on December 5th.
Figure 2: OBR public sector net debt forecasts since June 2010
(end March, % of GDP)
Debt forecasts 2010-13: ever-rising…
The other component of the government’s fiscal rule, that the structural deficit should be eliminated in a rolling five-year period, is still on track to be met according to the official forecasts. However, given that both the debt and deficit targets depend critically on the level of tax receipts and benefit payments which, in turn, have a strong connection with GDP growth, it is the fact that GDP growth is expected to return to trend in the medium term that drives the presumption that the structural deficit target will be met.
To illustrate the point, consider the situation in June 2010. At that time the OBR central forecast was for GDP growth to bounce back strongly; as a result it forecast the structural budget deficit to be eliminated by 2014-15, thereby ensuring that the fiscal rule was met. The latest forecasts, however, expect the structural budget deficit to only start entering positive territory around the end of 2016-17. So if the OBR’s forecasts had been right in 2010, this rule would have been broken from the start.
Figure 3: OBR deficit forecasts since 2010
(Cyclically adjusted surplus on current budget, % of GDP)
Deficit forecasts 2010-11: a surplus slips further…
Deficit forecasts 2012-13:..and further away
Figure 3 shows that a substantial downward revision to the deficit forecast came in Autumn Statement 2011: this is indicated by the graph lines shifting to the right. In December 2012, the OBR altered its understanding of the nature of the structural deficit, causing a change in the shape of the graph line; the most recent forecast does not alter the shape particularly, just shifts it further out once more.
Meanwhile, as figure 4 shows, there has been more consistency in the inflation forecasts, not least because the Bank of England’s mandate to keep inflation at 2 per cent in the medium term tends to cause forecast inflation values further out than the immediate few years to stick there. There was a spike in 2011 that was anticipated early that year; the most recent data expects a bit of an uplift this year not least because the lower value of sterling will cause the price of imports to rise.
Figure 4: OBR inflation forecasts since 2010
(CPI in Q4)
Inflation forecasts 2010-13: a spike in 2011
The good news comes in the employment figures where the strength of the labour market has consistently confounded expectations, and continues to do so. There are now 1.2 million more jobs in the economy compared to early 2010, and this is despite 400,000 public sector job cuts. Forecasts of the number of people in employment have been revised upwards every year; the latest data shows an upward revision of around 200,000. The question for economists is why this has not translated into higher GDP growth: productivity must have fallen at the same time.
Note that changes to the number of people in the labour force – for example from the arrival of lone parents with older children who are progressively being moved from income support to jobseekers allowance – means that the unemployment rate does not show exactly the same picture as the employment figures, although the overall direction of travel is broadly consistent.
Figure 5: OBR forecasts of the number of people in employment since 2010
Employment forecasts 2009-13: always rising:
There were over two hundred distinct policy measures announced or confirmed in this year’s Budget, most of which have some effect on the public finances. Overall, however, the budget is broadly fiscally neutral: it has moved money around rather than sought to alter the overall fiscal stance.
The main measures of note are:
Strengthening the ability of the Bank of England to signal its future intentions.
In line with the understood views of the incoming Bank of England Governor, Mark Carney, the Chancellor has asked the Bank to outline how it intends to use so-called “intermediate thresholds” in setting monetary policy. In practice this means that the Bank’s medium term inflation target will remain unaltered at 2 per cent, but that the Bank may additionally announce that it intends to, for example, keep interest rates at a certain level for a pre-determined length of time in order to have a deliberate effect on levels of confidence in the market with a view to dampening peaks and troughs in the business cycle. This could be very effective in periods of pronounced over – or under – exuberance but might also have an effect on expectations of inflation in the longer term. The Chancellor also announced measures to increase transparency and accountability of the deliberations of the Monetary Policy Committee, by aligning the publication of MPC letters with the dates that they actually meet. The Chancellor also placed on record his support for “unconventional monetary tools” giving the incoming governor license to innovate. In the meantime, the Bank’s Funding for Lending scheme announced last July appears to have had a demonstrable effect on lowering mortgage rates and is being continued.
More interventionist industrial policy.
As anticipated, the government accepted the vast majority of the recommendations in Lord Heseltine’s report on industrial policy, including the creation of a fund that local partnerships could bid into to obtain support they needed for sub-regional investment projects. Specific financial support was earmarked for high-productivity manufacturing sectors such as digital content production, aerospace, carbon capture and storage and research-intensive SMEs supplying government. The shale gas, social enterprise, oil and gas decommissioning and investment management sectors were also singled out for packages of support, and stamp duty will be abolished on shares in companies listed on growth markets such as AIM. A business bank is to be set up to meet gaps in SME finance and capital spending is to rise by an additional £3bn a year over and above the rises announced in 2011 and 2012. The government also announced more resource for the Treasury to attract greater external investment in infrastructure.
Support for home ownership
Not only did the Chancellor raise the discounts available for public sector housing tenants seeking to buy their homes to £100,000 but he also introduced innovative new off-balance-sheet Treasury support for homebuyers struggling to raise the necessary deposits. One scheme will enable the government to put up a deposit of up to 20 per cent of the value of a new-build property in return for 20 per cent of the equity; the government only need be re-paid when the property is sold. Although a cash outlay, this will be scored on the Treasury’s books as a financial market investment on the presumption that the value of the government’s stake will rise over time. The second innovation is to enable the government to guarantee the mortgages of individuals who meet every criteria for lending apart from the deposit; thereby enabling the loan to take place at acceptable risk to the lending institution. This is an enormous change in policy by the government, as the same approach could in principle be applied to any sector where it is seen as desirable to encourage lending (small businesses?). The government will take a small fee, in effect an insurance premium, for providing the guarantee; if this is equal to the risk of default then the actuarial cost to the taxpayer is nil. However the risk to the government is that their intervention might change behaviour and lead to loans being granted that are riskier than they may first appear.
Further squeeze on public sector pay
The existing 1 per cent cash cap on public sector pay rises will be extended, leading to real terms falls. In addition, the government has signalled its intention to increase the level of savings required from the next spending review period. Given that health and schools budgets will be protected this indicates that local government (excluding schools) will continue to feel harsh budget cuts. The policy of guaranteed pay progression whereby some public sector workers automatically get pay increases each year will also be abolished (with the exception of the armed services).
Review of Annually Managed Expenditure (AME)
The Chancellor announced that he intends to review the operation of Annually Managed Expenditure in the June spending review. This is the proportion of government expenditure that, in contrast to Departmental Expenditure Limits (DEL), relates to spending that depends on the level of external demand, such as welfare payments that are made if a recipient is entitled, without reference to whether the budget is available. This would be done, according to the Chancellor “without affecting the operation of automatic stabilisers”. This is slightly mystifying given that the Treasury’s own definition of AME spending is expenditure that “cannot reasonably be subject to close control over a three year period”, raising the question of whether the Chancellor intends to explore whether there can be a counter-cyclical element to the value of welfare spending. Further information will come at the spending review in June.
As previously announced, the budget included a commitment to pay 20 per cent of childcare costs up to a level of £6,000 per child under 12 each year in families where all parents work and have incomes above those that would make them eligible for tax credits or universal credit. Childcare support will also increase within universal credit. This is a significant change of tone: this administration has not previously seemed interested in encouraging second earners to work.
This budget saw the scrapping of the already-twice-deferred increase in fuel duty expected for September and adjustments to the tax on beer that would reduce the cost of a pint by a penny. Both are more significant for their political impact than for their effect on the economy.
There were no changes to the previously announced policies of raising welfare payments by lower than the rate of inflation; these are expected to feed through into the public finances as previously announced. The cost of care has been capped at £72,000 in response to the conclusions of the recent Dilnot review. Incentives are being given to employers to provide additional support for staff who are at risk of long-term sickness.
Large companies will benefit from the main rate of corporation tax falling to 20 per cent from April 2014; if they are research-intensive they will also benefit from a more generous R&D tax credit regime. Small companies will benefit from a £2,000 ‘employment allowance’ reduction in national insurance bills. Personal income tax allowances will rise to £10,000 from April 2014, meeting a key Liberal Democrat pledge.
Labour did not change its line from the position it adopted in Budget 2012. They laid the blame firmly at the government’s door for the deterioration in the growth and public finance forecasts, and accused them of prioritising tax cuts for the rich – symbolised by the previously-announced reduction in the top rate of tax from 50 per cent to 45 per cent due to come into force this April – over the needs of the rest of the country. They sought to up the ante the day after the Budget by demanding a U-turn in the government’s overall approach, which perhaps said more about their own presumption that the public will still be feeling the pinch come the next election. They briefly smelt blood when there was a few hours of uncertainty as to whether the new mortgage guarantee would be subsidising second homes, until the Treasury minister Mark Prisk categorically ruled it out.
The cut in beer duty dominated the print media, although not perhaps in the way the Chancellor had intended. The ever-loyal Express responded with the headline “Cheers!” but the Sun described it as more of a hangover. The Independent and Guardian led with the idea that the Chancellor was perhaps advising us to drown our sorrows. The Times and the Telegraph led on the drive to increase home ownership while the Mail published a photo of George Osborne morphing into Margaret Thatcher with the headline “The Laddie’s Not for Turning”, bewailing the fact that the new childcare support did not apply to stay-at-home mums. The FT described it as “A pitch for middle England as Osborne grapples for growth” with an editorial that described it as “not a Budget to bring recovery forward, but one for after the recovery has arrived”. City AM by contrast railed against guarantees for household mortgages under a banner headline “Welcome to sub-prime Britain”.
The business reaction was broadly supportive, verging on ecstatic in those sectors that received tax breaks. The CBI welcomed the support for the housing sector and supported the overall fiscal stance. The Federation of Small Businesses welcomed the Budget and in particular the employer’s allowance that will cut employer national insurance contributions by £2,000. The British Chambers of Commerce was more cautious, urging greater action to support growth and entrepreneurship, but welcoming the announcement of a timetable to the establishment of a business bank.
The priority for government will now be to agree the detail of the Spending Review for the year 2015-16, due to be published on June 26th. We have some clues as to what this will contain: the overall envelope has been agreed of £694bn in current spending and £50bn capital spending; we also know that the schools and health budgets will be ring-fenced, meaning pressure will come to bear on other departments, and particularly in public sector pay. Around £5bn of efficiency savings have also been earmarked.
In the meantime, the Finance Bill will start its journey through the House of Commons and is expected to receive Royal Assent by summer; expect the opposition parties to put down amendments cancelling the proposed cut in the top rate of tax in order to force a vote on the issue (that the government will win).
The next official growth forecasts will not come until the Autumn Statement, which could well be as far as nine months off. In the interim, analysts will continue to monitor data out-turns and crucially the euro-zone growth forecasts to form a view as to whether the growth and debt forecasts will need to be revised in the wrong direction, yet again.
For now however, the Chancellor will be sighing with relief that his budget did not immediately unravel and was as credible as could be expected in the circumstances.
Page references are to the red Budget 2013 book published by the Treasury where a complete list of all current measures is published.
Appendix Two: What Happens When (Key Measures)
- Beer duty escalator revoked and general beer duty reduced by 2 per cent – a penny off a pint of beer. All other excise duties to rise as previously announced.
- Income tax personal allowance will rise to £9,440 (basic rate limit £32,010; higher rate threshold £41,450)
- Top rate of income tax falls to 45p
- Main rate of corporation tax to fall to 23 per cent
- Age-related allowances frozen
- Working age benefits and tax credits to fall in real terms
- Further cuts to departmental budgets excluding schools and health, to the tune of £1.1bn
- Real terms public sector pay cuts (up to 1% cash rises on average)
- Charge on properties over £2m owned by companies
- 26 June: Spending round for year 2015-16: individual departmental budgets will be published as well as more detail on review of AME spending controls and plans for most economically valuable areas of capital expenditure to 2020-21.
- September 2013
- ABI to report back on a simple whole-of-life insurance product (Carol Sargeant review)
- Cancellation of fuel duty rise planned for September 2013.
- Autumn statement 2013, with updated official growth forecasts published by the OBR
- Progress report on simple financial products
- Income tax personal allowance will rise to £10,000, raising to 2.7 million the number of working age low earners lifted out of tax altogether. The basic rate limit will decrease to £31,865; the higher rate threshold will see a cash rise but a real terms fall to £41,865.
- Main rate of corporation tax to fall to 21 per cent
- Personal tax statements for individuals introduced
- Lifetime allowance for pension contributions fall from £1.5m to £1.25m and the annual allowance from £50,000 to £40,000
- Higher rate of income tax threshold to fall in real terms (1% cash rise) in 2014-15 and 2015-16
- Departmental budgets with the exception of schools and health face further squeezes to the tune of £1.2bn.
- Real terms public sector pay cuts (up to 1% cash rises on average)
- Employment allowance of £2,000 towards SME/charity national insurance contributions introduced
- New Right-to-buy changes introduced
- Stamp duty changes introduced – abolition for AIM and Schedule 19
- Corporation tax main rate reduced to 20 per cent
- Devolution of growth-related spending to local areas
- Switch from current to capital spending by £3bn per year, for example on infrastructure projects
- Real terms public sector pay cuts (up to 1% cash rises on average).
- Reforms to public sector pay progression will be introduced, but will not apply to military.
- New support for childcare to come on stream
- Help to buy scheme and build to rent schemes introduced
- General election
- Single tier state pension introduced
- £72,000 cap on social care costs introduced, following Dilnot review recommendation.
- Employees and their employers contracted out of state second pension will face higher national insurance contributions to pay for single tier state pension.