Budget 2015: Steady as she goes, or enough is enough?

Budget 2015: Steady as she goes, or enough is enough?

The Chancellor’s pre-election budget held on March 18th was designed first and foremost to be safe. A policy decision to sell £20bn of banking assets, combined with a fortuitous fall in debt and welfare payments at the same time as the economy is growing, allowed the chancellor to bring forward by one year – to 2014-15 – the date at which the stock of government debt peaks as a proportion of the economy. This had been his stated target in 2010 but since 2012 all forecasters including the Office of Budget Responsibility (OBR) had anticipated that it would be missed.

This is good politics for Mr Osborne for two reasons: it sets a symbolically important baseline against which the future plans – and record – of any other political party or government will be judged, and it removes the possibility of attacks during the imminent general election campaign for missing his original target to get debt to fall by the end of the parliament.

The other principal decision of the Budget was dramatically to increase projected levels of spending at the end of the forecast period in 2019-20 above the projections that had been laid out at the Autumn Statement three months previously. Labour had landed a political punch on the Chancellor back in December by implying that his original plans were too extreme “taking us back to the 1930s”; this time Mr Osborne took pains to point out that his new projections will cause total government spending to be the same size relative to the economy at the end of the parliament as it was in 2000.

However this didn’t stop Labour from asserting that the level of projected cuts at the beginning of the next parliament could still threaten the NHS, or require taxes such as VAT to rise, highlighting a comment by the OBR that public service funding faces a “rollercoaster profile”, namely a sharp tightening at the beginning of the parliament followed by a dramatic loosening at the end. Given that departmental budget allocations do not currently go beyond April 2016, the coalition government is currently in no position to make a promise on the level of NHS spending.

The Chancellor responded that the total reduction in government spending was projected to be at the same pace as previous years, but the OBR has shown that once payments on welfare and debt are taken into account this does indeed imply that departmental spending cuts will be steeper; this may be something that a future Conservative manifesto will seek to address.

With public support for further austerity starting to fall, the issue for the general election will now be whether the public prefers the “steady as she goes” approach as laid out by George Osborne, or think that “enough is enough” in terms of cuts as the economic recovery starts to gather pace and living standards rise.

One thing that is certain though is that unless the next government has the exact same political make-up of the current one, there will be an emergency budget soon after the election to give the new government the opportunity to differentiate itself from its predecessor.

This – by definition – may lead to an entirely new set of policy decisions, projections and priorities. As an example, the Conservatives have already pledged a commitment to a personal allowance of £12,500 and a higher-rate threshold of £50,000 which was not reflected in this Budget. And regardless of the outcome of the general election a spending review will be needed very soon afterwards to allocate departmental budgets into the next financial year.

Regardless of all of this, however, the lasting result of this Budget will be that it is now officially on record that Mr Osborne was the Chancellor who got UK government debt to start falling again.


Growth is solid…

The latest economic data has made it clear that forecasts of 3 per cent economic growth in 2014 were too optimistic, and in particular that business investment, although strong, did not come in as high as expected. However this does not detract from the headline story of a solidly expanding economy into the foreseeable future, with a smoother glide path than was foreseen a year ago, as chart 1 below shows.

The OBR growth assumptions are a little slower than those of the Bank of England and other independent forecasters so may be subject to further upward revision later in the year. They are also critically dependent on the assumption that productivity will start to rise as is usual at this stage in the economic cycle, although this is not yet showing through in the data.

Chart 1: GDP forecasts 2014-15

  …with inflation very low… The largest change to the economic forecast instead comes from much lower-than-expected inflation, driven mainly by the effect of a fall in the international price of oil driving down petrol and energy prices rather than any potentially worrying deflationary trends within the UK economy. Further downward pressure on prices comes from the recent appreciation of sterling reducing the cost of imports, and evidence of a supermarket price war. As the chart below shows, inflation is expected to be at an unprecedented low of 0.2 per cent in 2015 before rising slowly back to the Bank of England target rate of 2 per cent, indeed more slowly than the Bank of England itself expects. Having inflation lower than target is in turn is pushing to the right the date at which interest rates are expected to start rising again: whereas in December base rates were expected to inch up from late 2015, now the market does not expect rate rises until mid-2016. This has similarly pushed down UK bond yields resulting in savings to the taxpayer. The fall in inflation also has a positive impact on the public finances because welfare payments are uprated in cash terms to a measure of inflation. Lower prices also mean a rise – finally – in real wages which will be further lifted if and when productivity finally starts to rise again in future years. Indeed, conscious of Labour’s attack on living standards, the Chancellor was at pains to show that real household disposable income per head was now rising. The Institute for Fiscal Studies however, pointed out that this is only the case if projected data from the whole of 2015 is taken into account: it hasn’t demonstrably happened yet. Chart 2: Inflation forecasts 2014-15


…and employment forecasts remaining high.

Meanwhile the number of people employed in the economy remains at an all-time high, although going forward the forecast is now steadying:  this Budget is the first since 2012 where there has been no significant upward revision to the employment projections, albeit from a high base (see chart 3 below). Although a lot of the increase is coming from falling unemployment as people move off benefits and into work (the claimant count is expected to halve from 2013 to the end of the forecast period) there is also a significant and increased contribution expected in this Budget from the net inward flow of economic migrants which is having a measurably positive impact on rates of economic growth.

The increase in employment is not, however, expected to increase government revenue from income tax and national insurance until the second half of the next parliament due to the offsetting effect of an increase in the personal allowances.

In 2016-17 however there is a large increase in revenue from national insurance contributions (NICs) to the tune of £5bn due to a previous policy decision announced in Budget 2013 to end the NICs state second pension contracting out rebate.

Chart 3: Employment forecasts 2014-15

  The stock of national debt is expected to start falling… As described above, one of the most significant changes in this Budget compared to the Autumn Statement is the bringing forward by one year the date at which the stock of government debt starts to fall as a proportion of the economy, as chart 4 below shows. Chart 4: Public sector net debt forecasts 2014-15


The main change that enables this to happen is a policy decision to sell in this financial year £20bn of financial assets managed by the government since the height of the financial crisis, notably shares in Lloyds Bank and other assets previously belonging to Northern Rock and Bradford and Bingley.

Deciding to sell these assets now crystallises their value on the government’s balance sheet but takes away anticipated income streams that they would otherwise have generated in future years “only temporarily reducing the debt-to-GDP ratio” as the OBR pointed out.

However the debt to GDP ratio continues to fall in future compared to the previous forecast due to the projected gains from lower inflation and interest rates which have reduced outgoings on welfare payments and debt servicing respectively.


…but the deficit projections remain unchanged

With the exception of the final year of the forecast – 2019-20 – there has been little change in the government deficit forecasts. The headline rate of borrowing in 2014-15 is around 5 per cent of GDP, around half that at the beginning of the parliament, and equivalent to a cyclically adjusted deficit of 2.5 per cent.  Under the government’s new fiscal framework, their target is to project this latter ratio to surplus over a rolling 3 year period, which is comfortably met under the current projections as chart 5 below shows.

However a policy decision has been made to keep spending constant as a share of the economy in 2019-20 resulting in a flattening of the line in the final year compared to the projections in December.


Chart 5: Deficit forecasts 2014-15


It is worth noting in this regard that the high-level spending assumptions set out in the budget presume that total government expenditure falls at the same rate in the first few years of the next parliament as it did on average between 2010 and 2014. This has enabled the Chancellor to say that the cuts in the next parliament would be “at the same pace” as the cuts in this parliament.

However this total figure is principally comprised of two main components: externally-given welfare and debt payments, and policy-driven departmental spending. Using its assumptions on interest rates and inflation, that predominately affect the former, the OBR has calculated that the contribution to the overall savings target to come from departmental spending will need to increase, enabling Labour to say that the cuts to departmental public services, which includes the NHS, are planned to be harsher in the next parliament than they were in the last.


Giveaways and takeaways were broadly neutral…..

The Chancellor had promised a budget with no pre-election gimmicky giveaways and indeed the overall policy decisions of the budget are relatively small and broadly neutral until the final year. However the effect is front-loaded, with more revenue anticipated in the early years, and more spending in the later years.

The main giveaways were:

  • measures to support middle-income savings and pensions, principally the introduction of a Help to Buy ISA, greater flexibility across a given year for existing ISAs and the introduction of a new tax free allowance for savings income, totalling £5.1bn over five years.
  • An increase in the personal allowance to £10,800 in 2016-17 and £11,000 in 2017-18 with full gains to higher rate taxpayers, totalling £5.7bn over five years
  • A cancelling of the planned fuel duty rise in September 2015 and reductions in duties on beer, wine and spirits and a freezing on wine duty, totalling £2bn over five years.
  • An increase in tax allowances for oil and gas, designed to keep investment going in the North Sea while oil prices remained low, totalling £1.3bn

These were funded by an increase in the bank levy (£5.7bn over five years), a handful of smaller measures on company and housing-related tax avoidance (£2.6 billion over five years) and the reduction of the lifetime allowance for pension contributions from £1.25m to £1m (£1.9bn over five years).

The much trailed announcement that existing annuity pension holders would be able to sell their annuities to financial intermediaries is expected to raise money in the first few years, as any lump sums received by pensioners are taxed at marginal income tax rates, and then cost the exchequer in future years due to the loss of previously expected income from income tax paid on the original annuity streams.

…and the press responded broadly positively

With the exception of the Mirror, who depicted the Chancellor with his mouth zipped shut for failing to mention the alleged huge cuts to come to the NHS, Army and Police, the press reaction to the Budget was broadly positive. Most papers celebrated the support for savers, and the increase to the personal allowance, with the Financial Times focussing on the loosening of fiscal policy in the final year “in bid to spike Labour’s election guns” and the London-based Metro leading on the ISA help for first time buyers.


And finally…..things to watch

The budget is dependent on a number of assumptions which may not be borne out in practice.

The oil price: if it re-bounds faster than expected, that will put pressure on inflation and so interest rates and the public finances. This is one of the major assumptions behind the current forecast.

Productivity: The long-awaited rise in productivity drives much of the economic forecast: if it remains slow to materialise we may be in for a rougher ride than previously thought. However this is not something that will be known either way this side of the summer.

The Eurozone: If economic recovery in the Eurozone picks up faster than expected, then this will eliminate a dampener on UK growth forecasts, causing estimates of future growth to rise.

The Bank of England: their forecasts are of inflation rising back to 2 per cent a little faster than the OBR, and of slightly higher growth rates. If these persist, the OBR assumptions may look dated.

The markets: A prolonged period of uncertainty following an inconclusive general election result could cause a temporary rise in market interest rates and a fall in the value of sterling. Conversely, a swift and decisive result would cause relief.

The current account deficit: The UK has been running a medium current account deficit, driven by negative net exports, for a number of years. However it has recently widened to nearer 6 per cent of GDP, the highest level since 1955.

But the main change to watch out for are the new policy decisions that will come in the party manifestos after parliament has risen for the general election at the end of March. The significance of this Budget is that it will be the baseline against which these manifestos are judged, rather than a predictor of what will actually happen.

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