matthew whittaker slides for pre-spring 2017 budget event

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Economy DriveProspects and priorities ahead of the Spring

BudgetPre-Budget Event

Matt Whittaker

February 2017

@MattWhittakerRF @resfoundation

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THE PUBLIC FINANCE OUTLOOK

Some rare good news ahead

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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

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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

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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


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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


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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


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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


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• 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

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GOING ON AN ECONOMY DRIVE

Rebalancing UK growth

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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

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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


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In 2016, consumption

accounted for more than 100%

of overall growth in GDP per capita

And has been too reliant on private consumption growth


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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


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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


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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

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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

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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

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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


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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


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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


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• 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

matthew whittaker slides for pre-spring 2017 budget event

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