I'm currently reading through the Budget, and (as always) there's a lot to digest. As our initial comment reactions made clear, the most worrying thing about the announcements today were the continued high borrowing figures and downward revisions to growth. Essentially, the Coalition are still relying on strong medium growth to eliminate much of the deficit and the OBR now says real terms cuts to spending will be just 2.2% over this review period (2011/12 to 2014/15). So whilst there were some welcome changes on tax (corporation tax cuts, raising the personal allowance and the National Insurance break) and some worthy supply-side measures, the Coalition still rely on the OBR's forecasts in 3 or 4 years being right to eliminate lots of the deficit. Yet the OBR have been hopelessly optimistic on medium-term growth again and again and again.
I'll use this blog to make further observations as I read through:
As part of the spending framework the Chancellor announced that the Government would be introducing a firm limit on a significant proportion of Annual Managed Expenditure, including areas of welfare exependiture, but that they would do so in a way that allowed automatic stabilisers to work. Annual managed expenditure is basically everything that doesn't come under Departmental Expenediture limits and includes: social security, tax credits, debt interest payments and transfers to the EU. Given that the Chancellor has said that the firm limits on these would allow automatic stabilisers to work, e.g. that in a downturn they would allow the bill for Jobseekers' Allowance to go up without cutting the generosity of it, it suggests that the government would then have to adjust other spending streams within the overall AME framework. This is interesting. The state pension and other pensioner benefits take up a large chunk of the social security budget, and the Chancellor has previously introduced a fairly generous triple-lock on this. And welfare occupies over half the AME budget, while much of the rest are either small spending areas or things that the government cannot control easily. This suggests that the Government may well in future be looking for ideas on reducing eligibility for certain social security entitlements, or indeed reforming the generosity of things like tax credits.
One of the biggest surprises of the Budget was probably the £2,000 employment allowance for businesses and charities - a reduction in National Insurance bills which is designed to, in particular, provide some relief to small and micro businesses who might be looking to take on their first employee. This has largely been welcomed by business, and is a measure that - on the face of it - looks like a worth tax cut. However, Patrick Stevens of CIOT is surely right to say that this needs to be simple in execution as well concept. He says: "there are mechanics to sort out such as whether a small business withholds up to £2,000 of NICs or has to pay first and reclaim later." Let's hope it's kept as simple as possible.
A consistent feature of this Parliament has been that each time a Budget has been delivered, the OBR have forecast that in three/four years time, we would return to fairly fast growth. We have learned over time that their forecasts have persistently been way too optimistic. There's also a bit of hockey stick effect in today's forecasts. They expect growth in 2013 of 0.6% but then a big jump to 1.8% in 2014 and 2.3% in 2015. But what if this doesn't materialise, and actually our underlying growth potential is currently much lower than they predict? Part of the problem here is that the model that the OBR use is what's known as a ‘dynamic stochastic general equilibrium' (DSGE) forecasting model. This assumes GDP will be equal to its trend level in five years time, meaning that there will be no output gap. Therefore getting medium-term forecasting right is problematic: it not only relies on an accurate idea of what trend growth actually is post-financial crisis, but also discounts short-term effects when looking so far forward. It's for this reason that the OBR should really produce estimates of borrowing and debt assuming a range of growth assumptions.
In the Autumn Statement, the OBR set out how the Coalition would cut real terms total managed expenditure (TME) by just 3% between 2011/12 and 2014/15 (i.e. this spending review) and by 4.4% between 2010/11 and 2017/18. Well today's estimates are even less onerous. Over this review period, spending will have only fallen by 2.2% in real terms, and 2.7% by 2017/18. The Government are keen to say they have realised more under-spends than expected, but doesn't that just show that there is more fat to be tripped in the public sector? And that taking off some of the ring-fences, we might find more significant savings still? The table below sets this out: actually there are significant cuts to infrastructure and non-protected departments, but this is largely offset by increasing AME spending. Small wonder then that today's Budget set out the case for a firm limit on this area of expenditure. And given the overall scale of cut-backs is so unambitious, small wonder more progress in deficit reduction hasn't been made.