The public finances and the age of austerity

1. The public finances and the age of austerity Robert Chote Society of Business Economists, 23 June 2009

2. Outline © Institute for Fiscal Studies • The big picture • How much have the public finances deteriorated and why? • How big is the planned tightening and what will it achieve? • The tightening in more detail • How tight is the spending squeeze? • How might the cake be cut? • What contribution do tax increases make? • Conclusions

3. The problem: more borrowing, mostly structural Public sector net borrowing in Budget 2009, excluding PBR and Budget policy measures Sources: HM Treasury; IFS calculations; figures may not add due to rounding. © Institute for Fiscal Studies

4. The problem: more borrowing, mostly structural Public sector net borrowing in Budget 2009, excluding PBR and Budget policy measures Sources: HM Treasury; IFS calculations; figures may not add due to rounding. © Institute for Fiscal Studies

5. The problem: more borrowing, mostly structural Public sector net borrowing in Budget 2009, excluding PBR and Budget policy measures Sources: HM Treasury; IFS calculations; figures may not add due to rounding. © Institute for Fiscal Studies

6. Why has the structural deficit risen so much? © Institute for Fiscal Studies • Long-term productive potential of economy assumed 5% lower • Increases structural deficit by roughly 3.5% of GDP (£50+ billion)

7. A bust without a boom?

8. A bust without a boom?

9. A bust without a boom?

10. Why has the structural deficit risen so much? © Institute for Fiscal Studies • Long-term productive potential of economy assumed 5% lower • Increases structural deficit by roughly 3.5% of GDP (£50+ billion) • Long-term whole economy price level lower • Reduces tax revenues in cash terms, but has less impact on spending • Falls in long-term level of house prices and share prices • Long-term fall in financial sector profitability • Tax gap assumption locks in losses from higher VAT debts

11. Debt set to explode without fiscal tightening Note: Excludes unrealised losses on financial interventions. Sources: HM Treasury; IFS calculations. © Institute for Fiscal Studies

12. The response: giveaway followed by takeaway © Institute for Fiscal Studies Sources: HM Treasury; IFS calculations.

13. Debt set to explode without fiscal tightening Note: Excludes unrealised losses on financial interventions. Sources: HM Treasury; IFS calculations. © Institute for Fiscal Studies

14. Two parliaments of pain © Institute for Fiscal Studies Sources: HM Treasury; IFS calculations.

15. Eventual cost of fiscal tightening per family

16. Implications for public spending © Institute for Fiscal Studies • Remainder of Comprehensive Spending Review 2007 • 2010–11 • Spending Review 2010 • 2011–12 to 2013–14 • Beyond Spending Review 2010: the second parliament • 2014–15 to 2017–18

17. CSR 2007: 2010–11 © Institute for Fiscal Studies • £5bn PBR “efficiency savings” now allocated • Biggest in cash terms • £2.3bn from Department of Health • £0.6bn from Department of Children, Schools and Families • Biggest as a share of total budget • 3% from Transport • 2.9% from Home Office • Real spending growth over three CSR2007 years now • Current spending: 4.6% • Investment spending: 5.4% • Total spending: 4.6%

18. Spending Review 2010: 2011–12 to 2013–14 © Institute for Fiscal Studies • PBR 2008 plans • Current spending: real growth of 1.2% a year • Investment spending: real cuts of 2.6% a year • Total spending: real growth of 1.1% a year • Budget 2009 plans • Current spending: real growth of 0.7% a year • Investment spending: real cuts of 17.3% a year • “move to 1¼ per cent of GDP in 2013–14” in Darling-speak • Total spending: real cuts of 0.1% a year • Lowest since 1996–97 to 1999–00

19. How tight are these real spending plans? © Institute for Fiscal Studies

20. Cash spending has not fallen in any year since 1947 Sources: HM Treasury; IFS calculations. © Institute for Fiscal Studies

21. Impact on departmental spending on servicesAverage annual real increases 2011–12 to 2013–14 © Institute for Fiscal Studies

22. Impact on departmental spending on servicesAverage annual real increases 2011–12 to 2013–14 © Institute for Fiscal Studies

23. Impact on departmental spending on servicesAverage annual real increases 2011–12 to 2013–14 © Institute for Fiscal Studies

24. Impact on departmental spending on servicesAverage annual real increases 2011–12 to 2013–14 Weakest three year growth since 1977–78 to 1979–80 © Institute for Fiscal Studies

25. Impact on departmental spending on servicesAverage annual real increases 2011–12 to 2013–14 © Institute for Fiscal Studies

26. Cutting the shrinking cake Budget implies real cut in DELs of 2.3% a year or 6.7% after 3 years Equivalent to £26 billion a year real cut comparing 2013–14 to 10–11 Conservatives say they want to protect health and overseas aid, by which we assume they mean no real cuts and hitting the UN target Other DELs would have to fall 3.3% a year or 9.7% after 3 years Ed Balls says Labour would hope to avoid real cuts for schools too Other DELs would have to fall 4.7% a year or 13.5% after 3 years Either could also make benefits or tax credits less generous Both parties face same arithmetic

27. Beyond SR2010: 2014–15 to 2017–18 © Institute for Fiscal Studies Treasury has pencilled in fiscal tightening of 3.2% of national income or £45 billion in today’s money over these four years Will require some combination of tax increases and cuts in spending as a share of national income eventually equivalent to £1430 per family in today’s money

28. Tax increases: attention focused on the rich © Institute for Fiscal Studies • PBR 2008 • Personal allowance to be withdrawn in two c.£6.5k bands (above £100k and £140k), giving 60% marginal rates and raising £1.2bn • Tax rate above £150k to be 45% in 2010–11, raising £1.6bn • Budget 2009 • Personal allowance to be withdrawn in one c.£13k band (above £100k) , raising £180m more than the PBR proposal • Tax rate above £150k to be 50% from 2010-11, raising £800m more than the PBR proposal • Tax relief on pension contributions to be reduced gradually from 50% at £150k to 20% above £180k, raising £3.1bn

29. Income tax schedule, 2011-12 © Institute for Fiscal Studies

30. Income tax relief on pension contributions, 2011 © Institute for Fiscal Studies

31. Tax increases to date Attention focussed on the income tax increases for the rich: total income tax and pension package to raise £7bn a year From relatively few, relatively well-off people Roughly 2% of adults (750k) have incomes above £100k Roughly 1% of adults (350k) have incomes above £150k But part of an £18bn total tax increase in the Budget and PBR that affects much more of the population (NICs and fuel duties) Partially offset by £7bn tax cut in PBR, including rise in income tax personal allowance and NI primary threshold (legacy of 10p saga)

32. Conclusions HMT thinks fiscal deterioration mostly structural, not cyclical Timing and strength of recovery has little impact on necessary tightening if HMT right about structural deficit; very hard to tell Tightening more on spending than tax over next parliament Tightest squeeze on public services since late 1970s Tax increases not confined to the rich Scale, speed and composition of tightening still up for grabs Is economy strong enough to start tightening next year? Will markets force us to move more quickly? If so, will balance shift towards tax increases, even under the Tories? Voters deserve honesty and proper debate before the election