The public finances Robert Chote Carl Emmerson Christine

The public finances Robert Chote Carl Emmerson Christine Frayne

The Chancellor’s fiscal rules • ‘Golden rule’ • only borrow to invest • on average over the economic cycle • Sustainable investment rule • net debt below 40% of national income • every year of current economic cycle

Public finances under Labour Source: HM Treasury

Returning to surplus? Financial Growth in Output year economy gap Current budget surplus cyclical structural total 2005– 06 – 0. 9 2006– 07 – 0. 3 2007– 08 0. 0 2008– 09 0. 5 2009– 10 0. 7 2010– 11 0. 8 Source: HM Treasury

Returning to surplus? Financial Growth in Output year economy gap cyclical structural total 1¾% – 1. 4 – 0. 8 – 0. 1 – 0. 9 2005– 06 Current budget surplus 2006– 07 – 0. 3 2007– 08 0. 0 2008– 09 0. 5 2009– 10 0. 7 2010– 11 0. 8 Source: HM Treasury

Returning to surplus? Financial Growth in Output Current budget surplus year economy gap cyclical structural total 2005– 06 1¾% – 1. 4 – 0. 8 – 0. 1 – 0. 9 2006– 07 2¼% – 1. 5 – 0. 3 2007– 08 3% – 0. 7 0. 0 2008– 09 2¾% – 0. 1 0. 5 2009– 10 2¼% 0 0. 7 2010– 11 2¼% 0 0. 8 Source: HM Treasury

Returning to surplus? Financial Growth in Output Current budget surplus year economy gap cyclical structural total 2005– 06 1¾% – 1. 4 – 0. 8 – 0. 1 – 0. 9 2006– 07 2¼% – 1. 5 – 1. 0 0. 7 – 0. 3 2007– 08 3% – 0. 7 0. 0 2008– 09 2¾% – 0. 1 – 0. 2 0. 7 0. 5 2009– 10 2¼% 0 0 0. 7 2010– 11 2¼% 0 0 0. 8 Source: HM Treasury

A seven year cycle? Budget 05: 1999– 2000 to 2005– 06 Source: HM Treasury

A twelve year cycle? Budget 05: 1999– 2000 to 2005– 06 PBR 05: 1997– 98 to 2008– 09 Source: HM Treasury

A twelve year cycle? Budget 05: 1999– 2000 to 2005– 06 PBR 05: 1997– 98 to 2008– 09 Source: HM Treasury

Current budget balance New estimated cycle Previous estimated cycle Source: HM Treasury

Meeting the golden rule? 1999– 2000 to 2005– 06 Average surplus over current cycle (%GDP) Cumulative surplus (£bn 2005 -06 GDP terms) – 0. 0% –£ 1. 9 Source: HM Treasury

Meeting the golden rule? Average surplus over current cycle (%GDP) Cumulative surplus (£bn 2005 -06 GDP terms) 1999– 2000 to 2005– 06 – 0. 0% –£ 1. 9 1997– 98 to 2005– 06 +0. 1% +£ 10. 8 Source: HM Treasury

Meeting the golden rule? Average surplus over current cycle (%GDP) Cumulative surplus (£bn 2005 -06 GDP terms) 1999– 2000 to 2005– 06 – 0. 0% –£ 1. 9 1997– 98 to 2005– 06 +0. 1% +£ 10. 8 1997– 98 to 2008– 09 +0. 1% +£ 12. 8 Source: HM Treasury

Meeting the golden rule? Average surplus over current cycle (%GDP) Cumulative surplus (£bn 2005 -06 GDP terms) Current budget balance: first year of next cycle 1999– 2000 to 2005– 06 – 0. 0% –£ 1. 9 – 0. 9% 1997– 98 to 2005– 06 +0. 1% +£ 10. 8 – 0. 9% 1997– 98 to 2008– 09 +0. 1% +£ 12. 8 +0. 5% Source: HM Treasury

Recent forecasting errors Treasury estimates of current budget surplus Source: HM Treasury

Will the golden rule be met? Probability with 3 years of cycle remaining 50/50 chance Source: HM Treasury; IFS

Will the golden rule be met? Probability with 3 years of cycle remaining 50/50 chance Source: HM Treasury; IFS

Will the golden rule be met? Probability with 3 years of cycle remaining 50/50 chance Source: HM Treasury; IFS

The Chancellor’s fiscal rules • ‘Golden rule’ • only borrow to invest • on average over the economic cycle • Sustainable investment rule • net debt below 40% of national income • every year of current economic cycle

Will the investment rule be met? Source: HM Treasury; IFS

Will the investment rule be met? Source: HM Treasury; IFS

Reforming the fiscal framework • Both fiscal rules appropriate rules of thumb • ‘Golden rule’ • more forward-looking measure preferable • Net debt rule • wider measure might aid transparency • comprehensive measure potentially meaningless

Green Budget forecasts • Green Budget forecast • slightly weaker revenues in medium-term • assumes 2007 CSR envelope as PBR 2005

Green Budget forecasts • Green Budget forecast • slightly weaker revenues in medium-term • assumes 2007 CSR envelope as PBR 2005 • 50% chance of missing golden rule • 44% chance of missing SIR in 2008– 09

Green Budget forecasts • Green Budget forecast • slightly weaker revenues in medium-term • assumes 2007 CSR envelope as PBR 2005 • 50% chance of missing golden rule • 44% chance of missing SIR in 2008– 09 • Budget judgement • case for further £ 2½ billion tightening • larger tax increase required if smaller spending cut delivered over 2007 CSR period

Little difference in 2005– 06 £ billion PBR Dec. 2005 GB Jan. 2006 Difference Current receipts 483. 0 483. 1 0. 1 Current expenditure 493. 6 0. 0 Current budget surplus – 10. 6 – 10. 5 0. 1 Net investment 26. 3 0. 0 PSNB 37. 0 36. 8 – 0. 2 Source: HM Treasury; IFS

Receipts forecasts Source: HM Treasury; IFS

Treasury forecast optimistic? Analysis by Graham Secker, Morgan Stanley Research

Current spending forecasts Source: HM Treasury; IFS

Current budget balance Source: HM Treasury; IFS

Will the golden rule be met? Probability with 3 years of cycle remaining 50/50 chance Source: HM Treasury; IFS

Will the golden rule be met? Probability with 3 years of cycle remaining 50/50 chance Source: HM Treasury; IFS

Will the SIR be met? Chance of debt exceeding SIR limit HMT PBR 2005 2006– 07 1% 2007– 08 24% 2008– 09 37% Source: HM Treasury; IFS

Will the SIR be met? Chance of debt exceeding SIR limit HMT PBR 2005 IFS Green Budget 2006– 07 1% 2% 2007– 08 24% 31% 2008– 09 37% 44% Source: HM Treasury; IFS

Risks on the downside Current budget balance Source: HM Treasury; IFS

Budget judgement • Last two Green Budgets called for tightening of £ 11–£ 13 billion • 2005 PBR announced £ 3 billion tax increase, and pencilled in £ 8½ billion spending cut • 2006 Green Budget suggests case for modest further tax increase of £ 2½ billion • assumes provisional spending plans inked in • larger tax increase required if smaller spending cut delivered over 2007 CSR period