Disease and cure in the UK: The fiscal impact of the crisis and the policy response

1. Disease and cure in the UK: The fiscal impact of the crisis and the policy response Slides prepared by Carl Emmerson for SOLACE November 2010 http://www.ifs.org.uk/projects/346

2. Conclusions • Permanent hit to public finances from financial crisis estimated at £86 billion a year (in today’s terms) • Response is a £98 billion fiscal tightening by 2015–16, comprising a £24 billion tax rise and a £74 billion spending cut (in today’s terms) • OBR estimates 60% chance of hitting fiscal mandate on current policies • Overall post crisis tax and benefit reforms regressive across most of the income distribution, although very focussed on richest 2% • cuts to welfare payments for working-age individuals • Four years from next April will be the tightest sustained squeeze to public service spending since April 1976 to March 1980 • total DELs cut by 11% in real terms • overseas aid budget increased sharply • in England: NHS and schools relatively protected; largest cuts to: Communities and Local Government, DEFRA and BIS • Would be sensible to review plans in 2012

3. Disease • Outlook for the public finances dramatically weakened since Budget 2008 • Much of deterioration expected to be impervious to economic recovery • ‘structural’ rather than ‘cyclical’ increase in borrowing • Forecasting borrowing difficult • estimates of the size of the structural hole have changed over time • latest (June 2010) forecasts are slightly worse than the forecast made before the general election (March 2010)

4. Disease: size of the problem Permanent damage = 5.8% of GDP (£86bn) Note: Author’s calculations comparing HM Treasury June 2010 Budget with HM Treasury March 2010 Budget.

5. Disease: change over time Sources: HM Treasury; IFS calculations.

6. Cure • Labour (March 2010 Budget) • no fiscal tightening in 2010–11 (although economy would have to deal with the removal of the fiscal stimulus that was in place in 2009–10) • six year fiscal consolidation starting in April 2011 • composition of cure in 2014–15: 70% spending cuts, 30% tax rises • no detail of additional measures for 2015–16 and 2016–17 • New Government • fiscal tightening to start this year • aim to fill the hole in 2014–15, further tightening in 2015–16 to build some caution into the plans • overall package in 2014–15: 73% spending cuts and 27% tax rises

7. Fiscal tightening: Labour’s plans 30% 70% Sources: HM Treasury; IFS calculations.

8. Fiscal tightening: additional measures 22% 78% Sources: HM Treasury; IFS calculations.

9. Fiscal tightening: coalition plan 27% 73% Sources: HM Treasury; IFS calculations.

10. Differences in cure (2014–15) • Overall tightening: new Government to tighten by more • Composition of tightening • mix between tax and spending very similar to March 2010 Budget plan • sharper fall in borrowing leads to greater reduction in debt interest spending • similar £bn cut to investment spending (both very deep) • significant welfare cuts announced since election (not known whether Labour would have done this) • bigger £bn tax rises, and deeper £bn cut to non-investment spending, than implied by the March 2010 Budget plan

11. Composition of the tightening in 2014–15

12. Latest forecasts • Measures forecast to offset increase in underlying borrowing seen Budget 2008 • deficit to return to pre-crisis levels in 2015–16 • Measures also to return debt to a sustainable path • but constant borrowing beyond 2015–16 would see not debt return to pre-crisis levels until late 2020s • if no further tax rises / spending cuts to offset costs of ageing population then debt still sustainable, but may not return to below 40% of national income • Significant uncertainty remains • if latest forecasts are as accurate as previous ones then 60% chance of meeting the Government’s fiscal mandate on current policies • 40% chance that further tax rises or deeper spending cuts required

13. Cure: borrowing back to pre-crisis levels Sources: Author’s calculations using all Budgets and Pre-Budget Reports since March 2008 (all available at http://www.hm-treasury.gov.uk/).

14. Cure: debt sustainable but not back to pre-crisis levels for a generation Source: Author’s calculations based on the March 2008 and June 2010 Budget.

15. Meeting the fiscal mandate? 60% chance of surplus in 2015–16 Source: Office for Budget Responsibility (http://budgetresponsibility.independent.gov.uk/d/fan_charts_intervals.xls).

16. Tax & spend • Crisis depressed tax revenues and increased public spending as a share of national income • tax revenues: lower financial sector profits, lower house and equity prices • public spending: public service spending set in cash terms for three years in 2007 and economy turned out much smaller than expected • As a share of national income increase in spending greater than the fall in revenues • provides possible rationale for more of the policy response being on spending than on tax • aim to return spending to slightly below, and revenues to slightly above, pre-crisis levels

17. Cure: impact on tax and spending

18. Impact of tax rises and welfare cuts • Measures reduce net incomes across the income distribution • Impact regressive across most of the income distribution • with notable exception of the richest the losses are larger among low income groups than among higher income groups • Throughout the income distribution pensioners lose, on average, less than families with children

19. Cure: all in this together? Impact of tax & benefit reforms to be in place by 2014–15, by income

20. Cure: all in this together? Impact of tax & benefit reforms to be in place by 2014–15, by family type

21. Impact of cuts to spending on public services • Total spending on public services to be cut in real terms for six years • since WW2 cuts have only been achieved for two consecutive years • deepest sustained cuts since April 1975 to March 1980 • Central government spending on public services (DELs) • to be cut as a share of national income back to the late 1990s levels • in real terms spending in 2014–15 to be 11.2% lower than in 2010–11 or 13% below the level Labour planned for 2010–11

22. Cure: public service spending set for a squeeze Note: Figure shows total public spending less spending on welfare benefits and debt interest.

23. DELs: The grand old Duke of York? Note: Figure shows Departmental Expenditure Limits (DELs) as a share of national income under current policies.

24. DELs: deep cuts coming –11% –10% – 13%

25. Sharing the pain • Two winners? • spending on international aid and energy & climate change • Relative protection for NHS and schools? • tightest settlement for NHS spending since early 1950s • schools spending per pupil to fall in all but most deprived schools • Several losers? • Home office, Justice, Local Government and Department for Business, Innovation and Skills all face cuts of around one-quarter • latter primarily comes from deep cuts to taxpayer support for higher education teaching • One big loser? • DCLG communities budget to be cut by two-thirds, with capital budgets cut by three-quarters: public investment in new social housing the big loser

26. ‘Winners’ Note: Figures show real change in total (resource + capital) DEL

27. ‘Losers’ Note: Figures show real change in total (resource + capital) DEL

28. English schools spending • DfE to receive total real-terms cut in DEL of 10.8% • Schools spending including pupil premium to grow by 0.1% per year in real-terms (or 0.4% in total) • but total pupil numbers to increase by average of 0.7% per year • total schools spending per pupil to be cut in real-terms by 0.6% per year (total of 2¼%) • Assuming flat-rate pupil premium of £2,400 (stated total cost £2.5 billion) and underlying funding per pupil frozen in cash-terms • 60% of primary school pupils in schools where real funding falls • 87% of secondary school pupils in schools where real funding falls • 43% of pupils in (less deprived) schools would see cuts of 5% or more • 1 in 8 pupils in (very deprived) schools would see increase of 5% or more Note: Assumes all schools experience the same growth in pupil numbers.

29. Record breakers? • Real increase over next 4 years • total spending: tightest since World War II • spending on public services: tightest since April 1975 to March 1980 • NHS: tightest since April 1951 to March 1956 • (ODA: greatest since Jan 2002 to Dec 2006)

30. Conclusions • Permanent hit to public finances from financial crisis estimated at £86 billion a year (in today’s terms) • Response is a £98 billion fiscal tightening by 2015–16, comprising a £24 billion tax rise and a £74 billion spending cut (in today’s terms) • OBR estimates 60% chance of hitting fiscal mandate on current policies • Overall post crisis tax and benefit reforms regressive across most of the income distribution, although very focussed on richest 2% • cuts to welfare payments for working-age individuals • Four years from next April will be the tightest sustained squeeze to public service spending since April 1976 to March 1980 • total DELs cut by 11% in real terms • overseas aid budget increased sharply • in England: NHS and schools relatively protected; largest cuts to: Communities and Local Government, DEFRA and BIS • Would be sensible to review plans in 2012

31. Disease and cure in the UK: The fiscal impact of the crisis and the policy response Slides prepared by Carl Emmerson for SOLACE November 2010 http://www.ifs.org.uk/projects/346