Additional Policy Exchange analysis of Summer Budget 2015

July 13, 2015

Introducing the Living Wage Premium

The Office for Budget Responsibility (OBR) estimates that the new “Living Wage Premium” will see the effective Minimum Wage rise from £6.50 today to £9.35 by 2020, benefitting around 6 million people – but at the cost of 60,000 jobs, a small fall in average hours worked and slightly higher inflation.

This is not quite as big a change as it first looks, with the OBR estimating that the Minimum Wage would likely have reached £8.25 in any case by 2020 – and that is assuming that the Low Pay Commission did not restart the “escalator” which saw the Minimum Wage increase faster than average earnings in the years running up to the financial crisis. However, it still represents a significant change in the Government’s strategy for the labour market, with the emphasis moving away from securing “full employment” to higher pay. The Government hopes that restricting the new rate to over 25s will limit the impact on employment – although, like any intervention in the labour market, this will always be something of a risk.

This is not a Living Wage in the traditional sense. Instead, it is set at 60% of median earnings – similar to the international definition of low pay or relative poverty. The changes will take the UK from having an average minimum wage to having one of the highest minimum wages in the OECD. Given historical and international evidence, this higher rate seems likely to be the limit it can go without risking significant unemployment. If technology and globalisation keep putting further pressure on low skilled jobs, the Government will have to look at tools other than minimum wages to increase low incomes: increased productivity; higher National Insurance thresholds for employers and employees; and even, in the long run, a more generous Universal Credit.

Public finances – austerity delayed

By pushing back the promised surplus another year, and smoothing out the path to get there, the Chancellor was able to deliver much smaller departmental cuts, slower reductions in welfare and a surprise commitment to the 2% NATO defence target. Together with a windfall of £3.1 bn a year in higher predicted tax revenues and £6.9 bn in deliberate rises, this makes the autumn’s Spending Review much easier. Instead of finding £42 billion in real cuts to public spending by 2018-19, the Government instead only needs £18 billion by 2019-20.

This should not only help make it much easier to find long term efficiencies in public spending, but also to find the £9.4 billion the Chancellor needs by the end of the decade to pay for tax cuts. The Treasury estimates that further public sector pay restraint will save £5 billion by 2019-20, while the Cabinet Office believes it can find £15-£20 billion in new efficiency savings by 2019-20.

The Budget also gave details of the promised new fiscal rule to run surpluses in normal times – confirming that despite this easing, the Chancellor still maintains his preference for fiscal discipline. “Normal” times are to be defined as any time real growth is above 1% – which the OBR estimates has been the case for about a sixth of the time during the past six decades. No guidance has been given as to how big the surplus needs to be – a couple of pounds would do it – and no cap on how long the Government gets to return the budget to surplus if a recession should strike.

Education – universities continue to defy political gravity

The Higher Education sector did well out of the 2010 Spending Review settlement, which saw a big switch to fee loans, taking much of the Higher Education budget out of deficit and protecting universities from the wider public sector cuts taking place at the time. This Budget was again financially generous to universities, with institutions who pass a new Teaching Excellence Framework (TEF) benchmark from 2017-2018 allowed to increase their fees by inflation.

Index-linking fees is something that universities have been noisily calling for. Yet their case looked less than strong. Inflation is at very low levels and not predicted to rise significantly – and a sector asked to find perhaps 2% efficiencies a year, to cope with inflation, does not present the biggest challenge in public services at the present time. With university income is at record levels, and discretionary reserves (after accounting for pension liabilities) sitting at just under 50% of the entire annual income of the sector (albeit not evenly distributed), it would have been difficult for any impartial observer to conclude that the case for an inflationary fee increase had become unanswerable at this stage.

The government has made a series of further changes to offset the overall growing costs of Higher Education to the public purse – largely by proposing to freeze the repayment threshold for student loans at £21,000 and also through the much predicted switch of maintenance support from grants to loans. Yet the impact of such moves on student numbers and their ability to access and complete courses will fall upon the students and graduates themselves, rather than institutions – the full effects of which we will not understand for some time. As things stand, therefore, universities can look forward with confidence to further increases in student numbers from this September as the number controls lift, and further increases in fee income from September 2017, assuming they can pass the TEF threshold – which has yet to be fully developed.

Welfare reform – a fundamental shift

The Budget outlines clear justifications for why certain parts of the welfare bill have been targeted for savings. The rationale for the freeze of working age benefits was that their value has broadly risen faster than average earnings since 2008, whereas the protection of pensioner income is based upon the fact that they are a group “least able” to increase their earnings to counter welfare reform. More generally, the Chancellor has again indicated that he is sceptical of State in-work payments by saying, “…the welfare system should always support the elderly, the vulnerable and disabled people.”

The Chancellor has asked other parts of the public sector to take responsibility for welfare reductions. The BBC will take on the liability of free TV licences for the over-75s and Local Authorities will have to find savings to pay for social housing rent reductions. The private sector may have to shoulder further costs in the future too – the Government is looking into how employers and insurers could “play a greater role” in provision of support for those with industrial injuries.

April 2017 will mark a fundamental shift in welfare policy. The two child limit on Child Tax Credit, the removal of automatic entitlement for Housing Benefit for jobless 18-21 year olds, and the reduction in some Employment and Support Allowance (ESA) payments, all begin then. The Budget states that young jobseekers and the affected ESA claimants will receive support to help them get into work, but what this support will look like is not yet clear.

Housing – Housing Associations face tougher stance

Landlords – both social and private – bear the brunt of the Budget’s focus on housing. The most significant housing measure by far – both politically and in terms of fiscal impact – was the 1% reduction in social rents a year for the next 4 years. This is part of a wider, tougher, stance by Government towards Housing Associations, which is clearly exercised about large and growing surplus positions. Especially so when over 60% of Housing Associations’ rental income comes from housing benefit. The sector as a whole reported a surplus of £2.4bn in 2014 – built on the back of significant rental growth since 2010.

Opponents to the changes argue that the policy will reduce the number of affordable homes being built. The OBR estimates 14,000 fewer homes will be constructed; it is no coincidence then that the Chancellor talks of efficiencies as mitigation – i.e. fat trimming. Alongside the reductions in the household benefit cap from £26,000 to £23,000 in London and £20,000 outside, the associated increased risk of rental arrears is something of a double whammy for Housing Associations.

The reduction in mortgage interest relief for buy to let landlords, from typically 40 pence in the pound to 20 pence in the pound, opens up another frontier in the Government’s push for greater home ownership (Right to Buy extension, Help to Buy, starter homes are others), by removing a favourable tax treatment for buy to let landlords. However, in truth, the tax system massively favours home ownership – for one thing home owners do not have to pay capital gains tax on their principal residence, whereas buy to let landlords do on the rental properties they sell. Rental income is also taxed (and even more now).

The Government followed up its Budget statement with an announcement today that all “suitable” brownfield sites would be granted automatic planning permission. For some this represents a shift away from localism towards a “nationalised” planning system. It certainly represents a liberalisation of planning which should mean more homes being built. But will a “brownfield first” policy become a “brownfield only” one – pretty much what exists in London where affordability is worst? There is not enough brownfield land to enable us to build the 200,000+ homes we need to build each year on a sustainable basis.

Energy and environment – questions remain about renewables policy

The Budget proposed a number of taxation changes in the energy space. The exemption for renewables under the Climate Change Levy will be removed from 1st August 2015. This will lead to additional taxation receipts of £0.5 billion in 2015-16, rising to £0.9 billion by 2020. The rationale given for the change is that the exemption was distorting energy markets and benefitting renewables projects overseas by over £100 million per annum. This change will have a significant impact on the profitability of renewable energy projects, reducing revenues by approximately £5/MWh. Share prices for some renewables companies dropped significantly on this announcement.

The Budget also proposed a review of business energy efficiency taxes, as well as an expansion of North Sea oil and gas investment allowances. In addition, the Budget proposed significant changes to Vehicle Excise Duty: from 2017, newly registered cars will pay £140 per annum (except zero emission electric cars which will pay nil). From 2020-21, all proceeds from VED will be used to create a Roads Fund to invest in the English Strategic Road Network.

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