Autumn Statement 2014 – The Five Big Questions

December 1, 2014

This Wednesday, the Chancellor George Osborne will stand up to deliver the fifth and last Autumn Statement of this Parliament.
Besides the Coalition’s first Budget in June 2010, it has been the Autumn Statements under this Government in 2011 and 2012 in which the largest net fiscal changes have actually had to be made as the Chancellor seeks to react to the OBR’s changing forecasts.
Between them, the Government and the OBR should hopefully shed light on their views on some of the biggest economic questions of the day:

1) How much does the OBR think the worldwide slowdown will affect the UK?

UK growth for 2014 looks set to come in a little above the 2.7% predicted by the OBR back in March, with the average of independent forecasts now at 3% and the IMF expecting 3.1% for the year.

Elsewhere, however, the IMF has revised down growth forecasts for the Eurozone and Emerging Economies, while Japan is now back in recession with its economy shrinking 1.6% on an annual basis in the third quarter. As the downturn in 2012 showed, the UK is far from immune from the troubles of its main trading partners.

2) How much lower can unemployment go?

The UK labour market continues to surprise everyone on the upside. Since the March forecast, UK unemployment rate has fallen to 6%, a level the OBR did not expect to see until the end of 2016 – and two thirds of the total fall they expected to see in unemployment full stop before it levelled off.

Even more striking are the number of hours worked. Earlier this year, the OBR expected this to level off, but it has instead continued to  rise. How long this can continue is a big question – the UK is now back to the trend seen during the Great Moderation period (1992-2007).

3) When will productivity and pay start to pick up?

The flip side of the UK’s amazing employment performance has been a relative stagnation in wages. With inflation falling and wages growing, the two might potentially cross over again soon, but like most other current questions in the UK economy, sustained growth will depend on what happens to UK productivity.

Slow growth in wages has not been all bad news. The creation of new low paid jobs has kept many out of unemployment, while the recent ASHE data showed that if you have been in full-time continuous work for more than a year real wages have actually grown every year beside 2011.

4) How big is the hole in the public finances?

The other cost of slow wage growth has been lower tax revenues. While the Government has largely kept to its spending targets, the combination of wages, less activity than expected in the property market and falling oil and gas prices have seen tax revenue significantly underperform expectations.

Independent forecasts have always been more pessimistic than the OBR about the speed of deficit reduction. According to the latest Treasury survey of independent forecasts, they continue to expect the deficit to fall – but predict the Government to still be running a £25bn deficit in 2018.

What if lower tax revenues represent permanently lower productivity, rather than just a short term side effect of a flexible labour market?

Replicating the OBR’s formal methodology last month, the Financial Times suggested that the OBR would increase the size of the needed savings by a further £18bn.

In the past, however, the OBR has used its judgement to override the direct outputs of its models. Its March forecasts were already relatively pessimistic about the size of the spare capacity left in the economy. You could easily see the organisation again using its discretion to prevent the Government having to scramble to find another £18bn of perhaps unneeded cuts over a metric that is inevitably highly speculative.

The other big factor affecting how many savings the Government needs to make is where exactly you are trying to get to. The three main parties look to be making very different choices about how fast debt needs to be paid down:

  • The Coalition Government is formally targeting a surplus on the cyclically-adjusted current budget within a five year period, but both Coalition parties look to want to go faster and achieve this by 2017-18. The OBR’s latest estimates was that the current budget deficit – that is, excluding borrowing for investment – would be £41bn in 2015-16,  and that only one third of this would go away on its own as the economy improved.
  • Further to this, the Conservatives have argued that we should go further and run an absolute surplus by the end of the next Parliament. The last OBR forecast had the overall deficit at £75bn in 2015-16, and only around a fifth going away on its own.
  • Finally, Labour has pledged to balance the current budget at some point in the next Parliament. Assuming that the output gap is fully closed at some point, the main practical difference between this and the Liberal Democrat proposition is that Labour has more freedom to take longer to meet their target if necessary.

5) What are the parties going to do to close the gap?

On most metrics, we are currently around half the way through fiscal consolidation. There is going to be no going back to the sustained real term increases in spending seen in the early years of the last decade.

The three parties actually agree on a fair amount:

  • They all look set to ring-fence and even increase significant areas of public spending: health, aid, infrastructure, and the triple lock for pensions.
  • Their most significant savings are likely to come from further efficiency savings. Over this Parliament, the Government has targeted an additional £5bn in annual efficiency savings every year, without impacting frontline services. The next Government looks likely to continue this approach for at least another two years, with Danny Alexander announcing at the Liberal Democrat conference a target of a further £10bn in savings.

Where do the parties differ?

As a quick exercise, we added together the party’s main commitments for tax and spending. Wherever possible we used the party’s own costing, although in some cases we have had to use our own rough estimates. While it is impossible given the data the parties have released to give a perfect total of the savings each has committed to, we can get a feel for the right orders of magnitude.

Click for larger version of infographic

  • The Conservatives have given the clearest indication of their overall strategy, and what look to be real overall savings through continued real cuts to DEL and £12bn in welfare saving. They have been much vaguer about what the shape of these cuts look like – although George Osborne has indicated that there will be further pay restraint and freezes to working-age benefits. We also do not know how exactly the party’s proposed tax cuts will be paid for, and whether this will take the form of further spending cuts or other taxes going up.
  • Labour has given by far the longest and most detailed list of policy commitments. Furthermore, they have promised to continue to detail new savings ideas through their ongoing zero-based spending review. As it stands, however, the majority of their proposed savings such as the Mansion Tax or reductions in pension tax relief have gone on equal and opposite new commitments such as higher spending on the NHS, a freeze in business rates, the Compulsory Jobs Guarantee and the new 10p rate of income tax. Their main net savings announced so far are a two year 1% cap on Child Benefit – expected to save £400mn over the course of the Parliament – and the return of the 50p tax rate. While Labour has not formally said how much they have expected this to raise, they do continually refer to the drop from 50p to 45p as a ‘£3 bn tax cut.’ The amount this will actually raise however remains highly speculative – the Government, OBR and IFS all still believe that the cost to the exchequer of going from 50p to 45p was more like £100mn, not £3bn.
  • Like the other two parties, many of the proposed savings from the Liberal Democrats such as means testing Winter Fuel Payment or scrapping the Married Couples Allowance, have already been spent on other giveaways. The main revenue raising measure committed to by the Liberal Democrats is their own Mansion Tax, a new top band of council tax. However, the money raised by this is still likely to be less than the shortfall on the Liberal Democrat’s own commitment to raise the Personal Allowance to £12,500 by 2020 – a target for which they have only found £1.5bn of the needed £5bn or so.

In short, all three parties still have big questions to answer over their plans for the next Parliament.

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