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Economics focus: Weak tax receipts make the deficit task much harder

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George Osborne’s Autumn Statement contained surprises, including comprehensive stamp duty reform and a set of deficit projections that were not as bad as feared. But unless tax receipts recover more strongly in coming years, eliminating the budget deficit will be very hard work, with most of the strain taken by spending cuts.

George Osborne’s Autumn Statement contained good and bad news on the deficit but the underlying message is that the public finances are still a long way from being fixed, David Smith reports

The dust has settled on George Osborne’s fifth and possibly final Autumn Statement and it was rather more interesting than some suggested beforehand. The chancellor kept his deficit reduction plan on track, despite some slippage, and he was able to announce a few unexpected tax changes, most of all the welcome reform of SDLT.

Let me quickly run through what I saw as the highlights of Osborne’s announcements before coming on to the key issues left over from the Autumn Statement: will tax receipts recover following their disappointing performance so far; and can the spending cuts be delivered to eliminate the budget deficit?

On the numbers, the main magnitudes are that the Office for Budget Responsibility (OBR), against expectations (though not mine), predicts public borrowing of £91.3bn this year, down from the £97.5bn of 2013/14 but £4.9bn higher than it had expected in March. Given the way the monthly figures have been going, with borrowing running above last year’s levels, this assumes a big improvement in the remaining months of the year.

Next year, 2015/16, borrowing is projected to be £75.9bn, £7.7bn up on the March budget projection. This combined (projected) overshoot of £12.6bn is partly offset by small undershoots, of a combined £2.2bn, for the following three years. So it was a certainly a deterioration, but a rather smaller one than feared. Some assessments before the Autumn Statement had suggested a cumulative overshoot of £75bn, rather than the just over £10bn predicted by the OBR.

On growth, the OBR came in with numbers of 3% this year, 2.4% next and just over 2% a year after that. Growth, if the OBR is right, will be relatively subdued, reflecting the official view that ‘trend’ or underlying growth will be weaker than it was before the crisis. More on that in a moment.

As for the tax changes unveiled by the chancellor, their general tone was that richer individuals and big business can afford to pay more. The SDLT reform, as well as being clever, will hit only 2% of homebuyers at the top of the range; the same territory as Labour’s proposed mansion tax. Taxing transactions has to be the better route and there must be a serious doubt about whether the mansion tax will ever see the light of day.

The ‘Google tax’ may not raise much revenue – it could be difficult to raise any – but was as much about the politics as the economics. Allowing the banks to offset fewer of their crisis losses against tax will raise some revenue; around £700m a year.

What about other tax receipts? Regular Tax Journal readers will know that one of the themes of recent months has been the weakness of income tax receipts and, to a lesser extent, NICs. These are the revenues that should come back when the economy grows but have so far failed to do so.

According to the OBR, this is not a flash in the pan. Starting with a £4.5bn undershoot this year, 2014/15, income tax and NICs are expected to bring in less over the forecast period, culminating in a £15.2bn undershoot in 2018/19. Over five years, the cumulative loss of revenues from this source is £52.9bn. Though the public finances benefit from other changes, notably lower debt interest, the weakness of income tax and NICs makes it that much harder to eliminate the budget deficit; £15bn harder in five years’ time.

There are smaller downward revisions in other receipts, including VAT, but the big picture is that taxes are expected to play less of a part in bringing down the budget deficit than they were in March. By 2018/19, receipts are projected to be £25bn lower.

Where does this leave the budget deficit?

The budget deficit is the difference between two large numbers and these changes make a difference. Without the OBR’s new forecasts for receipts – as I say, partly offset by other factors – there would be less need for the ‘colossal’ cuts in spending by unprotected departments identified by the Institute for Fiscal Studies.

The Treasury was not too happy with that description by the IFS, or with references by both the OBR and the IFS to public spending falling to its lowest share of GDP since the 1930s. Osborne wants to be seen as tough but not draconian, particularly in the run up to the election. The Treasury also thinks the composition of future deficit reduction will be different to that envisaged by the OBR. One obvious source of that would be if tax receipts turn out to be stronger. It could be that the OBR, which is required to be cautious, has overreacted to the recent weakness of receipts. We shall see, though perhaps not for another year or so.

If not, how realistic are the deficit reduction plans? The challenge is not so much in continuing to reduce the ratio of public spending to GDP; that has been done quite effectively over the past five years. The challenge is to carry on doing it while so many parts of public spending, notably the NHS and schools, are ringfenced from the cuts. That is where the ‘colossal’ cuts come, to the non-ringfenced departments.

My judgment is that it will be hard to return the public finances to surplus over the next few years if there is not a stronger recovery in tax receipts. If there is, and the ringfence becomes a little less binding, then things could turn around faster than most experts currently fear. But the experience of the past few years has been to expect disappointment as far as the public finances are concerned. We are due for a change. Let us hope there is one on the way.

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